Computerized and High‐Frequency Trading

AuthorMichael A. Goldstein,Frank C. Graves,Pavitra Kumar
Date01 May 2014
Published date01 May 2014
The Financial Review 49 (2014) 177–202
Computerized and High-Frequency
Michael A. Goldstein
Babson College
Pavitra Kumar
The Brattle Group
Frank C. Graves
The Brattle Group
The use of computers to execute trades, often with very low latency, has increased over
time, resulting in a variety of computer algorithms executing electronically targeted trading
strategies at high speed. Wedescribe the evolution of increasingly fast automated trading over
the past decade and some key features of its associated practices, strategies, and apparent
profitability. We also survey and contrast several studies on the impacts of such high-speed
trading on the performance of securities markets. Finally, we examine some of the regulatory
questions surrounding the need, if any,for safeguards over the fairness and risks of high-speed,
computerized trading.
Keywords: high-frequency trading, HFT, algorithmic trading, market liquidity, market effi-
ciency, price volatility, market regulation
JEL Classifications: G10, G12, G14, G15, G18, G19, G20, G23, G28, G29
Corresponding author: Babson College, Finance Department, 231 Forest Street, Babson Park, MA
02457-0310; Phone: (781) 239-4402; Fax: (781) 239-5004; E-mail:
We thank LyndaBorucki, Bonnie Van Ness and Robert VanNess (the editors), and an anonymous referee
for helpful comments and support. The views expressed in this paper are strictly those of the authors and
do not necessarily state or reflect the views of The Brattle Group, Inc.
C2014 The Eastern Finance Association 177
178 M. A. Goldstein et al./The Financial Review 49 (2014) 177–202
1. Introduction
Rapid, computerized trading refers to the execution of electronic trading
strategies involving extremely fast order submissions, cancellations, and execu-
tions. Such trading is characterized by the use of computer algorithms to an-
alyze quote data and detect and exploit short-lived trading opportunities. The
needed response time is fleeting: U.S. Securities and Exchange Commission
(SEC; 2010, p. 3605) notes “For example, the speed of trading has increased to
the point that the fastest traders now measure their latencies in microseconds.”
Such rapid transactions can be undertaken with the intent to hold securities for
various durations, depending on the motivation for pursuing them in the first place.
One possibility is that firms use rapid computer programs to acquire and hold secu-
rities for quite a while, until new information or valuation signals indicate it is time
to (rapidly) exit.
However, much of the attention focuses on high-speed trading by proprietary
trading firms using computer algorithms. When such trading is deemed “high-
frequency trading,” or HFT, it involves the use of fast, sophisticated computers
and computer algorithms to submit and cancel orders rapidly (and frequently) and to
trade securities quickly, often resulting in very short holding periods.1Some of this
trading is done in anticipation of expected momentum shifts, or it may be pursued
because of perceived arbitrage across the prices of related securities.
Regardless of the reason or strategy, the increase in high-speed, computerized
trading is controversial. Some suggest that such rapid in/out trading is a benign
activity relatively independent of fundamental market values, market efficiency, and
fair access to new information about companies and their securities—like the frothy
turbulence or foam on the longer,slower and deeper surface waves seen at the beach—
and not fundamentally affecting large-scale patterns of movement.2However, if/when
fast trading induces large aberrations in value, perhaps due to failed position limits
1Although the distinction between different kinds of computerized trading (such as algorithmic trading
and HFT) is blurred, SEC (2010, p. 3606) suggests that “One of the most significant market structure
developments in recent years is high frequency trading (‘HFT’). The term is relatively new and is not
yet clearly defined. It typically is used to refer to professional traders acting in a proprietary capacity
that engage in strategies that generate a large number of trades on a daily basis. . . . Other characteristics
often attributed to proprietary firms engaged in HFT are: (1) The use of extraordinarily high-speed and
sophisticated computer programs for generating, routing, and executing orders; (2) use of co-location
services and individual data feeds offered by exchanges and others to minimize network and other types
of latencies; (3) very short time frames for establishing and liquidating positions; (4) the submission of
numerous orders that are cancelled shortly after submission; and (5) ending the trading day in as close to
a flat position as possible (that is, not carrying significant, unhedged positions over-night).”
2A related question is whether orders submitted by HFT and the resultant trades are notably different
than those from non-HFTs. Using a NASDAQ HFT database, Davis, Van Ness and Van Ness (2014)
find that HFT trades notably cluster less on prices that end in zeros or fives (i.e., prices that are end in
$xx.x0 or $xx.x5—dimes and nickels) than do non-HFTs, particularly when HFTs are on both sides of the
transaction (liquidity provider and liquidity demander), providing at least some indication that the nature
of trading changes with increased HFT participation.

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