September 22, 2015
The website deleted the link to the Fabrizzi et all paper on high frequency data and trading, so I am submitted this additional comment providing excerpts and a citation to the authors. This is in support of my prior comment that the combination of decimalization, new data feeds, new trading forms including algorithmic trading, and new forms of data access for trading, quotations, information on bids and liquidity, and execution, all through electronic communication and location and latency advantages for the 400 or so high frequency trading entities must be examined, subject to data submission, and regulated if necessary to promote fair markets, equal access, and public confidence in markets.
In this paper, we discuss the state of the art of high-frequency trading (HFT) and important issues related to the econometric analysis of high-frequency data (HFD) and the impact of HFT on financial markets. ... As we explain in this paper, this results in the emergence of new risks related to the speed of HFT. The notion of interaction between algorithms becomes critical, requiring the careful design of electronic markets.
Note on text Only about 2% of 20,000 firms are the key HFTs.
"400 firms (see Clark 2010). Many of these firms are privately held proprietary trading firms or hedge funds. The biggest players in HFT are reported to include the electronic market-makers Getco, Tradebot, Citadel, and QuantLab; hedge funds such as D.E. Shaw, SAC Global Advisors, and Renaissance Technologies; and the proprietary trading desks of Goldman Sachs, Morgan Stanley, and Deutsche Bank. The technology goal of HFTers is to reduce latency (i.e., delay) in placing, filling, confirming, or cancelling orders; the business goal is typically to profit from small arbitrage opportunities present at short time horizons."
A typical objective of HFTers is to identify and capture (small) price discrepancies present in the market. They do so with no human intervention, using computers to automatically capture and read market data in real-time, transmit thousands of order messages per second to an exchange, and execute, cancel, or replace orders based on new information on prices or demand.
The NYSE is completing construction of a nearly 400,000-square-foot data center facility in Mahwah, New Jersey, where it hopes to attract in co-location large Wall Street banks, traditional brokerages, and hedge funds. The center's 40- gigabyte-per-second standard hardware will allow it to handle up to a million messages a second; new trading technology will reduce latency to 10 microseconds. Meanwhile, work is proceeding at the NYSE Euronext to design an ultra-low latency core network that will support 50-microsecond roundtrips
Frederi Viens, Professor of Statistics and Mathematics and Director of the Computational Finance Program at Purdue University, offers an initial response: It is my guess is that HFT impacts price processes in a big way. As far as I am aware, financial mathematics people have not yet found a way to explain how to price equities under microstructure noise without arbitrage, and therefore I would venture to say that high-frequency-traded stocks can still be priced using standard frequency methods, but there will be some uncertainty in the pricing due to the microstructure noise. I am not aware of any way to perform equity and option pricing in an arbitrage- free way on UHFD without having to resort to saying that microstructure noise exists. However, if one such way would exist, it would automatically imply that there should be two distinct pricing theories depending on the frequency of trading. That would be a most uncomfortable situation.
One area of consensus on the need to regulate was on sponsored access. Sponsored (or naked) access gives trading firms using brokers' licenses unfettered access to stock markets. The Boston-based research firm Aite estimates that by 2009 38% of all U.S. stock trading was done by firms using sponsored access to the markets. The fear is that naked access typically without (adequate) validation of margins via direct market access may create strong short-term price movements up or down and liquidity crashes. Professor Hautsch comments, "The problem is not just HFT or direct market access (DMA) but a combination of this together with high leverage, stop orders, naked access, etc. But this does not product bubbles. In normal times, naked access is not a problem but in non normal times, if all the effects come together, it can produce a cascading effect. What is missing is a warning system.
Frank J. Fabozzi, Sergio M. Focardi, and Caroline Jonas* HIGH-FREQUENCY TRADING: METHODOLOGIES AND MARKET IMPACT