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High Frequency Trading And The Trading Computer
Did you realize that by some estimates so called High Frequency Trading (HFT) makes up 70% of the daily volume of the US market for stocks? In fact, the trading computer and HFT is blamed for the flash crash of 2010. The SEC ordered steps to prevent future flash crashes like that one, so clearly the SEC see HFT as a risk to the structure of electronic trading. Do you believe the game is rigged and there is no way to make money trading stocks? Well that is just not true.
In the early days of the markets (early 1800s until the 1960s), before the trading computer, all orders were handled in an open outcry and/or speicalist system and processed via pencil and paper.
A customer wanting to buy a stock would call his broker. The broker would then call down to a trading room who in turn would call a dealer or exchange to execute the order. The process could take 5 to 10 minutes or even longer! By the time the customer got his order filled, the execution many times was very different from what he expected. Back in these days it was not unusual to have several middle men take a piece. Even in the period just before the internet, brokerage firms could take minutes to execute a market order and so called market makers could literally skim fractions of a dollars like Vegas takes a vig.
Once the internet took off and fractions were eliminated, pricing information became more transparent and spreads between bids and asks tightened up substantially. Online brokerage firms sprang up and order executions were in seconds. The invention of the high speed Trading Computer was an absolute must for traders. Commissions dropped to nearly zero and 90% of market makers went looking for a new job. I know because I was a stock broker during that period; the last half of the 1990s and early 2000’s.
Essentially the internet and the trading computer have cut the vig to zero! Price execution is no measured in milliseconds. So where do HF traders come into the picture? They are the new market makers. In fact their algorithms actually help execution instead of hurt it. So is the market rigged? Compare to yesteryear the market is much more transparent than it used to be. Did HF traders cause the flash crash? No the NYSE with their lack of oversight caused it.
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