IAIP – High Frequency Trading…

IAIP – High Frequency Trading, Algorithmic Buy Side Execution and Linguistic Syntax

April 23rd, 2012; Mumbai

High-frequency trading (HFT) is the use of sophisticated technological tools to trade securities like stocks or options. HFT compete on a basis of speed with other high-frequency traders, and compete for very small, consistent profits. As a result, high-frequency trading has been shown to have a potential Sharpe ratio (measure of reward per unit of risk) thousands of times higher than the traditional buy-and-hold strategies. By 2010 high-frequency trading accounted for over 70% of equity trades in the US and is rapidly growing its popularity in Europe and Asia.

To get a better perspective on HFT and how the concept could be used for the benefit of Buy side clients, IAIP had an opportunity to host Dan Di Bartolomeo, President & Founder, Northfield Information Services Inc., at the speaker event in Mumbai on April 23rd. Based in Boston since 1986, Northfield develops quantitative models of financial markets.   The firm’s clients include nearly three hundred financial institutions in twenty countries.


As per Dan trading is zero sum game and HFT trade makes money at expense of other investors like retail, HNI or other institutional investors. Main reason for opting for HFT is to trade quickly as trading is exposed to two type of risk 1) Uncertainty risk: Longer the trade remain un-executable long risk of uncertainty (of price movement) 2)opportunity cost: If price move adversely and trade is not executable it is loss of opportunity.

For developing any HFT three steps are followed 1) Understanding process of particular client: where risk profile of a client and his return expectation is taken into account, based on this information composition and various strategy of underlining portfolio is finalised 2) Trade scheduling: where a large equity orders is broken into a series of smaller trade and time limit for execution is finalised. 3)Micro management: Size and frequency of smaller trades are decided in order to hide large trade so it would be difficult for market participant to gauge its impact. Size and frequency of orders is also altered depending upon flow of news, price movement and other live parameters at time of execution of trade.

There are some caveats of HFT which should be taken into consideration while executing trade. HFT trade process fastens whenever when ever prices are favourable (i.e. lower for buy orders and higher for sell orders) and slows trades while prices are unfavourable. Hypothesis behind this process is stock price momentum will moderate and hence stock prices will come back to its steady state level as time passes. However there may be cases that prices continue to rise or continue to fall and trade is executed at unfavourable prices or it is not at all executed resulting in opportunity loss.

At the time of any announcement or news stock volatility (and hence risk) increases. On back of higher risk associated, person demands higher return. Since risk has increased, as per various model like WACC and others, positive news will have less positive impact on stock prices and negative news will have sharp negative impact on the stock prices. As positive impact is less and negative impact is high, an HFT trade is generally skewed toward short position during time of news or announcement.

About the Speaker:

Dan Di Bartolomeo is President and founder of Northfield Information Services, Inc.  Based in Boston since 1986, Northfield develops quantitative models of financial markets.   The firm’s clients include nearly three hundred financial institutions in twenty countries. Dan is a Visiting Professor at the CARISMA Research Centre of Brunel University in London.  In addition, he serves on the Board of Directors of the Chicago Quantitative Alliance and the advisory board of the International Association of Financial Engineers.  He is also an active member of the Financial Management Association, and “QWAFAFEW”.

Dan has a long list of more than thirty publications including books, book chapters and research papers in professional journals such as Financial Analyst Journal, Quantitative Finance and Journal of Investing. Di Bartolomeo has also written extensively for the CFA Research Foundation.  His most recent publication is “Equity Risk, Credit Risk, Default Correlation and Corporate Sustainability” which was published in the Journal of Investing in December of 2010.

 Contribution by: Jignesh Kamani, CFA, IAIP Volunteer

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