The Infinitely Long Life of A Microsecond

An Introduction to High Frequency Trading (HFT)

Shubham Dhage on Unsplash

‘The long run is a misleading guide to current affairs. In the long run we are all dead,’ — John Maynard Keynes, A Tract on Monetary Reform, 1923

The world of finance is staid — sedate, respectable and unadventurous. However, once every decade, a few innovations turn into a tsunami and engulf the financial markets — think blockchains and cryptocurrencies today. Blockchains are reshaping the role of banks, currencies, venture capital funds and the world of financial services in general.

Two such innovations in the twentieth century changed the world for retail investors — one beneficial and widely celebrated; the other low profile and detrimental. The creation of the first index fund by John Bogle in 1976 i.e. Vanguard 500 fund which tracks the returns of the S&P 500 and marked the first index fund marketed to retail investors. Index funds provided the best way for retail investors to invest in the stock market.

Another innovation, which many think had the opposite effect on retail investors i.e. it put retail investors at a disadvantage and largely went unnoticed by the masses, until a New York Times article published in 2009 made it more public, is High Frequency Trading (HFT). Today, HFT accounts for a large percentage of trading volumes on major stock exchanges such as the New York Stock Exchange (NYSE). It is both a funny and serious to think that I, a retail investor, could be trading with HFT algorithms/bots instead of actual humans.

What is HFT?

High Frequency Trading (HFT), as the name suggests is a trading system run by computer algorithms that can execute thousands of orders in fractions of a second i.e. milliseconds or microseconds. To give you an idea of how fast trades occur — a microsecond is unit of time equal to one millionth of a second. HFT is characterizied by highly sophisticated algorithms, co-location, and very short-term investment horizons.The SEC defines High Frequency Trading as “professional traders acting in a proprietary capacity that engage in strategies that generate a large number of trades on a daily basis.”