Role of high frequency trading in modern financial markets - Essay Example

High Frequency Trading or HFT used propriety trading strategies which allow traders and firms to conclude transactions within the micro-seconds. With the help of sophisticated computer algorithms as well as other tools positions can be easily taken and closed within seconds or less than a second to take advantage of the smallest movements in the prices of the securities. HFT firms are not only market makers but they offer critical liquidity to the market also. In 2000, the overall volume of HFT was relatively low however, during the recent years, it witnessed an explosive growth.

Firms are increasingly relying on HFT to gain required advantage as well as to remain ahead of the competition. The closely guarded algorithms process large volume of data at really rapid speed and offer cost advantage while having smaller portfolio holding periods. Though the overall number of firms using HFT is relatively low however, the overall volume of trade showed erratic trends with rapid increase as well as decrease in the overall trading activity. This paper will discuss and describe what High Frequency Trading is and will further elaborate on the role of HFT in modern financial markets.

Modern financial Markets Financial Markets are still under the stress of financial meltdown which started during 2007-2008. With massive breakdown of banks and other financial institutions, the crisis exposed the overall vulnerable nature of the modern financial markets and created an uncertainty over the ability of modern markets to function properly and effectively. Though the major impact of the financial crisis is over however, financial markets are still under the stress. In such an environment, regulatory bodies have developed rules and regulations which did not allow firms to take on the speculative positions and implement proper risk management systems in place.

The importance of new parameters of risk became significant specially in the wake of the recent financial crisis wherein regulatory bodies became relatively more conscious in terms of erratic behavior of financial services firms. (Aldridge, 24) It is also critical to note that the financial markets have grown more complicated over the period of time. The sheer size and volume of the transactions, the use of information technology as well as development of sophisticated trading and valuation models added more complexity to the overall markets.

Despite the fact that the markets operate on the basis of the perfect market hypothesis and all the subsequent theory has been developed on this promise, it is still important to note that many imperfections exist in markets allowing market makers and investors to take advantage of such opportunities. There has been a relentless improvement and development of modern technology which will continue to dominate the present and future of the financial markets at the global level. The development of new technologies has actually created new opportunities which human traders may not be able to spot as well as execute.

As such, modern financial institutions tend to focus on combining the power of human insight with the speed and efficiency of the modern