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High-frequency trading (HFT) is fundamentally based on how market participants (for this discussion I'm talking about stock markets) place their orders to buy and sell shares and how HFT players act on those orders.
For every stock that's traded there is always (or at least it used to be "always") a "bid" and an "ask" price. Sometimes you'll hear the term "offer" or "offered" price, those terms are interchangeable with the term "ask" or "asking price."
The bid price is the price which someone is "bidding," or willing to pay to own shares. The ask price is the price which someone is willing to sell shares, or is "offering" or "asking" to sell at.
Bids and offers each come with the quantity of shares that the buyer or seller want to trade. There are millions of bids and offers made all day long, every trading day.
In fact, for every stock there are many bids and offers at several different prices.
The best bid, the highest price someone is willing to pay and how many shares they are willing to buy, and the best offered price, the lowest price at which someone is willing to sell their shares, constitutes a stock's current "quote."
In the U.S. we call that quote the NBBO, or national best bid and offer. But there are almost always other bids at lower prices and other offers at higher prices for all stocks.
High-frequency traders employ pattern recognition algorithms that look deeply at bids and offers on stocks to determine if the movement on the bid quotes or offered quotes implies a directional tendency.
Computer-driven algorithms are "reading" the quotes, the intentions of buyers and sellers as they put down their orders in real-time, to make a trade that the higher frequency trader expects to profit from if the directional bias their computers pick up is correct.
High-frequency trading computers look at all the bids and offers wherever any stock is traded. Sometimes stocks are traded at several different exchanges or "venues" at the same time.
But trading the price discrepancies that sometimes occur because there are different quotes at the same time at different exchanges for the same stocks isn't where high-frequency traders make their money, although they do that, too.
What the high-frequency traders actually do more is "high-frequency quoting."
They [high-frequency traders] have their computers send out their own bids and offers, or quotes, to all the exchanges, almost all the time.
Why High-Frequency Trading Is a Scam
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About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.