Ever since one former Goldman trader, Haim Bodek, told the SEC that stock exchanges are giving high frequency trading firms an advantage over average investors, HFT has become the hot topic of conversation.But the problem with that is, despite the fact that 60% of all trading is HFT, people rarely know how HFT works, what the relationship between exchanges and high frequency traders really is, or what’s at stake for regular investors.
For simplicity’s sake, let’s take on that last one. It’s the most basic thing you need to know about HFT — after that, you’re in the woods.
Here’s what high frequency trader (who makes his living exploiting the strange movements HFT causes) told Zero Hedge about the three simple ways the every-day investor falls behind.
One, HFTs have better access to the market. They have what we call direct access, which means they don’t have to go through a broker to execute their trades. When you place an order with, say, Scottrade, Scottrade will choose which exchange the order goes to, and they’re going to execute the order where it’s best for them. They’re going to buy it at the best price they can and then sell it to you.
HFTs, on the other hand, can choose the exchange that they want to trade on. They can look at all the prices for a given stock on all of the exchanges and make their own decision, rather than having a broker make it for them.
Two, HFTs obviously have a major speed advantage over other investors. They glean this advantage in many ways: by putting their servers right next to the exchanges’ servers, by using very sophisticated equipment, and also simply by virtue of programming a computer to act on pre-set instructions, which it can do much, much faster than a human ever could.
Third, the best HFTs have an impeccable understanding of the market micro-structure: what happens after you submit an order to your broker? Where does your order go, how is it executed, how are orders prioritised? HFTs are experts on this, but very few retail investors even understand the basics.
Those are the basics, but there’s more: predatory programs that sniff out your movements (like if you’re entering a stop-loss), or programs that move stock prices up and down…
It’s whole different world in there, so check out the rest of the interview here.
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