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Setting Up Protection From HFT Predation

stock market numbersWhile the majority of high frequency trader (HFT) activity in the market is deemed as positive by many participants (such as market making, cross asset/market arbitrage, and statistical arbitrage), there are strategies that exist which are believed to be ‘predatory’ in nature.

To protect themselves, institutional investors should take steps. Here are some ways that they can protect themselves from HFT predation:

Examples of Some HFT Strategies Deemed as ‘Predatory’*

Strategy

Type

Description

     

Order anticipation

Directional

Detecting and trying to trade in front of what is expected to be large trading interest by using publicly available exchange data (price, volume, bid-ask…)

Dark order signaling

Directional

Detecting and trying to trade in front of what is expected to be large trading interest by using ‘dark pinging’ strategies or by using publicly available ‘dark’ execution data

Momentum ignition

Directional

Initiating a series of order and trades in an attempt to ignite a rapid price move either up or down and incite others to trade at artificially high or low prices

Layering

Directional

Placing multiple, large orders to ‘push’ the book away, which could temporarily create artificially low or high prices that can be acted upon by incoming orders

Latency gaming

Structural

Anticipating orders via the use of speed through co-location to exploit the latency differentials caused by the geographical separation of marketplaces

Benefiting from ‘stale’ quote data

Structural

Generating orders via the use of co-location and direct data feeds to take advantage of the ‘stale’ quote data from marketplaces that use a slower data feed (Ie. the SIP in the U.S.)

Quote stuffing

Structural

Sending an unusual number of orders to trade a security and immediately cancelling them to ‘flood’ trading systems with excessive market data messages (causes latency disruptions)

Sub-penny queue jumping

Structural

Using the structure of the marketplace fees (maker/taker) to improve queue priority of passive orders

Kelly Reynolds is head trader at Hillsdale Investment Management Inc.

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