The Volume Clock

That is the title of a new paper by David Easley, Marcos M. Lopez de Prado, and Maureen O’Hara:

Over the last two centuries, technological advantages have allowed some traders to be faster than others. We argue that, contrary to popular perception, speed is not the defining characteristic that sets High Frequency Trading (HFT) apart. HFT is the natural evolution of a new trading paradigm that is characterized by strategic decisions made in a volume-clock metric. Even if the speed advantage disappears, HFT will evolve to continue exploiting Low Frequency Trading’s (LFT) structural weaknesses. However, LFT practitioners are not defenseless against HFT players, and we offer options that can help them survive and adapt to this new environment.

The paper has many interesting bits, such as this:

Databases with trillions of observations are now commonplace in financial firms. Machine learning methods, such as Nearest Neighbor or Multivariate Embedding algorithms search for patterns within a library of recorded events. This ability to process and learn from what is known as “big data” only reinforces the advantages of HFT’s “event-time” paradigm, very much like how “Deep Blue” could assign probabilities to Kasparov’s next 20 moves, based on hundreds of thousands of past games (or more recently, why Watson could outplay his Jeopardy opponents).

The upshot is that speed makes HFTs more effective, but slowing them down won’t change their basic behavior: Strategic sequential trading in event time.

One message of the paper is that sequential strategic behavior will occur at any speed.  I liked this sentence:

As we have seen, HFT algos can easily detect when there is a human in the trading room, and take advantage.

And the ending bit is this:

There is a natural balance between HFTs and LFTs. Just as in nature the number of predators is limited by the available prey, the number of HFTs is constrained by the available LFT flows. Rather than seeking “endangered species” status for LFTs (by virtue of legislative action like a Tobin tax or speed limit), it seems more efficient and less intrusive to starve some HFTs by making LFTs smarter. Carrier pigeons or dedicated fiber optic cable notwithstanding, the market still operates to provide liquidity and price discovery – only now it does it very quickly and strategically.


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