In an earlier thread someone used the term "legalized front running" to describe HFT, and in thread the final pieces fell into place.
Fact 1: we know that HFT companies have special hardware in place. They have effectively built FPGA's (or even ASICs) that can process incoming orders while the message is still partially on the wire. This allows them to react to new orders and executions with a latency that is below the transmission delay of the protocol packet.
Fact 2: HFT companies have built directional radio links to get their messages faster between exchanges. Speed of light is still a limiting factor, and the distance traveled between exchange A to exchange B is somewhat longer along the fiber.
Fact 3: The basic rule of trading is "buy low, sell high".
So, if you can process order information faster than than it takes to receive the entire exchange message, you can use that as an advantage against the rest of the market. The HFT systems know the current price for a stock in the system (the lowest standing price), and when they receive an execution, they know that someone else just traded at that price. They can send out a message to other exchanges to quickly buy the said stock at the said price and put out offers at a slightly higher price.
The net effect? "I just bought all of the stocks under your nose. Here's what I'm willing to sell them for you."
As long as the price they're selling the stock out is within the limit, they'll get an immediate risk-free trade. The HFT systems already had a buyer ready before making their orders.
> this strategy has been around for a long time, well before HFT.
I have no doubt about that. Very few things are new.
But if you're deploying special hardware in an attempt to cheat the speed of light and gain an advantage of mere microseconds, the system is FUBAR (or recognition).
In an earlier thread someone used the term "legalized front running" to describe HFT, and in thread the final pieces fell into place.
Fact 1: we know that HFT companies have special hardware in place. They have effectively built FPGA's (or even ASICs) that can process incoming orders while the message is still partially on the wire. This allows them to react to new orders and executions with a latency that is below the transmission delay of the protocol packet.
Fact 2: HFT companies have built directional radio links to get their messages faster between exchanges. Speed of light is still a limiting factor, and the distance traveled between exchange A to exchange B is somewhat longer along the fiber.
Fact 3: The basic rule of trading is "buy low, sell high".
So, if you can process order information faster than than it takes to receive the entire exchange message, you can use that as an advantage against the rest of the market. The HFT systems know the current price for a stock in the system (the lowest standing price), and when they receive an execution, they know that someone else just traded at that price. They can send out a message to other exchanges to quickly buy the said stock at the said price and put out offers at a slightly higher price.
The net effect? "I just bought all of the stocks under your nose. Here's what I'm willing to sell them for you."
As long as the price they're selling the stock out is within the limit, they'll get an immediate risk-free trade. The HFT systems already had a buyer ready before making their orders.
[1]: http://ra.ziti.uni-heidelberg.de/cms/images/pdfs/High-freque...