Algorithmic trading

1,277 out of 1,278 trading days,[12] losing money just one

day, empirically demonstrating the law of large numbers
benet of trading thousands to millions of tiny, low-risk
and low-edge trades every trading day.[13]

Algorithmic trading, also called algo trading and

blackbox trading, encompasses trading systems that are
heavily reliant on complex mathematical formulas and
high-speed, computer programs to determine trading
strategies.[1][2] These strategies use electronic platforms
to enter trading orders with an algorithm which executes pre-programmed trading instructions accounting for a variety of variables such as timing, price,
and volume.[3] Algorithmic trading is widely used by
investment banks, pension funds, mutual funds, and other
buy-side (investor-driven) institutional traders, to divide
large trades into several smaller trades to manage market
impact and risk.[4][5]

Algorithmic trading may be used in any investment strategy or trading strategy, including market making, interAlgorithmic Trading. Percentage of Market Volume.[14]
market spreading, arbitrage, or pure speculation (including trend following). The investment decision and implementation may be augmented at any stage with algorith- A third of all European Union and United States stock
trades in 2006 were driven by automatic programs, or
mic support or may operate completely automatically.
algorithms.[15] As of 2009, studies suggested HFT rms
Many types of algorithmic or automated trading activ- accounted for 60-73% of all US equity trading volities can be described as high-frequency trading (HFT), ume, with that number falling to approximately 50% in
which is a specialized form of algorithmic trading charac- 2012.[16][17] In 2006, at the London Stock Exchange, over
terized by high turnover and high order-to-trade ratios.[6] 40% of all orders were entered by algorithmic traders,
As a result, in February 2012, the Commodity Futures with 60% predicted for 2007. American markets and
Trading Commission (CFTC) formed a special working European markets generally have a higher proportion of
group that included academics and industry experts to algorithmic trades than other markets, and estimates for
advise the CFTC on how best to dene HFT.[7][8] HFT 2008 range as high as an 80% proportion in some marstrategies utilize computers that make elaborate decisions kets. Foreign exchange markets also have active algorithto initiate orders based on information that is received mic trading (about 25% of orders in 2006).[18] Futures
electronically, before human traders are capable of pro- markets are considered fairly easy to integrate into algocessing the information they observe. Algorithmic trad- rithmic trading,[19] with about 20% of options volume
ing and HFT have resulted in a dramatic change of the expected to be computer-generated by 2010.[20] Bond
market microstructure, particularly in the way liquidity markets are moving toward more access to algorithmic
is provided.[9]
traders.[21]

Algorithmic trading and HFT have been the subject

of much public debate since the U.S. Securities and
Exchange Commission and the Commodity Futures
Trading Commission said in reports that an algorithmic trade entered by a mutual fund company triggered a wave of selling that led to the 2010 Flash
Crash.[22][23][24][25][26][27][28][29] The same reports found
HFT strategies may have contributed to subsequent
volatility by rapidly pulling liquidity from the market. As
a result of these events, the Dow Jones Industrial Average suered its second largest intraday point swing ever
to that date, though prices quickly recovered. (See List
of largest daily changes in the Dow Jones Industrial Average.) A July, 2011 report by the International Organization of Securities Commissions (IOSCO), an interna-

Emblematic examples

Protability projections by the TABB Group, a nancial services industry research rm, for the US equities
HFT industry were US$1.3 billion before expenses for
2014,[10] signicantly down on the maximum of US$21
billion that the 300 securities rms and hedge funds that
then specialized in this type of trading took in prots
in 2008,[11] which the authors had then called relatively
small and surprisingly modest when compared to the
markets overall trading volume. In March 2014, Virtu
Financial, a high-frequency trading rm, reported that
during ve years the rm as a whole was protable on
1

3 STRATEGIES

tional body of securities regulators, concluded that while

algorithms and HFT technology have been used by market participants to manage their trading and risk, their
usage was also clearly a contributing factor in the ash
crash event of May 6, 2010.[30][31] However, other researchers have reached a dierent conclusion. One 2010
study found that HFT did not signicantly alter trading
inventory during the Flash Crash.[32] Some algorithmic
trading ahead of index fund rebalancing transfers prots
from investors.[33][34][35]

the bid and oer prices, decreasing the market-makers

trading advantage, thus increasing market liquidity.

Robert Greifeld, NASDAQ CEO, April 2011[37]

History

Computerization of the order ow in nancial markets

began in the early 1970s, with some landmarks being the introduction of the New York Stock Exchange's
designated order turnaround system (DOT, and later
SuperDOT), which routed orders electronically to the
proper trading post, which executed them manually. The
opening automated reporting system (OARS) aided the
specialist in determining the market clearing opening
price (SOR; Smart Order Routing).
Program trading is dened by the New York Stock Exchange as an order to buy or sell 15 or more stocks valued
at over US$1 million total. In practice this means that all
program trades are entered with the aid of a computer. In
the 1980s, program trading became widely used in trading between the S&P 500 equity and futures markets.
In stock index arbitrage a trader buys (or sells) a stock
index futures contract such as the S&P 500 futures and
sells (or buys) a portfolio of up to 500 stocks (can
be a much smaller representative subset) at the NYSE
matched against the futures trade. The program trade at
the NYSE would be pre-programmed into a computer to
enter the order automatically into the NYSEs electronic
order routing system at a time when the futures price and
the stock index were far enough apart to make a prot.
At about the same time portfolio insurance was designed
to create a synthetic put option on a stock portfolio by
dynamically trading stock index futures according to a
computer model based on the BlackScholes option pricing model.
Both strategies, often simply lumped together as program trading, were blamed by many people (for example by the Brady report) for exacerbating or even starting
the 1987 stock market crash. Yet the impact of computer driven trading on stock market crashes is unclear
and widely discussed in the academic community.[36]
Financial markets with fully electronic execution and
similar electronic communication networks developed in
the late 1980s and 1990s. In the U.S., decimalization,
which changed the minimum tick size from 1/16 of a
dollar (US$0.0625) to US$0.01 per share, may have encouraged algorithmic trading as it changed the market microstructure by permitting smaller dierences between

This increased market liquidity led to institutional traders

splitting up orders according to computer algorithms so
they could execute orders at a better average price. These
average price benchmarks are measured and calculated by
computers by applying the time-weighted average price or
more usually by the volume-weighted average price.
It is over. The trading that existed down the centuries
has died. We have an electronic market today. It is the
present. It is the future.

A further encouragement for the adoption of algorithmic trading in the nancial markets came in 2001 when
a team of IBM researchers published a paper[38] at the
International Joint Conference on Articial Intelligence
where they showed that in experimental laboratory versions of the electronic auctions used in the nancial markets, two algorithmic strategies (IBMs own MGD, and
Hewlett-Packard's ZIP) could consistently out-perform
human traders. MGD was a modied version of the GD
algorithm invented by Steven Gjerstad & John Dickhaut
in 1996/7;[39] the ZIP algorithm had been invented at HP
by Dave Cli (professor) in 1996.[40] In their paper, the
IBM team wrote that the nancial impact of their results
showing MGD and ZIP outperforming human traders
"...might be measured in billions of dollars annually"; the
IBM paper generated international media coverage.
As more electronic markets opened, other algorithmic
trading strategies were introduced. These strategies are
more easily implemented by computers, because machines can react more rapidly to temporary mispricing
and examine prices from several markets simultaneously.
For example, Chameleon (developed by BNP Paribas),
Stealth[41] (developed by the Deutsche Bank), Sniper
and Guerilla (developed by Credit Suisse[42] ), arbitrage,
statistical arbitrage, trend following, and mean reversion.
This type of trading is what is driving the new demand
for Low Latency Proximity Hosting and Global Exchange
Connectivity. It is imperative to understand what latency
is when putting together a strategy for electronic trading.
Latency refers to the delay between the transmission of
information from a source and the reception of the information at a destination. Latency is, as a lower bound, determined by the speed of light; this corresponds to about
3.3 milliseconds per 1,000 kilometers of optical bre.
Any signal regenerating or routing equipment introduces
greater latency than this lightspeed baseline.

3 Strategies

3.4

3.1

Arbitrage

Trading ahead of index fund rebalanc- temporal state and a positive cash ow in at least one state;
in simple terms, it is the possibility of a risk-free prot at
ing

Most retirement savings, such as private pension funds or

401(k) and individual retirement accounts in the US, are
invested in mutual funds, the most popular of which are
index funds which must periodically rebalance or adjust
their portfolio to match the new prices and market capitalization of the underlying securities in the stock or other
index that they track.[43][44] Prots are transferred from
investors to algorithmic traders, estimated to be at least
21 to 28 basis points annually for S&P 500 index funds,
and at least 38 to 77 basis points per year for Russell 2000
funds.[34] John Montgomery of Bridgeway Capital Management says that the resulting poor investor returns
from trading ahead of mutual funds is the elephant in the
room that shockingly, people are not talking about.[35]

zero cost. Example: One of the most popular Arbitrage

trading opportunities is played with the S&P futures and
the S&P 500 stocks. During most trading days these two
will develop disparity in the pricing between the two of
them. This happens when the price of the stocks which
are mostly traded on the NYSE and NASDAQ markets
either get ahead or behind the S&P Futures which are
traded in the CME market.
3.4.1 Conditions for arbitrage
Further information:
mechanics

Rational pricing Arbitrage

Arbitrage is possible when one of three conditions is met:

3.2

Pairs trading

Pairs trading or pair trading is a long-short, ideally

market-neutral strategy enabling traders to prot from
transient discrepancies in relative value of close substitutes. Unlike in the case of classic arbitrage, in case of
pairs trading, the law of one price cannot guarantee convergence of prices. This is especially true when the strategy is applied to individual stocks - these imperfect substitutes can in fact diverge indenitely. In theory the longshort nature of the strategy should make it work regardless of the stock market direction. In practice, execution
risk, persistent and large divergences, as well as a decline
in volatility can make this strategy unprotable for long
periods of time (e.g. 2004-7). It belongs to wider categories of statistical arbitrage, convergence trading, and
relative value strategies.[45]

3.3

Delta-neutral strategies

The same asset does not trade at the same price on

all markets (the "law of one price" is temporarily
violated).
Two assets with identical cash ows do not trade at
the same price.
An asset with a known price in the future does not
today trade at its future price discounted at the riskfree interest rate (or, the asset does not have negligible costs of storage; as such, for example, this
condition holds for grain but not for securities).
Arbitrage is not simply the act of buying a product in one
market and selling it in another for a higher price at some
later time. The long and short transactions should ideally
occur simultaneously to minimize the exposure to market risk, or the risk that prices may change on one market before both transactions are complete. In practical
terms, this is generally only possible with securities and
nancial products which can be traded electronically, and
even then, when rst leg(s) of the trade is executed, the
prices in the other legs may have worsened, locking in a
guaranteed loss. Missing one of the legs of the trade (and
subsequently having to open it at a worse price) is called
'execution risk' or more specically 'leg-in and leg-out
risk'.[lower-alpha 1]

In nance, delta-neutral describes a portfolio of related

nancial securities, in which the portfolio value remains
unchanged due to small changes in the value of the underlying security. Such a portfolio typically contains options and their corresponding underlying securities such
that positive and negative delta components oset, resulting in the portfolios value being relatively insensitive to
In the simplest example, any good sold in one market
changes in the value of the underlying security.
should sell for the same price in another. Traders may, for
example, nd that the price of wheat is lower in agricultural regions than in cities, purchase the good, and trans3.4 Arbitrage
port it to another region to sell at a higher price. This
In economics and nance, arbitrage /rbtr/ is the type of price arbitrage is the most common, but this simpractice of taking advantage of a price dierence be- ple example ignores the cost of transport, storage, risk,
tween two or more markets: striking a combination of and other factors. True arbitrage requires that there be
matching deals that capitalize upon the imbalance, the no market risk involved. Where securities are traded on
prot being the dierence between the market prices. more than one exchange, arbitrage occurs by simultaneWhen used by academics, an arbitrage is a transaction ously buying in one and selling on the other. Such sithat involves no negative cash ow at any probabilistic or multaneous execution, if perfect substitutes are involved,

3 STRATEGIES

minimizes capital requirements, but in practice never creates a self-nancing (free) position, as many sources incorrectly assume following the theory. As long as there is
some dierence in the market value and riskiness of the
two legs, capital would have to be put up in order to carry
the long-short arbitrage position.

3.7 Transaction cost reduction

Most strategies referred to as algorithmic trading (as

well as algorithmic liquidity-seeking) fall into the costreduction category. The basic idea is to break down a
large order into small orders and place them in the market over time. The choice of algorithm depends on various factors, with the most important being volatility and
liquidity of the stock. For example, for a highly liquid
stock, matching a certain percentage of the overall or3.5 Mean reversion
ders of stock (called volume inline algorithms) is usually
a good strategy, but for a highly illiquid stock, algorithms
Mean reversion is a mathematical methodology some- try to match every order that has a favorable price (called
times used for stock investing, but it can be applied to liquidity-seeking algorithms).
other processes. In general terms the idea is that both
a stocks high and low prices are temporary, and that a The success of these strategies is usually measured by
stocks price tends to have an average price over time. comparing the average price at which the entire order
An example of a mean-reverting process is the Ornstein- was executed with the average price achieved through a
benchmark execution for the same duration. Usually, the
Uhlenbeck stochastic equation.
volume-weighted average price is used as the benchmark.
Mean reversion involves rst identifying the trading range At times, the execution price is also compared with the
for a stock, and then computing the average price using price of the instrument at the time of placing the order.
analytical techniques as it relates to assets, earnings, etc.
A special class of these algorithms attempts to detect alWhen the current market price is less than the average gorithmic or iceberg orders on the other side (i.e. if you
price, the stock is considered attractive for purchase, with are trying to buy, the algorithm will try to detect orders
the expectation that the price will rise. When the current for the sell side). These algorithms are called sning almarket price is above the average price, the market price gorithms. A typical example is Stealth.
is expected to fall. In other words, deviations from the
Some examples of algorithms are TWAP, VWAP, Impleaverage price are expected to revert to the average.
mentation shortfall, POV, Display size, Liquidity seeker,
The standard deviation of the most recent prices (e.g., the and Stealth. Modern algorithms are often optimally conlast 20) is often used as a buy or sell indicator.
structed via either static or dynamic programming .[46]
[47]
Stock reporting services (such as Yahoo! Finance, MS
Investor, Morningstar, etc.), commonly oer moving averages for periods such as 50 and 100 days. While reporting services provide the averages, identifying the high and 3.8 Strategies that only pertain to dark
pools
low prices for the study period is still necessary.

3.6

Scalping

Scalping is liquidity provision by non-traditional market

makers, whereby traders attempt to earn (or make) the
bid-ask spread. This procedure allows for prot for so
long as price moves are less than this spread and normally
involves establishing and liquidating a position quickly,
usually within minutes or less.
A market maker is basically a specialized scalper. The
volume a market maker trades is many times more
than the average individual scalper and would make use
of more sophisticated trading systems and technology.
However, registered market makers are bound by exchange rules stipulating their minimum quote obligations.
For instance, NASDAQ requires each market maker to
post at least one bid and one ask at some price level, so
as to maintain a two-sided market for each stock represented.

Recently, HFT, which comprises a broad set of buyside as well as market making sell side traders, has become more prominent and controversial.[48] These algorithms or techniques are commonly given names such
as Stealth (developed by the Deutsche Bank), Iceberg, Dagger, Guerrilla, Sniper, BASOR (developed by Quod Financial) and Snier.[49] Dark pools
are alternative trading systems that are private in nature
and thus do not interact with public order owand
seek instead to provide undisplayed liquidity to large
blocks of securities.[50] In dark pools trading takes place
anonymously, with most orders hidden or iceberged.[51]
Gamers or sharks sni out large orders by pinging
small market orders to buy and sell. When several small
orders are lled the sharks may have discovered the presence of a large iceberged order.
Now its an arms race, said Andrew Lo, director of the
Massachusetts Institute of Technologys Laboratory for
Financial Engineering. Everyone is building more sophisticated algorithms, and the more competition exists,
the smaller the prots.[52]

4.3

Event arbitrage

High-frequency trading

Main article: High-frequency trading

As noted above, high-frequency trading (HFT) is a form
of algorithmic trading characterized by high turnover
and high order-to-trade ratios. Although there is no
single denition of HFT, among its key attributes are
highly sophisticated algorithms, specialized order types,
co-location, very short-term investment horizons, and
high cancellation rates for orders.[6] In the U.S., highfrequency trading (HFT) rms represent 2% of the approximately 20,000 rms operating today, but account
for 73% of all equity trading volume. As of the rst
quarter in 2009, total assets under management for hedge
funds with HFT strategies were US$141 billion, down
about 21% from their high.[53] The HFT strategy was
rst made successful by Renaissance Technologies.[54]
High-frequency funds started to become especially popular in 2007 and 2008.[54] Many HFT rms are market
makers and provide liquidity to the market, which has
lowered volatility and helped narrow Bid-oer spreads
making trading and investing cheaper for other market
participants.[53][55][56] HFT has been a subject of intense
public focus since the U.S. Securities and Exchange Commission and the Commodity Futures Trading Commission stated that both algorithmic trading and HFT contributed to volatility in the 2010 Flash Crash. Among
the major U.S. high frequency trading rms are Chicago
Trading, Virtu Financial, Timber Hill, ATD, GETCO,
and Citadel LLC.[57]

5
gives a relation between the prices of a domestic bond, a
bond denominated in a foreign currency, the spot price of
the currency, and the price of a forward contract on the
currency. If the market prices are suciently dierent
from those implied in the model to cover transaction cost
then four transactions can be made to guarantee a riskfree prot. HFT allows similar arbitrages using models
of greater complexity involving many more than 4 securities. The TABB Group estimates that annual aggregate
prots of low latency arbitrage strategies currently exceed US$21 billion.[16]
A wide range of statistical arbitrage strategies have been
developed whereby trading decisions are made on the
basis of deviations from statistically signicant relationships. Like market-making strategies, statistical arbitrage
can be applied in all asset classes.

4.3 Event arbitrage

A subset of risk, merger, convertible, or distressed securities arbitrage that counts on a specic event, such as
a contract signing, regulatory approval, judicial decision,
etc., to change the price or rate relationship of two or
more nancial instruments and permit the arbitrageur to
earn a prot.[59]

There are four key categories of HFT strategies: marketmaking based on order ow, market-making based on
tick data information, event arbitrage and statistical arbitrage. All portfolio-allocation decisions are made by
computerized quantitative models. The success of computerized strategies is largely driven by their ability to simultaneously process volumes of information, something
ordinary human traders cannot do.

Merger arbitrage also called risk arbitrage would be an

example of this. Merger arbitrage generally consists of
buying the stock of a company that is the target of a
takeover while shorting the stock of the acquiring company. Usually the market price of the target company
is less than the price oered by the acquiring company.
The spread between these two prices depends mainly on
the probability and the timing of the takeover being completed as well as the prevailing level of interest rates. The
bet in a merger arbitrage is that such a spread will eventually be zero, if and when the takeover is completed.
The risk is that the deal breaks and the spread massively
widens.

4.1

4.4 Spoong

Market making

Market making involves placing a limit order to sell (or

oer) above the current market price or a buy limit order
(or bid) below the current price on a regular and continuous basis to capture the bid-ask spread. Automated Trading Desk, which was bought by Citigroup in July 2007,
has been an active market maker, accounting for about
6% of total volume on both NASDAQ and the New York
Stock Exchange.[58]

Main article: Layering (nance)

One strategy that some traders have employed, which has

been proscribed yet likely continues, is called spoong.
It is the act of placing orders to give the impression of
wanting to buy or sell shares, without ever having the intention of letting the order execute to temporarily manipulate the market to buy or sell shares at a more favorable
price. This is done by creating limit orders outside the
current bid or ask price to change the reported price to
4.2 Statistical arbitrage
other market participants. The trader can subsequently
Another set of HFT strategies in classical arbitrage strat- place trades based on the articial change in price, then
egy might involve several securities such as covered canceling the limit orders before they are executed.
interest rate parity in the foreign exchange market which Suppose a trader desires to sell shares of a company with a

7 ISSUES AND DEVELOPMENTS

current bid of $20 and a current ask of $20.20. The trader

would place a buy order at $20.10, still some distance
from the ask so it will not be executed, and the $20.10
bid is reported as the National Best Bid and Oer best
bid price. The trader then executes a market order for the
sale of the shares they wished to sell. Because the best
bid price is the investors articial bid, a market maker
lls the sale order at $20.10, allowing for a $.10 higher
sale price per share. The trader subsequently cancels their
limit order on the purchase he never had the intention of
completing.

constantly altered to reect the subtle changes in the market as well as to combat the threat of the strategy being
reverse engineered by competitors. This is due to the evolutionary nature of algorithmic trading strategies they
must be able to adapt and trade intelligently, regardless of
market conditions, which involves being exible enough
to withstand a vast array of market scenarios. As a result,
a signicant proportion of net revenue from rms is spent
on the R&D of these autonomous trading systems.[16]

6 Strategy implementation
4.5

Quote stung

Main article: Quote stung

Quote stung is a tactic employed by high-frequency
traders that involves quickly entering and withdrawing
large quantities of orders in an attempt to ood the market, thereby gaining an advantage over slower market
participants.[60] The rapidily placed and canceled orders
cause market data feeds that ordinary investors rely on to
delay price quotes while the stung is occurring. HFT
rms benet from proprietary, higher-capacity feeds and
the most capable, lowest latency infrastructure. Researchers showed high-frequency traders are able to prot
by the articially induced latencies and arbitrage opportunities that result from quote stung.[61]

Most of the algorithmic strategies are implemented using

modern programming languages, although some still implement strategies designed in spreadsheets. Increasingly,
the algorithms used by large brokerages and asset managers are written to the FIX Protocols Algorithmic Trading Denition Language (FIXatdl), which allows rms
receiving orders to specify exactly how their electronic
orders should be expressed. Orders built using FIXatdl
can then be transmitted from traders systems via the FIX
Protocol.[66] Basic models can rely on as little as a linear regression, while more complex game-theoretic and
pattern recognition[67] or predictive models can also be
used to initiate trading. Neural networks and genetic programming have been used to create these models.

7 Issues and developments

5

Low Latency Trading Systems

Algorithmic trading has been shown to substantially improve market liquidity[68] among other benets. HowNetwork-induced latency, a synonym for delay, measured ever, improvements in productivity brought by algorithin one-way delay or round-trip time, is normally dened mic trading have been opposed by human brokers and
as how much time it takes for a data packet to travel from traders facing sti competition from computers.
one point to another.[62] Low latency trading refers to the
algorithmic trading systems and network routes used by
nancial institutions connecting to stock exchanges and 7.1 Cyborg Finance
Electronic communication networks (ECNs) to rapidly
execute nancial transactions.[63] Most HFT rms de- Technological advances in nance, particularly those
pend on low latency execution of their trading strategies. relating to algorithmic trading, has increased nancial
Joel Hasbrouck and Gideon Saar (2013) measure latency speed, connectivity, reach, and complexity while simultabased on three components: the time it takes for 1) in- neously reducing its humanity. Computers running softformation to reach the trader, 2) the traders algorithms ware based on complex algorithms have replaced humans
to analyze the information, and 3) the generated action to in many functions in the nancial industry. Finance is
reach the exchange and get implemented.[64] In a contem- essentially becoming an industry where machines and
porary electronic market (circa 2009), low latency trade humans share the dominant roles transforming modinto what one scholar has called, cyborg
processing time was qualied as under 10 milliseconds, ern nance
[69]
nance.
[65]
and ultra-low latency as under 1 millisecond.
Low-latency traders depend on ultra-low latency networks. They prot by providing information, such as
competing bids and oers, to their algorithms microseconds faster than their competitors.[16] The revolutionary
advance in speed has led to the need for rms to have
a real-time, colocated trading platform to benet from
implementing high-frequency strategies.[16] Strategies are

7.2 Concerns
While many experts laud the benets of innovation in
computerized algorithmic trading, other analysts have expressed concern with specic aspects of computerized
trading.

7.3

Recent developments

The downside with these systems is their

black box-ness, Mr. Williams said. Traders
have intuitive senses of how the world works.
But with these systems you pour in a bunch of
numbers, and something comes out the other
end, and its not always intuitive or clear why
the black box latched onto certain data or relationships. [52]

Flash Crash,[22][24] when the Dow Jones Industrial Average plunged about 600 points only to recover those losses
within minutes. At the time, it was the second largest
point swing, 1,010.14 points, and the biggest one-day
point decline, 998.5 points, on an intraday basis in Dow
Jones Industrial Average history.[76]

The Financial Services Authority has been

keeping a watchful eye on the development of
black box trading. In its annual report the regulator remarked on the great benets of eciency that new technology is bringing to the
market. But it also pointed out that 'greater
reliance on sophisticated technology and modelling brings with it a greater risk that systems
failure can result in business interruption'. [70]

Financial market news is now being formatted by rms

such as Need To Know News, Thomson Reuters, Dow
Jones, and Bloomberg, to be read and traded on via algorithms.

UK Treasury minister Lord Myners has

warned that companies could become the
playthings of speculators because of automatic high-frequency trading. Lord Myners
said the process risked destroying the relationship between an investor and a company.[71]
Other issues include the technical problem of latency or
the delay in getting quotes to traders,[72] security and the
possibility of a complete system breakdown leading to a
market crash.[73]
Goldman spends tens of millions of dollars on this stu. They have more people working in their technology area than people on the
trading desk...The nature of the markets has
changed dramatically. [74]
On August 1, 2012 Knight Capital Group experienced
a technology issue in their automated trading system,[75]
causing a loss of $440 million.
This issue was related to Knights installation of trading software and resulted in Knight
sending numerous erroneous orders in NYSElisted securities into the market. This software
has been removed from the companys systems.
[..] Clients were not negatively aected by the
erroneous orders, and the software issue was
limited to the routing of certain listed stocks to
NYSE. Knight has traded out of its entire erroneous trade position, which has resulted in
a realized pre-tax loss of approximately $440
million.
Algorithmic and high-frequency trading were shown to
have contributed to volatility during the May 6, 2010

7.3 Recent developments

Computers are now being used to generate

news stories about company earnings results or
economic statistics as they are released. And
this almost instantaneous information forms a
direct feed into other computers which trade
on the news.[77]
The algorithms do not simply trade on simple news stories but also interpret more dicult to understand news.
Some rms are also attempting to automatically assign
sentiment (deciding if the news is good or bad) to news
stories so that automated trading can work directly on the
news story.[78]
Increasingly, people are looking at all
forms of news and building their own indicators around it in a semi-structured way, as
they constantly seek out new trading advantages said Rob Passarella, global director of
strategy at Dow Jones Enterprise Media Group.
His rm provides both a low latency news feed
and news analytics for traders. Passarella also
pointed to new academic research being conducted on the degree to which frequent Google
searches on various stocks can serve as trading indicators, the potential impact of various
phrases and words that may appear in Securities and Exchange Commission statements and
the latest wave of online communities devoted
to stock trading topics.[78]
Markets are by their very nature conversations, having grown out of coee houses and
taverns, he said. So the way conversations
get created in a digital society will be used to
convert news into trades, as well, Passarella
said.[78]
There is a real interest in moving the process of interpreting news from the humans to
the machines says Kirsti Suutari, global business manager of algorithmic trading at Reuters.
More of our customers are nding ways to use
news content to make money.[77]

10

An example of the importance of news reporting speed to

algorithmic traders was an advertising campaign by Dow
Jones (appearances included page W15 of the Wall Street
Journal, on March 1, 2008) claiming that their service had
beaten other news services by two seconds in reporting an
interest rate cut by the Bank of England.

COMMUNICATION STANDARDS

milliseconds and even microseconds, have become very

important.[84][85]
More fully automated markets such as NASDAQ, Direct
Edge and BATS (formerly an acronym for Better Alternative Trading System) in the US, have gained market
share from less automated markets such as the NYSE.
Economies of scale in electronic trading have contributed
to lowering commissions and trade processing fees, and
contributed to international mergers and consolidation of
nancial exchanges.

In July 2007, Citigroup, which had already developed its

own trading algorithms, paid $680 million for Automated
Trading Desk, a 19-year-old rm that trades about 200
million shares a day.[79] Citigroup had previously bought
Lava Trading and OnTrade Inc.
Competition is developing among exchanges for the
In late 2010, The UK Government Oce for Science ini- fastest processing times for completing trades. For examtiated a Foresight project investigating the future of com- ple, in June 2007, the London Stock Exchange launched
puter trading in the nancial markets,[80] led by Dame a new system called TradElect that promises an averClara Furse, ex-CEO of the London Stock Exchange and age 10 millisecond turnaround time from placing an orin September 2011 the project published its initial nd- der to nal conrmation and can process 3,000 orders
ings in the form of a three-chapter working paper avail- per second.[86] Since then, competitive exchanges have
able in three languages, along with 16 additional papers continued to reduce latency with turnaround times of 3
that provide supporting evidence.[81] All of these nd- milliseconds available. This is of great importance to
ings are authored or co-authored by leading academics high-frequency traders, because they have to attempt to
and practitioners, and were subjected to anonymous peer- pinpoint the consistent and probable performance ranges
review. Released in 2012, the Foresight study acknowl- of given nancial instruments. These professionals are
edged issues related to periodic illiquidity, new forms of often dealing in versions of stock index funds like the
manipulation and potential threats to market stability due E-mini S&Ps, because they seek consistency and riskto errant algorithms or excessive message trac. How- mitigation along with top performance. They must lever, the report was also criticized for adopting standard ter market data to work into their software programming
pro-HFT arguments and advisory panel members being so that there is the lowest latency and highest liquidity
at the time for placing stop-losses and/or taking proflinked to the HFT industry.[82]
its. With high volatility in these markets, this becomes a
complex and potentially nerve-wracking endeavor, where
a small mistake can lead to a large loss. Absolute fre8 Technical design
quency data play into the development of the traders preprogrammed instructions.[87]
The technical designs of such systems are not standardized. Conceptually, the design can be divided into logical In the U.S., spending on computers and software in the
nancial industry increased to $26.4 billion in 2005.[4][88]
units:
1. The data stream unit (the part of the systems that
receives data such as quotes and news from external
sources)
2. The decision or strategy unit
3. The execution unit
With the wide use of social networks, some systems implement scanning or screening technologies to read posts
of users extracting human sentiment and inuence the
trading strategies. [83]

Eects

10 Communication standards
Algorithmic trades require communicating considerably
more parameters than traditional market and limit orders.
A trader on one end (the "buy side") must enable their
trading system (often called an "order management system" or "execution management system") to understand
a constantly proliferating ow of new algorithmic order
types. The R&D and other costs to construct complex
new algorithmic orders types, along with the execution
infrastructure, and marketing costs to distribute them, are
fairly substantial. What was needed was a way that marketers (the "sell side") could express algo orders electronically such that buy-side traders could just drop the new
order types into their system and be ready to trade them
without constant coding custom new order entry screens
each time.

Though its development may have been prompted by decreasing trade sizes caused by decimalization, algorithmic trading has reduced trade sizes further. Jobs once
done by human traders are being switched to comput- FIX Protocol is a trade association that publishes free,
ers. The speeds of computer connections, measured in open standards in the securities trading area. The FIX

9
language was originally created by Fidelity Investments,
and the association Members include virtually all large
and many midsized and smaller broker dealers, money
center banks, institutional investors, mutual funds, etc.
This institution dominates standard setting in the pretrade and trade areas of security transactions. In 20062007 several members got together and published a draft
XML standard for expressing algorithmic order types.
The standard is called FIX Algorithmic Trading Denition Language (FIXatdl).[89]

11

See also

2010 Flash Crash

Alternative trading system
Articial intelligence
Best Execution
Complex event processing
Electronic trading platform

[7] CFTC Panel Urges Broad Denition of High-Frequency

Trading, Bloomberg News, June 20, 2012
[8] Futures Trading Commission Votes to Establish a New
Subcommittee of the Technology Advisory Committee
(TAC) to focus on High Frequency Trading, February 9,
2012, Commodity Futures Trading Commission
[9] Easley, D., M. Lpez de Prado, M. O'Hara: The Microstructure of the 'Flash Crash': Flow Toxicity, Liquidity Crashes and the Probability of Informed Trading, The
Journal of Portfolio Management, Vol. 37, No. 2, pp.
118128, Winter, 2011, SSRN 1695041
[10] FT.com (3 April 2014). Fierce competition forces ash
HFT rms into new markets.
[11] Opalesque (4 August 2009). Opalesque Exclusive: Highfrequency trading under the microscope.
[12] Virtu Financial Form S-1, available at
//www.sec.gov/Archives/edgar/data/1592386/
000104746914002070/a2218589zs-1.htm

https:

[13] Laughlin, G. Insights into High Frequency Trading from

the Virtu Financial IPO WSJ.com Retrieved 22 May
2015.

High-frequency trading

[14] Morton Glantz, Robert Kissell. Multi-Asset Risk Modeling: Techniques for a Global Economy in an Electronic and
Algorithmic Trading Era. Academic Press, Dec 3, 2013,
p. 258.

Mirror trading

[15]

FIXatdl

Technical analysis

12

Notes

[1] As an arbitrage consists of at least two trades, the

metaphor is of putting on a pair of pants, one leg (trade)
at a time. The risk that one trade (leg) fails to execute is
thus 'leg risk'.

13

References

[1] The New Financial Industry, Alabama Law Review, available at: http://ssrn.com/abstract=2417988
[2] Lemke and Lins, Soft Dollars and Other Trading Activities, 2:30 (Thomson West, 2015-2016 ed.).
[3] The New Investor, UCLA Law Review, available at: http:
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[5] Algorithmic Trading: Hype or Reality?
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14 External links

12

15

15
15.1

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Text and image sources, contributors, and licenses

Text

Algorithmic trading Source: https://en.wikipedia.org/wiki/Algorithmic_trading?oldid=711013829 Contributors: Edward, Jdoherty,

JASpencer, Sunray, Mattaschen, Bnn, Khalid hassani, Beland, Quarl, Karol Langner, Elroch, Now3d, Seer, Leibniz, Bender235, Flashgreen~enwiki, Vipul, Cretog8, Viriditas, Jimg, Alex.g, Woohookitty, Mrkwpalmer, GregorB, Waldir, Ronnotel, DavidCane, Rjwilmsi,
X1011, Lmatt, Digitalme, Gwernol, Dili, Rsrikanth05, Yahya Abdal-Aziz, Rjlabs, Voidxor, LisaCarrol, Glich, Sameer81, Fram, JLaTondre, Killerandy, Groyolo, Capitalist, DocendoDiscimus, Veinor, SmackBot, Afekz, Gilliam, DomQ, Ohnoitsjamie, Anwar saadat, Oli Filth,
Pdek, Mitsuhirato, Smallbones, DMacks, A5b, Lambiam, Polihale, Kuru, Giric, Evenios, Ckatz, Hu12, Papertiger, Iridescent, Chrismartins,
Trade2tradewell, Eastlaw, Mellery, CmdrObot, The ed17, Justin.short, Jesse Viviano, Joelholdsworth, John M Baker, Krauss, DumbBOT,
Faust.ua, Diabloblue, Headbomb, Michael A. White, Wai Wai, Pi314159, SummerPhD, Adam Chlipala, Deective, Davewho2, Barek,
MER-C, TAnthony, Magioladitis, Eganesan, VoABot II, Nakkisormi, SSZ, JohnLai, Strateg68, DGG, Kgeis, Jim.henderson, EdBever,
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Jojalozzo, Cheesefondue, HotBridge, Bbosh, PixelBot, Pladook, Iohannes Animosus, ChrisHodgesUK, Vagieray, Erwinduke, XLinkBot,
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Comp.arch, Tonytonov, Shearyer, Glins1, Ari.benesh, WallStreet7177, WPGA2345, Stamptrader, FinancialResearchGroup, ICP Group
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Gragre123, Fundron1, Rmh789, MpowerTrading, Loraof, Potemkin70, 1744Y, AlgoTradingSoftware, D9TyEUVIG9, Jldalldorf, Hillbilly
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