High Frequency Trading, Flash Trading and Algo Trading
Mon, 07 Jun 2010 18:16:00 GMT
Interview with Peter Green
In this first in our series of High Frequency Trading Interviews, we talk to Peter Green, Founding Partner and CEO of The Kyte Group, a leading independent clearer, broker & trader of financial derivatives. The firm was established on the LIFFE exchange in the mid-1980’s and has grown to become a significant participant in the world’s major futures exchanges.
As well as being Chief Executive Officer of The Kyte Group, Peter serves as a trustee for the Nightingale House charity.
High Frequency Trading Review: Peter, welcome to the High Frequency Trading Review. What’s your own definition of high frequency trading?
Peter Green: My definition of high frequency trading would entail a large amount of relatively small orders, in and out of the market, where round trip times are measured in milliseconds if not microseconds, where the trading model is taking advantage of the “noise” in the market, to a degree providing liquidity to the market. But holding a position for more than a minute would be unusual for a high frequency trader.
HFTR: Ok, so HFTs generally hold a position for less than a minute?
PG: Yes and in many cases for a few seconds only, although there may be times when they hold the position for five minutes or more. One other qualification that is usually the case with high frequency traders is that they are flat at the end of the day, they do not take long term directional views. That’s an incredibly important factor when we come to talk about the systemic risk that HFTs provide to the market.
HFTR: One of the of big areas of confusion in the marketplace is regarding terminology, or the distinction between high frequency trading, flash trading andalgorithmic trading, which are all terms that seem to be interspersed but they do mean different things. Can you help us draw a distinction between those three different terms?
PG: Yes of course. Algorithmic trading, or algo trading, is a generic term that effectively describes a style of trading where algorithms are used to generate the orders. Effectively, it means there is some kind of computer model rather than human interaction in terms of artificial intelligence or some kind of sophisticated matrix that will generate trading signals. You could have a system that is algorithmic that generates signals without necessarily generating a trade and it doesn’t have to be a high frequency trade or a high frequency signal. Certainly groups like AHL, which is part of Man Group’s portfolio of trading hedge funds, is regarded as one of the worlds largest algo trading systems but it is not considered high frequency. It’s a trend following system; it’s made up of thousands of different computer programs. The people behind AHL (Adam, Harding and Lueck) were engineering graduates and geniuses in their fields, regarded as world leaders. So although that is algorithmic trading, their typical time frame could be two weeks to three months when they are holding a position.
You could have an algorithm that generates the signals, you can have a separate algorithm that would actually execute the orders and send them into the market. People will talk about things like VWAP when they are trading shares, which is a Volume-Weighted Average Price, itself an algorithmic application.
If you look at the exchanges, the LIFFE exchange for example has a process where in certain products, they judge your order on the time angle in terms of “did I put my bid into the market before you?”. They also have a pro-rata share-out where it depends on the size of my bid compared to yours. That in itself is referred to as an algorithm. It is the exchange’s algorithm of how they will deal with orders coming into the exchange and how they will share out whatever transaction is being processed at any one time.
So the term algorithm is quite generic. You must be aware that people talk about “algo” traders but there is a lot of crossover between the use of the term algo trader and the use of high frequency trader. By definition, a high frequency trader is an algorithmic trader but not the reverse.
As far as “flash” trading goes, flash trading by definition is a form of high frequency trading. But the controversy about this particular type of trading (and this is peculiar to the US stock markets, and not all of the stock exchanges in the US) is where the exchanges effectively created a club of favored high frequency traders who were getting to see orders in a very short period of time – but still a period of time – before the rest of the market (who weren’t members of that club) would get to see them. And because high frequency traders have algorithms that can make a thousand different decisions in a split second, by giving them even a fraction of a second to see an order before the rest of the market could see them, it gives them an unfair advantage. And so flash trading is the one that really got the goat of the politicians and the media in the States because this type of trading is not on a level playing field.
For example, if you wanted to go and buy Vodafone shares and you knew that every time there was a seller in the market, I could have a look 10 seconds before you see it and decide whether I wanted to buy that offer and you would be given the leftovers, you would be pretty upset. However, if both of us are allowed to see that offer in the Vodafone share at exactly the same time, but I’ve paid £10,000 for my computer and you’ve bought something from PC World for 500 quid, you have less right to be upset if I am getting that order executed a fraction of a second before you every time. You are allowed to go and spend £10,000 on the same piece of hardware as me to get your orders in quicker, you’ve just chosen not to.
As long as the market is managed as a level playing field, we should have the same fairness, the same rules, the same access and then it’s down to each individual as to how clever they are in designing their own algorithms and how much resource they want to throw at the system. For some of our traders here at Kyte, they don’t need to be split seconds ahead to do their trading, they are very happy to be not the first in the queue or not the fastest because sometimes the style of trading doesn’t require nanosecond technology.
HFTR: Can you elaborate a little on how high frequency trading is actually used at Kyte Group?
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