High-frequency trading (HFT) is a type of algorithmic trading, specifically the use of sophisticated technological tools and computer algorithms to rapidly trade securities. HFT uses proprietary trading strategies carried out by computers to move in and out of positions in seconds or fractions of a second. Firms focused on HFT rely on advanced computer systems, the processing speed of their trades and their access to the market.
As of 2009, studies suggested HFT firms accounted for 60-73% of all US equity trading volume, with that number falling to approximately 50% in 2012.
High-frequency traders, move in and out of short-term positions aiming to capture sometimes just a fraction of a cent in profit on every trade. HFT firms do not employ significant leverage, accumulate positions or hold their portfolios overnight; they typically compete against other HFTs, rather than long-term investors. As a result, HFT has a potential Sharpe ratio (a measure of risk and reward) thousands of times higher than traditional buy-and-hold strategies.
HFT may cause new types of serious risks to the financial system. Algorithmic and HFT were both found to have contributed to volatility in the May 6, 2010 Flash Crash, when high-frequency liquidity providers rapidly withdrew from the market. Several European countries have proposed curtailing or banning HFT due to concerns about volatility. Other complaints against HFT include the argument that some HFT firms scrape profits from investors when index funds rebalance their portfolios.
History
Profiting from speed advantages in the market is as old as trading itself. In the 17th century, the Rothschilds were able to arbitrage prices of the same security across country borders by using carrier pigeons to relay information before their competitors. HFT modernizes this concept using the latest communications technology.
High-frequency trading has taken place at least since 1999, after the U.S. Securities and Exchange Commission (SEC) authorized electronic exchanges in 1998. At the turn of the 21st century, HFT trades had an execution time of several seconds, whereas by 2010 this had decreased to milli- and even microseconds. Until recently, high-frequency trading was a little-known topic outside the financial sector, with an article published by the New York Times in July 2009 being one of the first to bring the subject to the public’s attention. On September 2, 2013, Italy became the world’s first country to introduce a tax specifically targeted at HFT, charging a levy of 0.002% on equity transactions lasting less than 0.5 seconds.
In the United States, high-frequency trading firms represent 2% of the approximately 20,000 firms operating today, but account for 73% of all equity orders volume.
As HFT strategies become more widely used, it can be more difficult to deploy them profitably. According to an estimate from Frederi Viens of Purdue University, profits from HFT in the U.S. has been declining from an estimated peak of $5bn in 2009, to about $1.25bn in 2012.
Vincent “Vinnie” Viola, the founder of Virtu Financial Inc, is High Frequency Trading’s (HFT) first billionaire. He has an impressive track record of just “one losing trading day” during a 1,238 trading-day period.
How does he do it? The same way other High-Frequency Traders do it: front running trades and scalping countless billions and billions of fractions-of-pennies in the process.
High-frequency trading could soon officially mint its first billionaire.
Vincent “Vinnie” Viola, the founder of Virtu Financial Inc., could have his stake valued at around $2 billion once the company sells shares to the public, according to two people familiar with the matter.
In a filing Monday, Virtu said it hoped to raise $100 million in an initial public offering, though that figure is just a placeholder that could change based on investor demand. The company will likely seek to raise between $200 million and $250 million, according to the people. At the high end of that range, Virtu would be valued at about $3 billion.
Mr. Viola owns almost 70% of the company. Virtu is hoping that its stellar record – having just “one losing trading day” during a 1,238 trading-day period concluding at the end of December – will grab the interest of investors despite growing scrutiny of the high-frequency trading industry.
Virtu said in its prospectus that the U.S. Commodity Futures Trading Commission was “looking into our trading during the period from July 2011 to November 2013.”
The CFTC is examining Virtu’s “participation in certain incentive programs offered by exchanges or venues during that time period.” Virtu said it didn’t believe it violated any statute or regulatory provision.
The Securities and Exchange Commission has also said it is looking into the impact of high-frequency traders on market stability and fairness.
In addition, a French regulator, Autorité des Marchés Financiers, is examining the 2009 trading activities of a company that eventually became part of Virtu, the prospectus said.
Virtu declined to comment on the regulatory inquiries.
Mr. Viola gained attention last year after paying $240 million for control the Florida Panthers of the National Hockey League. He put his Manhattan mansion on the market for $114 million in December.
(Sources: Various, Wall Street Journal, New York Times)
