High-Frequency Trading: The Good, the Bad and the Ugly


In part two of the GreySpark report on high-frequency trading (HFT) — High-Frequency Trading: The Good, the Bad and the Ugly — risk controls are highlighted as essential elements of e-trading.

HFT can increase liquidity, reduce volatility and enhance price discovery and price improvement in global capital markets. HFT firms and venues where HFT is present are failing to safeguard their operations if they do not correctly implement the necessary risk management measures.

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In this report we examine the impact of High-Frequency Trading on markets; in particular, we assess liquidity, volatility and price discovery, which in most circumstances can benefit from the presence of HFT.

Algorithmic trading creates a set of risks, and we recommend making risk management an essential element of electronic trading. Within HFT implementation of risk management techniques becomes increasingly important as the complexity of the systems being used becomes more sophisticated. As such, a holistic approach to HFT risk management at key points in markets is needed.

We recommend that, in all cases, HFT players in capital markets must take a holistic approach to risk management. It should include business measures – a set of five checks in the risk management process – and technology measures like high standards of design, implementation, monitoring and management. On top of recommendations for traders, we highlight the importance of HFT risk management by trading venues.

The research is based on our hands-on experience working with Tier I and Tier II banks, hedge funds and leading vendors. Our analysis of HFT market trends is based on a survey of more than 50 industry participants from Africa, the Americas, Asia-Pacific, Europe and the Middle-East.

Published on: 23 Apr, 2013

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High-Frequency Trading – Table of Content

  • 1.0 The Electronic Trading Environment
    • 1.1. Distinguishing Between HFT and Algorithmic Trading
  • 2.0 Technology Is Critical for Effective HFT
    • 2.1. Technology Enables the Removal of Intermediaries: Direct Data Feeds and Direct Access
    • 2.2. Reliability of the Whole Trading Infrastructure
  • 3.0 The Market Impact of Electronic Trading
    • 3.1. Less Quoted Size
    • 3.2. Narrowing Spreads
    • 3.3. Costs of Trading
  • 4.0 The Market Impact of HFT
    • 4.1. Liquidity – HFT Increases the Liquidity of Liquid Instruments
    • 4.2. Volatility – HFT Reduces Volatility
    • 4.3. Price Discovery and Price Improvement
    • 4.4. Other Impacts – A Need to Handle Large Numbers of Quotes
  • 5.0 Risks of Algorithmic Trading and HFT
  • 6.0 HFT Risk Management – What Can Be Done?
    • 6.1. Business Risk Management
    • 6.2. Technology Driven Risk Management
  • 7.0 Risk Management on Trading Venues
    • 7.1. Circuit Breakers
    • 7.2. Infrastructure Management and Monitoring
    • 7.3. Audit Routine
  • 8.0 HFT and Low Latency Trading Systems Are Here to Stay