session 3a 2 golub

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ContentHigh Frequency Trading

Mini Flash CrashesReferences

High Frequency Trading

Anton Golub

Manchester Business School

May 5, 2011

Anton Golub High Frequency Trading
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High Frequency TradingCharacteristicsMarket MicrostructureHigh Frequency Trading Strategies

Mini Flash CrashesIntroductionDefinitionExamplesStatistics

References

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CharacteristicsMarket MicrostructureHigh Frequency Trading Strategies

Definition & Characteristics

High Frequency Trading (HFT):

extremely fast, fully automated and computerized trading

short trading time horizon

benefits from market liquidity imbalances and short-term pricinginefficiencies

require real-time data analysis and trading decisions

do not carry overnight positions

As HFT is sensitive to latency, high frequency trading firms:

co-locate their computers next to exchanges

buy raw data from exchanges and reconstruct the order book bythem self

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Volume & Who is trading & Annual Profits

HFT represents 70% of U.S equity volume (77% in UK) - done by only2% of traders;

Biggest traders: Goldman Sachs, Credit Suisse, GETCO, Renaissance

Technologies, Citadel. Yearly profits in U.S. are estimated to $21 billion.Anton Golub High Frequency Trading

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Strategies

HFT can be broadly categorized into:

liquidity detection strategies: Rebate Trading, Automated MarketMaking

pricing inefficiencies strategies: Scalping, Latency Arbitrage,Statistical Arbitrage

predatory strategies: Flash Trading, Quote Stuffing


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What is the essence of HFT strategies?

Customer: How much are those?Merchant: A buck fifty.Customer: Ill take some.

Merchant: Theyre a buck fifty-one.Customer: Um, you said a buck fifty.Merchant: That was before I knew you wanted some.Customer: You cant do that!Merchant: Its my shop.Customer: But I need to buy a hundred!

Merchant: A hundred? Then its buck fifty-two.Customer: Youre ripping me off.Merchant: Supply and demand, pal. You want em or not?


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Rebate Trading

HFT Strategies:Rebate Trading


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Rebate Trading

Exchanges pay HF traders that post best limit sell or best limit buyorders - Liquidity Rebate: $0,003/share.

HF traders plan: place a limit buy order

if his order is matched, he turns around and place a limit sell orderat the same price

profit from trading will be $0,00, but he will collect rebates!


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Rebate Trading

Price Sharesbest offer 10,02 600

best bid 10,01 100 HFT buy order

bid 10,00 100

Price Sharesoffer 10,02 600

best offer 10,01 100 HFT sell order

best bid 10,00 100

Total profit = Profit from trading + Rebates =$0, 00 100 + $0, 003 200 = $0, 60.


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High Frequency TradingMini Flash Crashes

References


Flash Trading

HFT Strategies:Flash Trading


ContentCharacteristics
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References


Flash Trading

exchange A exchange BPrice Shares Price Shares

offer 10,02 600 10,02 400best offer 10,01 500

best bid 10,00 100 10,00 200

mutual fund sends an order to buy 500 shares to exchange A

exchange A does not have the best offer, so the order must berouted to exchange B

instead exchange A flashes the order to privileged group of HFtraders for 30 milliseconds

if the order is matched it will be traded at $10,00 (superior to all sellorders)


ContentCharacteristics
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References


Flash Trading

What is the problem with Flash Trading?

creating a tiered market - some traders see the incoming order, otherdo not

gaming the exchange fee structure - orders must be routed to thevenue with the best possible price

allows front running - HF traders have the upper hand in knowing

mutual funds intentions


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References

DefinitionExamplesStatistics

Flash Crash

FLASH CRASH


ContentHigh Fre enc Trading

IntroductionDefinition


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May 6th Flash Crash

May 6th Flash Crash: second largest point swing of 1,010.14 points

biggest one-day point decline of 998.5 points, on an intraday basis inDJIA history

markets crashed in less than 5 minutes, just to soon recover

Figure: Flash Crash

Flash Crash + scaling laws/fractal nature of price mini Flash crash





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References


Definition of Mini Flash Crash

Nanex Llc. defined a up/down mini Flash Crash as:

at least 10 up/down price moves before ticking down/up

price change has to be greater than 0.8%,

all within 1.5 seconds.Down Crashes Up Crashes

2006 254 2082007 2,557 2,4562008 4,065 4,354

2009 1,462 1,2532010 1,041 777Total 9,379 9,048



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References


Figure: Daily occurrences between January 1, 2006 and November 3, 2010





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References


Example of Up Crash

Figure: Goldman Sachs (GS) Up Crash



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g q y gMini Flash Crashes

ReferencesExamplesStatistics

Example of Down Crash

Figure: Goldman Sachs (GS) Down Crash



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g gMini Flash Crashes

ReferencesExamplesStatistics

Important Research Questions

How is getting hurt by mini Flash Crashes?

How can we prevent mini Flash Crashes? Should we penalize the

parties involved? What is the most likely time for a mini Flash Crash to occur?

Which companies are most likely to get hit?

Can HFT be singled out as the main source?

Does the behavior of price change before/after the mini Flash Crash?

Can mini Flash Crashes be predicted?



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ExamplesStatistics

Distribution of Crashes during the day

Figure: Distribution of crashes during the day



Mi i Fl h C h

IntroductionDefinitionE l
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ExamplesStatistics

Average Price before the Crash

Figure: Average Price before the crash



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IntroductionDefinitionE l


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ExamplesStatistics

Average Price vs. Intensity of the Crash

Figure: Average Price of the down-crash vs. Intensity of the down-crash



Mini Flash Crashes

IntroductionDefinitionExamples
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ExamplesStatistics

Average Price vs. Intensity of the Crash

Figure: Average Price of the down-crash vs. Intensity of the down-crash



Mini Flash Crashes

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ExamplesStatistics

Impact on Liquidity - bid/ask spread

No Impact on Bid-Ask Spread!

Figure: Average spread before vs. after the crash



Mini Flash Crashes

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ExamplesStatistics

How Can a mini Flash Crash Occur?

Crashes might be a result of top of the book protection that isintended to prevent trade-throughs.

INET ARCAbid/ask price size price size

ask 32.02 500 32.02 500ask 32.01 500

best ask 32.00 500

best bid 31.99 100 31.99 100

Table: Order book of security XYZ

Market order to buy 1000 shares is sent to ARCA; 500 shares will berouted to INET (32.00), but the remaining 500 shares will be filled on

ARCA (32.02).



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References

References

High Frequency Trading and its Impact on Market Quality, Jonathan A.Brogaard, November 2010Low-Latency Trading, Joel Hasbrouck, Gideon Saar, November 2010Does Algorithmic Trading Improve Liquidity, Terrence Hendershott,

Charles M. Jones, Albert J. Menkveld, Journal of Finance, ForthcomingThe Effect of High-Frequency Trading on Stock Volatility and PriceDiscovery, X. Frank Zhang, August 2010Market Efficiency and Microstructure Evolution in U.S. Equity Markets:A High-Frequency Perspective, Jeff Castura, Robert Litzenberger,

Richard Gorelick, Yogesh Dwivedi, August 2010Empirical Limitations on High Frequency Trading Profitability, MichaelKerns, Alex Kulesza, Yuriy Nevmyvaka, June 2010Nanex LLc, nanex.net



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References

The End

Thank you for your attention!

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session 3a 2 golub

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