All accredited economists agree that modern markets are free, fair and efficient. Open to all, and accessible with a few taps on your smart phone, anyone can trade the markets in a matter of seconds – and you are encouraged to do so by many adverts on a daily basis. Few people realize however, that none of this would be possible without a little something called High Frequency Trading. High Frequency Trading, shortened to HFT, is a form of automated trading that executes thousands of trades a second using state of the art technology, and it has some of our best and brightest engineers working on it, instead of building airplanes and cars like they used to.
HFT makes up the majority of the volume on modern stock exchanges, providing liquidity to millions of traders and investors, big and small. Many HFT companies actually have special high-speed physical connections to the exchanges, giving them a well-deserved edge over the rest of the market, and allowing them to front-run peoples’ orders to provide liquidity before it’s even needed. This makes the markets incredibly efficient and aids in price discovery, helping economists and business owners understand what things are worth and plan or the future. This liquidity-producing effect has also made the markets more stable than ever, with efficient prices reflecting the real goings-on in the economy.
HFT algorithms engage in a variety of clever trading strategies that are simply not available to less sophisticated traders. One such strategy is called “spoofing”, in which an order is placed and then removed again before it is filled, in a short period of time. This technique is designed to fool market participants into reacting in a certain way, in order to front-run and capitalize on their response. HFT’s also have clever ways of fishing out where the majority of people are setting their stops, and then targeting these stops to create air pockets and rapid price movements, that can then be capitalized on. These clever strategies help weed out less savvy traders, leaving only the most professional traders to participate in the process of price discovery.
Many smaller traders often complain that they are being targeted by HFT’s and that less sophisticated traders are having a hard time protecting their trades from predatory algorithms with more visibility of the order books, deeper pockets and special connections to the exchanges. But these people gladly use all of the liquidity provided by HFT’s without ever showing any gratitude. Instead of complaining about electronic trading like the whiners and conspiracy theorists on Zerohedge, we should be praising them for creating the efficient and stable markets that we all benefit from today. HFT’s are here to stay, and they’re only going to get more sophisticated with time. So rather than complain about it, we need to embrace the future, and marvel at these incredible inventions of the modern age.