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high frequency trading Final Paper

high frequency trading Final Paper

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Published by: block100 on Dec 13, 2009
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11/04/2012

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What is high Frequency Trading ? 
In electronic financial markets algorithmic trading or automated trading, alsoknown as high
-frequency trading
is the use of computer programs for enteringtrading orders with the computer algorithm deciding on aspects of the order suchas the timing, price, or quantity of the order, or in many cases initiating the order without human intervention.These Powerful algorithms execute millions of orders a second and scan dozens of public and private marketplacessimultaneously. They can spot trends before other investors can blink, changingorders and strategies within milliseconds. [
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]High-frequency traders often confound other investors by issuing and thencanceling orders almost simultaneously. Loopholes in market rules give high-speed investors an early glance at how others are trading. And their computerscan essentially bully slower investors into giving up profits and then disappear before anyone even knows they were there. High-frequency traders also benefitfrom competition among the various exchanges, which pay small fees that areoften collected by the biggest and most active traders typically a quarter of a centper share to whoever arrives first. Those small payments, spread over millions of shares, help high-speed investors profit simply by trading enormous numbers of shares, even if they buy or sell at a modest loss. high-frequency trading is widely used by pension funds, mutual funds, and other buy side (investor driven)institutional traders, to divide large trades into several smaller trades in order tomanage market impact, and risk. [
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]
 How does high frequency trading work ? 
To understand High frequency Trading let’s examine when slow moving every day traders such as the general public sitting at home on their pc go up againstthese high frequency computers running these pre-set algorithms. It turns out to be a slaughter just like when the hump back whales open its enormous mouths tofeed and suck up every little fish in sight.
 
It was July 15, and intel the computer chip giant, had reporting robust earningsthe night before. Some investors, smelling opportunity, set out to buy shares inthe semiconductor company Broadcom. (Their activities were described by aninvestor at a major Wall Street firm who spoke on the condition of anonymity toprotect his job.) The slower traders faced a quandary: If they sought to buy alarge number of shares at once, they would tip their hand and risk driving upBroadcom’s price. So, as is often the case on Wall Street, they divided their ordersinto dozens of small batches, hoping to cover their tracks. One second after themarket opened, shares of Broadcom started changing hands at $26.20.The slower traders began issuing buy orders. But rather than being shown to allpotential sellers at the same time, some of those orders were most likely routed toa collection of high-frequency traders for just 30 milliseconds — 0.03 seconds —in what are known as flash orders. While markets are supposed to ensuretransparency by showing orders to everyone simultaneously, a loophole inregulations allows marketplaces like Nasdaq to show traders some orders aheadof everyone else in exchange for a fee.In less than half a second, high-frequency traders gained a valuable insight: thehunger for Broadcom was growing. Their computers began buying up Broadcomshares and then reselling them to the slower investors at higher prices. Theoverall price of Broadcom began to rise.Soon, thousands of orders began flooding the markets as high-frequency software went into high gear. Automatic programs began issuing and canceling tiny orders within milliseconds to determine how much the slower traders were willing topay. The high-frequency computers quickly determined that some investors’upper limit was $26.40. The price shot to $26.39, and high-frequency programs began offering to sell hundreds of thousands of shares.The result is that the slower-moving investors paid $1.4 million for about 56,000shares, or $7,800 more than if they had been able to move as quickly as the high-frequency traders.Multiply such trades across thousands of stocksa day, and the profits aresubstantial. High-frequency traders generated about $21 billion in profits last year, the Tabb Group, a research firm, estimates. [
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Who are the big players in high frequency? 
They range from well- to lesser-known firms. Goldman Sachs Group Inc. andChicago hedge fund Citadel Investment Group LLC have high-frequencoperations. An innovator in superfast trading strategies is hedge-fund firmRenaissance Technologies LLC.Privately held Getco LLC, a Chicago high-frequency firm founded in 1999, is a registered market maker with operations in

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