Content High Frequency Trading Mini Flash Crashes References

High Frequency Trading
Anton Golub
Manchester Business School

May 5, 2011

Anton Golub

High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

High Frequency Trading Characteristics Market Microstructure High Frequency Trading Strategies Mini Flash Crashes Introduction Definition Examples Statistics References

Anton Golub

High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Characteristics Market Microstructure High Frequency Trading Strategies

Definition & Characteristics
High Frequency Trading (HFT): extremely fast, fully automated and computerized trading short trading time horizon benefits from market liquidity imbalances and short-term pricing inefficiencies require real-time data analysis and trading decisions do not carry overnight positions As HFT is sensitive to latency, high frequency trading firms: co-locate their computers next to exchanges buy raw data from exchanges and reconstruct the order book by them self

Anton Golub

High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Characteristics Market Microstructure High Frequency Trading Strategies

Volume & Who is trading & Annual Profits
HFT represents 70% of U.S equity volume (77% in UK) - done by only 2% of traders;

Biggest traders: Goldman Sachs, Credit Suisse, GETCO, Renaissance Technologies, Citadel. Yearly profits in U.S. are estimated to $21 billion.
Anton Golub High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Characteristics Market Microstructure High Frequency Trading Strategies

Strategies

HFT can be broadly categorized into: liquidity detection strategies: Rebate Trading, Automated Market Making pricing inefficiencies strategies: Scalping, Latency Arbitrage, Statistical Arbitrage predatory strategies: Flash Trading, Quote Stuffing

Anton Golub

High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Characteristics Market Microstructure High Frequency Trading Strategies

What is the essence of HFT strategies?

Customer: Merchant: Customer: Merchant: Customer: Merchant: Customer: Merchant: Customer: Merchant: Customer: Merchant:

How much are those? A buck fifty. I’ll take some. They’re a buck fifty-one. Um, you said a buck fifty. That was before I knew you wanted some. You can’t do that! It’s my shop. But I need to buy a hundred! A hundred? Then it’s buck fifty-two. You’re ripping me off. Supply and demand, pal. You want ’em or not?

Anton Golub

High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Characteristics Market Microstructure High Frequency Trading Strategies

Rebate Trading

HFT Strategies: Rebate Trading

Anton Golub

High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Characteristics Market Microstructure High Frequency Trading Strategies

Rebate Trading

Exchanges pay HF traders that post best limit sell or best limit buy orders - Liquidity Rebate: $0,003/share. HF traders plan: place a limit buy order if his order is matched, he turns around and place a limit sell order at the same price profit from trading will be $0,00, but he will collect rebates!

Anton Golub

High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Characteristics Market Microstructure High Frequency Trading Strategies

Rebate Trading
Price 10,02 10,01 10,00 Price 10,02 10,01 10,00 Shares 600 100 100 Shares 600 100 100

best offer best bid bid

← HFT buy order

offer best offer best bid

← HFT sell order

Total profit = Profit from trading + Rebates = $0, 00 × 100 + $0, 003 × 200 = $0, 60.

Anton Golub

High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Characteristics Market Microstructure High Frequency Trading Strategies

Flash Trading

HFT Strategies: Flash Trading

Anton Golub

High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Characteristics Market Microstructure High Frequency Trading Strategies

Flash Trading
exchange A Price Shares 10,02 600 10,00 100 exchange B Price Shares 10,02 400 10,01 500 10,00 200

offer best offer best bid

mutual fund sends an order to buy 500 shares to exchange A exchange A does not have the best offer, so the order must be routed to exchange B instead exchange A ”flashes” the order to privileged group of HF traders for 30 milliseconds if the order is matched it will be traded at $10,00 (superior to all sell orders)
Anton Golub High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Characteristics Market Microstructure High Frequency Trading Strategies

Flash Trading

What is the problem with Flash Trading? creating a tiered market - some traders see the incoming order, other do not ”gaming” the exchange fee structure - orders must be routed to the venue with the best possible price allows front running - HF traders have the upper hand in knowing mutual funds’ intentions

Anton Golub

High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Introduction Definition Examples Statistics

Flash Crash

FLASH CRASH

Anton Golub

High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Introduction Definition Examples Statistics

May 6th Flash Crash
May 6th Flash Crash: second largest point swing of 1,010.14 points biggest one-day point decline of 998.5 points, on an intraday basis in DJIA history markets crashed in less than 5 minutes, just to soon recover

Figure: Flash Crash

Flash Crash + scaling laws/fractal nature of price ⇒ mini Flash crash
Anton Golub High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Introduction Definition Examples Statistics

Definition of Mini Flash Crash
Nanex Llc. defined a up/down mini Flash Crash as: at least 10 up/down price moves before ticking down/up price change has to be greater than 0.8%, all within 1.5 seconds. 2006 2007 2008 2009 2010 Total Down Crashes 254 2,557 4,065 1,462 1,041 9,379 Up Crashes 208 2,456 4,354 1,253 777 9,048

Anton Golub

High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Introduction Definition Examples Statistics

Figure: Daily occurrences between January 1, 2006 and November 3, 2010
Anton Golub High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Introduction Definition Examples Statistics

Example of Up Crash

Figure: Goldman Sachs (GS) Up Crash

Anton Golub

High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Introduction Definition Examples Statistics

Example of Down Crash

Figure: Goldman Sachs (GS) Down Crash

Anton Golub

High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Introduction Definition Examples Statistics

Important Research Questions

How is getting hurt by mini Flash Crashes? How can we prevent mini Flash Crashes? Should we penalize the parties involved? What is the most likely time for a mini Flash Crash to occur? Which companies are most likely to get hit? Can HFT be singled out as the main source? Does the behavior of price change before/after the mini Flash Crash? Can mini Flash Crashes be predicted?

Anton Golub

High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Introduction Definition Examples Statistics

Distribution of Crashes during the day

Figure: Distribution of crashes during the day
Anton Golub High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Introduction Definition Examples Statistics

Average Price before the Crash

Figure: Average Price before the crash

Anton Golub

High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Introduction Definition Examples Statistics

Average Price vs. Intensity of the Crash

Figure: Average Price of the down-crash vs. Intensity of the down-crash
Anton Golub High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Introduction Definition Examples Statistics

Average Price vs. Intensity of the Crash

Figure: Average Price of the down-crash vs. Intensity of the down-crash
Anton Golub High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Introduction Definition Examples Statistics

Impact on Liquidity - bid/ask spread
No Impact on Bid-Ask Spread!

Figure: Average spread before vs. after the crash
Anton Golub High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

Introduction Definition Examples Statistics

How Can a mini Flash Crash Occur?
Crashes might be a result of ”top of the book” protection that is intended to prevent ”trade-throughs”. INET price size 32.02 500 32.01 500 32.00 500 31.99 100 ARCA price size 32.02 500

bid/ask ask ask best ask best bid

31.99

100

Table: Order book of security XYZ

Market order to buy 1000 shares is sent to ARCA; 500 shares will be routed to INET (32.00), but the remaining 500 shares will be filled on ARCA (32.02).

Anton Golub

High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

References
High Frequency Trading and its Impact on Market Quality, Jonathan A. Brogaard, November 2010 Low-Latency Trading, Joel Hasbrouck, Gideon Saar, November 2010 Does Algorithmic Trading Improve Liquidity, Terrence Hendershott, Charles M. Jones, Albert J. Menkveld, Journal of Finance, Forthcoming The Effect of High-Frequency Trading on Stock Volatility and Price Discovery, X. Frank Zhang, August 2010 Market Efficiency and Microstructure Evolution in U.S. Equity Markets: A High-Frequency Perspective, Jeff Castura, Robert Litzenberger, Richard Gorelick, Yogesh Dwivedi, August 2010 Empirical Limitations on High Frequency Trading Profitability, Michael Kerns, Alex Kulesza, Yuriy Nevmyvaka, June 2010 Nanex LLc, nanex.net

Anton Golub

High Frequency Trading

Content High Frequency Trading Mini Flash Crashes References

The End

Thank you for your attention!

Anton Golub

High Frequency Trading

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