What is the overall impact of High Frequency Trading (HFT)
With the ability to enter thousands or even millions of trades on multiple exchanges, and in fractions of a second, arbitrage is taken to new heights. This volume of relatively small trades in large volume adds up to a lot of money.
The advantage comes from exploiting small disparity in bid/ask spreads between exchanges, momentarily inefficiency in pricing, and momentary changes in stock price trends. This is seen by manty as unfair. But here’s the big question: Yes, it is unfair, but does it adversely impact what you can earn in your own portfolio?
This is where doubt enters the picture.
A changing landscape
Two points: First, even with an advantage for the big traders using powerful algo systems, the individual investor probably was never impacted at all (pointing out the differences between something being “unfair” versus harming profitability for smaller investors). Second, the one-time advantage of HFT has disappeared and no longer is as factor.
It’s comparable to the auto business. When Ford began using the assembly line to mass produce cars, his operation was the only game in town. By 1909, there were 272 auto manufacturers in operation ( How Did Detroit Become Motor City?)
The point is that good ideas tend to bring in more competition, a basic economic reality. And more competition means less market share to go around. This is exactly what has happened to HFT. It has become unprofitable because too many institutions are practicing this system. The overall profit pool due to arbitrage and HFT usually does not beat the market any more, as it did only a few years ago.
Overall, HFT-generated profits might still present a small advantage, but it is distributed over so many institutions that the algo and computer investment is not yielding the kind of profits you might expect. With too many players, the profit pool has been diluted. Consequently, the unfair advantage once enjoyed by the big institutions has disappeared.
Slow regulatory response
The trend came to an end so rapidly that regulators and politicians did not have time to figure out how to control or stop HFT. Among the disturbing aspects of the practice was that according to some critics, exchanges were giving HFT traders priority in trade execution. This would be disturbing if the practice was having an impact on profits for retail investors. But no laws were being broken at the time, and the popularity among institutions brought about the demise of HFT.
Forbes published an article on this topic in March 2017 (Don't Worry, Be Happy - High Frequency Trading Is Over, Dead, It's Done). The story points out that “HFT has gone from invention, though something many opposed, to it now being a boring and unprofitable part of the basic infrastructure of the markets. We've had the entire cycle, the entire economic technology cycle, in only a couple of decades.”
The disappearance of HFT’s advantage helps options traders, perhaps more than most others. Using options to hedge equity positions with well-timed trades, as it turns out, continues to be more beneficial than the minor profits that must be shared among many institutions.
Michael C. Thomsett is a widely published author with over 80 business and investing books, including the best-selling Getting Started in Options, coming out in its 10th edition later this year. He also wrote the recently released The Mathematics of Options. Thomsett is a frequent speaker at trade shows and blogs on his website at Thomsett Guide as well as on Seeking Alpha, LinkedIn, Twitter and Facebook.
What Is SteadyOptions?
Full Trading Plan
Complete Portfolio Approach
Diversified Options Strategies
Exclusive Community Forum
Steady And Consistent Gains
High Quality Education
Risk Management, Portfolio Size
Performance based on real fills
Non-directional Options Strategies
10-15 trade Ideas Per Month
Targets 5-7% Monthly Net Return
Recent Articles
Articles
Pricing Models and Volatility Problems
Most traders are aware of the volatility-related problem with the best-known option pricing model, Black-Scholes. The assumption under this model is that volatility remains constant over the entire remaining life of the option.
By Michael C. Thomsett, August 16
- Added byMichael C. Thomsett
- August 16
Option Arbitrage Risks
Options traders dealing in arbitrage might not appreciate the forms of risk they face. The typical arbitrage position is found in synthetic long or short stock. In these positions, the combined options act exactly like the underlying. This creates the arbitrage.
By Michael C. Thomsett, August 7
- Added byMichael C. Thomsett
- August 7
Why Haven't You Started Investing Yet?
You are probably aware that investment opportunities are great for building wealth. Whether you opt for stocks and shares, precious metals, forex trading, or something else besides, you could afford yourself financial freedom. But if you haven't dipped your toes into the world of investing yet, we have to ask ourselves why.
By Kim, August 7
- Added byKim
- August 7
Historical Drawdowns for Global Equity Portfolios
Globally diversified equity portfolios typically hold thousands of stocks across dozens of countries. This degree of diversification minimizes the risk of a single company, country, or sector. Because of this diversification, investors should be cautious about confusing temporary declines with permanent loss of capital like with single stocks.
By Jesse, August 6
- Added byJesse
- August 6
Types of Volatility
Are most options traders aware of five different types of volatility? Probably not. Most only deal with two types, historical and implied. All five types (historical, implied, future, forecast and seasonal), deserve some explanation and study.
By Michael C. Thomsett, August 1
- Added byMichael C. Thomsett
- August 1
The Performance Gap Between Large Growth and Small Value Stocks
Academic research suggests there are differences in expected returns among stocks over the long-term. Small companies with low fundamental valuations (Small Cap Value) have higher expected returns than big companies with high valuations (Large Cap Growth).
By Jesse, July 21
- Added byJesse
- July 21
How New Traders Can Use Trade Psychology To Succeed
People have been trying to figure out just what makes humans tick for hundreds of years. In some respects, we’ve come a long way, in others, we’ve barely scratched the surface. Like it or not, many industries take advantage of this knowledge to influence our behaviour and buying patterns.
- Added byKim
- July 21
A Reliable Reversal Signal
Options traders struggle constantly with the quest for reliable
By Michael C. Thomsett, July 20
- Added byMichael C. Thomsett
- July 20
Premium at Risk
Should options traders consider “premium at risk” when entering strategies? Most traders focus on calculated maximum profit or loss and breakeven price levels. But inefficiencies in option behavior, especially when close to expiration, make these basic calculations limited in value, and at times misleading.
By Michael C. Thomsett, July 13
- Added byMichael C. Thomsett
- July 13
Diversified Leveraged Anchor Performance
In our continued efforts to improve the Anchor strategy, in April of this year we began tracking a Diversified Leveraged Anchor strategy, under the theory that, over time, a diversified portfolio performs better than an undiversified portfolio in numerous metrics. Not only does overall performance tend to increase, but volatility and drawdowns tend to decrease: