High Frequency Trading and the Stock Exchanges; an example

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Say the public market in a stock has the national best bid and offer (NBBO) priced at $50.00/$50.02. A large size buyer comes into the market and decides that they are prepared to buy up all stock available at any price up to and including $50.05. To do this, they conduct an “inter-market sweep”, where they submit ISO limit buy orders priced at $50.05 to many (if not all) trading venues “simultaneously”. I say “simultaneously” because clearly there are delays in the handling and processing of orders due to both design issues in the execution algos/order management system and the network infrastructure utilized to transmit messages to the various venues.

If you’re an Ultra Low Latency High Frequency Trading (ULLHFT) outfit geared for this, when you see on one exchange an order trading through the NBBO up to $50.05, you can assume (probabilistically) that there is a liquidity sweep being conducted and race the orders to other exchanges. Your objective is to take liquidity at some other exchange at $50.03 and $50.04 and turn around immediately and offer the acquired shares at $50.05. If you’re successful, you’ve managed to buy shares at $50.03 & $50.04 (and possibly even $50.02) and then sold them a cent or more higher with relatively little risk. The only reason that you’d be able to trade this kind of strategy is because of the higher latencies of other market participants.

The risk is if your assumption was wrong and the buyer doesn’t require that much size to fill their initial order. Now you have inventory that you cannot unload.

Long-story short, we prefer to avoid these games. That is why we trade futures markets that have one exchange instead of the fragmented stock market which has at least 13 exchanges.

Remember, not all HFT is the same; for example, we have HFT strategies but simply utilize speed to gain priority in the que (order fills). The alpha is more directional rather than game theory based on other market participants entering orders.

Thanks for the read,

David

TradeMyAlgos.com

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  • […] Trading Start/Career When I was younger, roughly 23, I luckily found the dream job of a life-time. I grabbed the opportunity by the horns, packed up all my things, and moved to south Florida in pursuit of a better career and life. This was all made possible by  my boss and mentor (a life-savior and changer), a storied trader that has milked the markets for more than you could ever imagine. Working under my boss has provided me with one-on-one support from a trading genius.  Prior to setting up his own shop, he worked at some of the most prestigious firms out there, for example, Salomon Brothers and Citadel.  Under his direction, I have learned how to program, trade, think like the big guys, and compete with the algorithmic and HFT programs he helped design back in his Wall Street and Whacker Drive days. So my professional trading career has taught me the ways of the secret “market-maker” and highly tight-lipped HFT industry! So I won’t say a word – I’m sworn in. Here is a quick post explaining an example of high frequency trading (HFT) in the stock exchanges: HFT_Example_Blog_Post […]

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