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Explanation of High-Frequency Trading - Assignment Example

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The author of the paper "Explanation of High-Frequency Trading " states that the arena of high-frequency trading represents a computer algorithmic profit generation trading approach that is based on detecting small variances in price movement projections…
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Download file to see previous pages High-frequency trading (HFT) uses algorithms to identify fleeting moves in the direction of equities and commodities (Aldridge, 2013, p. 35). These consist of ‘signals’ such as the movement of interest rates that can provide an indication concerning the manner equities or commodities may move over a short period (Coates et al, 2008, p. 627). Other approaches entail looking for and taking advantage of what are termed as subtle quirks in trading infrastructure (Blair et al, 2010, pp. 1336-1337). The strategy entails capturing profits that can be as low as a fraction of a pence for each trade (Menkveld, 2013, p. 720). The strategy does not entail taking positions in equities or commodities as the process seeks immediate profits using the volume of the trade times the possible return (Jarrow and Protter, 2011, pp. 16-17).  The case of Steve Swanson provides important insights concerning how this works (Philips, 2013, p. 1). He developed one of the first high-frequency trading algorithms that predicted stock price movements “… 30 to 60 seconds into the future …” (Philips, 2013, p. 1). This permitted trades to be placed in time to take advantage of these projections and then to move back out of them. The volume of trades moved by high-frequency traders in 2009 ranged around 3.25 billion shares per day, with the average profits amounting to a tenth of a pence to a twentieth of a pence (Philips, 2013, p. 1). By 2012 volume had fallen to approximately 1.6 billion shares a day (Philips, 2013, p. 1). The reason for the decline is that the volume of trading was making it virtually impossible to reap profits as the hundreds of trading programs were cannibalizing profits from each other (Philips, 2013, p. 1). Market making is a key technique that is used in the process of high-frequency trading (Campbell et al, 2009, pp. 71-72). It represents where the trader or firm involved in the process places what is termed as a limit order using the computer (Sandas, 2001, pp. 714-716). A limit order is when the buyer of a stock states they will buy the stock only at the price indicated (Ranaldo, 2004, pp. 59-60). This technique is essential to the high-frequency trading process as the strategy is based on buying the stock at a predetermined price, per the movement projections, so it can be sold at the price point to make a profit (Scalas et al, 2004, pp. 699-701). These predetermined buy/sell ranges are the basis for high-frequency trading. In exploring the impact of high-frequency trading on equities, it is necessary to provide a summary understanding of the stock trading process in order to understand its impacts. There are a number of reasons for companies being listed. In the instance of newer companies the reasons represent access to non-debt capital (Draho, 2004, pp. 25-28). This means that the issued stock of a company, or in other words its paper, is traded on stock exchanges where, if needed, the company can use this to raise funds for projects, expansion, equipment or other purposes without taking on debt (Draho, 2004, pp. 25-28). ...Download file to see next pagesRead More
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