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High-frequency trading has taken place at least since
1999, after the U.S. Securities and Exchange Commission
authorized electronic exchanges in 1998. At the turn of
the 21st century, HFT trades had an execution time of
several seconds, whereas by 2010 this had decreased to
milli- and even microseconds.
High-frequency trading (HFT) is a primary form of
algorithmic trading in finance. Specifically, it is the use of
algorithms to rapidly trade securities. HFT uses
proprietary trading strategies carried out by computers to
move in and out of positions in seconds or fractions of a
second. It is estimated that as of 2009, HFT accounted for
60-73% of all US equity trading volume, with that number
falling to approximately 50% in 2012. High-frequency
traders move in and out of short-term positions at high
volumes aiming to capture sometimes a fraction of a cent
in profit on every trade.
A substantial body of research argues that HFT and
electronic trading pose new types of challenges to the
financial system. Algorithmic and high-frequency traders
were both found to have contributed to volatility in the
May 6, 2010 Flash Crash, when high-frequency liquidity
providers rapidly withdrew from the market. [2][10][13][14][15]

Several European countries have proposed curtailing or

banning HFT due to concerns about volatility. [16] Other
complaints against HFT include the argument that some
HFT firms scrape profits from investors when index funds
rebalance their portfolios.
We will begin by imagining a market with lots of small
individual traders. Then we will look at how large
institutional investors change the market. Next we will
look at high frequency trading. Finally, well explain how
small investors are impacted.
Now consider that the traders are not all small investors.
Large institutional traders are doing the same thing
some buying and some sellingbut theres a difference
between them and individual investors. When a large
mutual fund or pension fund places a buy order, it could
be for a million shares, not a hundred shares. Similarly,
sell orders from institutions come in very large quantities.
Over the course of the day, these large institutional
orders cause a lumpy pattern. The chart shows what such
a price line looks like. There is no noticeable trend up or
down, but each institutional order moves the market up
or down, and it takes a while for the price to return to the
underlying trend line. Thats illustrated with the red line in
the accompanying chart.
HFT is not as easy as this simple explanation sounds.
First, there are many HFTs. If one is slow, the profit
opportunity may have been captured by other HFTs.

Second, not every blip is just a blip. If the stock is

impacted by an downward trend in the overall stock
market, the HFT would buy lots of different stocksand
then watch them all go down further. A good HFT has to
be fast, but not so fast as to get caught be a surprise. In
practice, the HFTs are no longer just looking at just one
stock in isolation. They are looking at all the prices
coming in, including stocks, bonds, commodities, futures
and options. This massive data crunching helps them
identify what are likely to be short-term blips but not
long-lasting trends.
In the early days, it was fairly easy. As more companies
got into the business, the easy trades were quickly taken
by others. HFTs needed to move faster and faster, while
crunching ever more data to avoid losing trades. Much of
the attention they have received lately is due to their
extreme efforts to reduce their reaction time, which is
measured in milliseconds. This effort is not made to be
faster than individual investors or institutional investors;
HFTs are already faster than them. Instead, the effort is
made to be faster than competing HFTs.
Further, investors face a spread between the price at
which they buy (the ask price) and the price at which
they sell (the bid). This bid-ask spread compensates the
market makers for executing trades at exactly the time
that I want to trade. The more volatile the stock price
usually is, the wider the bid-ask spread. HFTs tend to
narrow the bid-ask spread by protecting the market

makers from bad news while they hold their positions.

Thus, my trading costs get lower.

Algorithm trading is a system of trading which facilitates
transaction decision making in the financial markets
using advanced mathematical tools.
In this type of a system, the need for a human trader's
intervention is minimized and thus the decision making is
very quick. This enables the system to take advantage of
any profit making opportunities arising in the market
much before a human trader can even spot them.
As the large institutional investors deal in a large amount
of shares, they are the ones who make a large use of
algorithmic trading. It is also popular by the terms of algo
trading, black box trading, etc. and is highly technologydriven. It has become increasingly popular over the last
few years.

Suppose a trader follows these simple trade criteria:

Buy 50 shares of a stock when its 50-day moving
average goes above the 200-day moving average

Sell shares of the stock when its 50-day moving

average goes below the 200-day moving average
Using this set of two simple instructions, it is easy to write
a computer program which will automatically monitor the
stock price and place the buy and sell orders when the
defined conditions are met. The trader no longer needs to
keep a watch for live prices and graphs, or put in the
orders manually. The algorithmic trading system
automatically does it for him, by correctly identifying the
trading opportunity..
Algorithmic trading is widely used by investment banks,
pension funds, mutual funds, and other buy-side
(investor-driven) institutional traders, to divide large
trades into several smaller trades to manage market
impact and risk.

The trading volume created by institutional orders that
are unavailable to the public. The bulk of dark pool
liquidity is represented by block trades facilitated away
from the central exchanges.

Why Use a Dark Pool?

Contrast this with the present-day situation, in which an

institutional investor uses a dark pool to sell a 1 million
share block. The lack of transparency actually works in
the institutional investors favor, since it may result in a
better realized price than if the sale was executed on an
exchange. Note that as dark pool participants do not
disclose their trading intention to the exchange prior to
execution, there is no order book visible to the public.
Trade execution details are only released to the
consolidated tape after a delay.
In finance, a dark pool (also black pool) is a private
forum for trading securities. Liquidity on these markets is
called dark pool liquidity. The bulk of dark pool trades
represent large trades by financial institutions that are
offered away from public exchanges like the New York
Stock Exchange and the NASDAQ, so that such trades
remain confidential and outside the purview of the
general investing public. The fragmentation of financial
trading venues and electronic trading has allowed dark
pools to be created, and they are normally accessed
through crossing networks or directly among market
participants via private contractual arrangements. Some
dark pools are available to the public and can be
accessed via retail brokers.
One of the main advantages for institutional investors in
using dark pools is for buying or selling large blocks of
securities without showing their hand to others and thus
avoiding market impact as neither the size of the trade
nor the identity are revealed until the trade is filled.

However, it also means that some market participants are

disadvantaged as they cannot see the trades before they
are executed; prices are agreed upon by participants in
the dark pools, so the market becomes no longer