While the national media has focused much attention on the field of high-frequency trading (HFT), there continues to be a great amount of confusion surrounding the practice. Indeed The Tech recently ran a New York Times article erroneously headlined “SEC Seeks To Ban High-Frequency Trading,” which was quickly corrected to “SEC Seeks To Ban Flash Orders.” As a recent MIT graduate working for Jump Trading, a major player in the HFT world, I wish to share my first-hand exposure to the industry and clear the air surrounding some of the claims the media has brought up. In this article I discuss what high frequency trading is, the role of flash orders, and the false perception that HFT firms have an unfair advantage over the rest of the market.
What is HFT?
High-frequency trading can occur in different forms, but at its core, HFT is characterized by professional trading firms who have invested heavily in technology and algorithm creation. Since the advent of HFT, spreads have become smaller, and markets more liquid, providing a benefit to all market participants. Jump Trading and other HFT firms are exposed to the same risks of market fluctuation as any other player.
HFT strategies can derive profit in a number of ways. Some firms employ “market-making” strategies in which they post a price that they are willing to buy a given product, and a higher price that they are willing to sell the product. If people trade against both their buy and sell orders, they will profit from what is called the “bid-ask spread.” A second type of HFT strategy involves searching for market inefficiencies, and trading in ways that correct them, earning profit for the firm while simultaneously improving efficient price-discovery for all market participants. Regardless of the strategy, there is always the risk that the market will not go in the direction the algorithms predict.
Flash orders have been made out by the media to be a huge source of profit for the HFT industry, when in reality they are a small and often non-existent component of the business conducted by HFT firms. Most simply, flash orders are offered by exchanges to prevent routing order flow to rival exchanges. Orders of this type would be “flashed” to members of the particular exchange for less than a second before being sent out to other exchanges. I know from personal experience that Jump Trading has never used flash orders in any capacity, nor does the recent SEC ban affect our firm. In fact, we support the ban.
Do HFT firms have an unfair advantage?
The media often likes to make it sound like top of the line computers and co-locations are private playgrounds exclusively for the high frequency community. These two things are available to anyone. Can you name one other business where participants are not allowed to use the best technology available? Using the best technology available is simply smart business, and everyone trying to do their business intelligently is doing the exact same thing. Having good computers and low latency is only one small part in the high frequency puzzle. Trading is a very difficult business, and having a good computer doesn’t mean that you’re automatically going to be successful.
HFT is just the next evolution of professional trading, using technology to do what traders have been doing for hundreds of years. If anything, adding liquidity to the markets and tightening price spreads makes the markets more efficient, which benefits everyone including the average investor.
David Iba is a member of the Class of 2009 and an employee of Jump Trading.