Section B - HFT and CBT

What is High-Frequency Trading (HFT)?

An automated trading strategy using ultra-fast computers to make large volumes of trades in milliseconds.

What is Computer-Based Trading (CBT)?

Trading strategies based on pre-programmed algorithms that may not require high speed but still automate decision-making.

How does HFT differ from CBT?

HFT focuses on speed and ultra-short-term trades, while CBT includes a broader range of algorithmic strategies with varied time horizons.

What is the trade-off between speed and complexity in CBT/HFT?

Faster strategies increase volatility and reduce informational depth, while complex strategies trade less frequently and focus on fundamentals.

How does algorithmic trading impact liquidity?

It can supply liquidity but may also withdraw it during shocks, leading to fragile liquidity.

What is shallow liquidity in the context of HFT?

When orders disappear during stress, causing small trades to move prices significantly.

What is quote stuffing?

Placing many non-executable orders to overload systems and mislead competitors—slows markets and increases noise.

How does HFT affect information efficiency?

It may distort price signals by overwhelming slower, information-based trading with speed-based noise.

What is a flash event?

A rapid and extreme price movement in a financial asset that does not reflect fundamental information and is quickly reversed.

What caused the 2010 Flash Crash?

A mix of algorithmic momentum trading, quote stuffing, and a large sell order led to a collapse in liquidity and a rapid price drop.

What are feedback loops in HFT/CBT?

Chain reactions where algorithmic responses amplify small disturbances, e.g., price drops triggering further automated selling.

What is endogenous risk in algorithmic trading?

Risk that arises from within the system, such as algorithms reacting to each other, creating self-reinforcing shocks.

How does CBT/HFT impact price discovery?

It can improve price efficiency but may distort discovery if trades are driven by non-informational momentum.

How has HFT affected transaction costs?

It has reduced transaction costs overall but may increase costs during volatility due to wider spreads.

What is the systemic divergence feedback loop?

Liquidity fragmentation across venues (e.g. London vs Munich) leads to pricing inefficiencies and arbitrage loss.

What does Payne (2011) find about HFT's market impact?

Algorithmic trading increased depth at quotes and decreased bid-ask spreads, improving liquidity.

What is meant by 'normalisation of deviance'?

Treating abnormal or unexplained behaviour as acceptable due to frequent exposure—can mask risks.

What regulatory measure did MiFID II introduce?

60% of submitted quotes must be executable to reduce quote stuffing and improve transparency.

What unintended effect can circuit breakers have?

They may increase volatility as traders rush to sell before the circuit breaker is triggered.

Why does HFT increase systemic risk?

It amplifies small shocks via speed and volume, and creates tightly coupled systems vulnerable to cascades.

What is the risk of algorithm similarity?

Algorithms using similar inputs/strategies can react the same way, reinforcing trends and instability.

How do execution algorithms minimise transaction costs?

By optimising order size, timing, and placement based on volatility, liquidity, and market depth.

What is delta-hedging and how does it relate to instability?

Adjusting positions to remain market-neutral—can cause feedback loops when many actors hedge simultaneously.

What is market maker inventory risk?

The risk that limit orders placed by market makers are executed in trending markets, locking in losses.

What is Direct Market Access (DMA)?

A system allowing traders to place orders directly on exchange systems without a broker—reduced barriers to entry.

Why is mapping the HFT network important?

To understand how trades and shocks flow across actors—but limited by secrecy and data privacy concerns.

What is auction design in market regulation?

The rules for how orders are matched (e.g. call auctions) to promote stability and price discovery.

Why are dark pools problematic for transparency?

They obscure order flow and price discovery, limiting the ability of markets to fully reflect available information.

What is the downside of requiring algorithm disclosure?

It may disincentivise innovation due to competitive secrecy concerns.

What's the relationship between latency and trading advantage?

Lower latency allows traders to act on information faster than competitors, increasing profit opportunities.

What are the 6 types of feedback loops associated with HFT/CBT?

1) Momentum cascade 2) Shallow liquidity 3) Quote delay 4) Pass-the-parcel trading 5) Venue divergence 6) Capital base collapse (delta hedging).

What is the pass-the-parcel feedback loop?

HFTs offload predicted underperforming assets to others → they sell too → cascading volume and price collapse.

What is the quote delay feedback loop?

Market systems show stale bid/ask prices due to processing delays → triggers misinformed sell-offs and spreads confusion.

What is systemic divergence?

A liquidity shock in one venue (e.g. London) causes pricing discrepancies across markets due to algorithmic interdependence, leading to fragmentation.

What is the delta-hedging feedback loop?

Falling prices reduce capital bases, prompting systemic asset sales to reduce risk → lowers prices further → repeats.

What are execution algorithms designed to do?

Minimise transaction costs by optimising order timing, size, and placement using real-time data on volatility, liquidity, and price trends.

How do market makers manage inventory risk?

By placing limit orders strategically based on volatility and price trends; they adjust parameters to avoid losses in trending markets.

What are ticks in algorithmic trading?

The minimum price movement a security can make; execution algorithms monitor ticks to trigger order placements.

How do traders use order flow information?

They assess the imbalance between buy and sell volume to anticipate price direction and adjust strategies accordingly.

What is arbitrage in CBT/HFT contexts?

Exploiting small pricing inefficiencies between related instruments or markets before they converge.

What is the technical significance of cylindrical server design in HFT?

Minimises wire length to reduce signal transmission time—critical for ultra-low latency.

What is the impact of HFT on trading floor dynamics?

It has depopulated physical trading floors, reducing collective perception and informal information sharing.

Why is mapping HFT networks important for regulation?

It helps regulators understand interdependencies and systemic vulnerabilities—but is resisted due to secrecy.

What are the barriers to mapping HFT networks?

Competitive secrecy, proprietary algorithms, and data privacy concerns.

What is a call auction?

A type of auction where orders are collected over a period, then a single price is determined to maximise trading volume.

Why is the 60% rule under MiFID II controversial?

It may disincentivise genuine quotes, which are critical to price discovery, especially for those without asset holdings.

What is emergent behaviour in HFT systems?

Unpredictable market dynamics that arise from complex interactions between algorithms, not traceable to any single part.

What network structure is less vulnerable to systemic failure?

A dispersed (grid-like) network is more resilient than a centralised (star-shaped) network.

What is meant by "too central to fail" in HFT networks?

Certain institutions are so critical to transaction flows that their failure would collapse the system, prompting bailouts.