HFT is known not only for rapid-fire purchases and sales, but for its high rate of share turnover. The algorithms aren’t looking for long-term holds. They flip shares as soon as the data says they should, experts note. The profit on a single trade may be a fraction of a cent, but multiply that by billions of trades on multiple exchanges throughout the trading day and the strategy starts to make sense.

Many firms engaged in HFT are plugged into exchanges that average investors won’t even be aware of. When their algorithms detect that the price of a share is lower on Exchange A than it is on Exchange B — a difference that may only exist for a few seconds or in some cases fractions of a second — a common strategy will be to purchase a large number of shares on Exchange A and then sell them on Exchange B, almost instantly, for a slightly higher price.

Because high frequency trading is also high tech trading, larger investment firms, which have the capital and capacity required to develop, construct and maintain cutting-edge HFT infrastructures, tend to be the most successful users of this strategy.

So it’s no surprise that HFT has come under criticism for replacing human broker-dealers and putting smaller brokerage houses at a competitive disadvantage. Plus, the technology was responsible for the largest intraday crash in the history of the Dow Jones Industrial Average, which fell by 1,000 points in just 20 minutes on May 6, 2010 after a substantial automated order sparked a chaotic sell-off.

That 2010 “flash crash” was a major impetus behind the addition of more “circuit breakers” to stock exchanges worldwide. Those circuit breakers are able to instantly shut down trading if a particular stock index drops by a predetermined percentage. For example, since early 2013, market-wide circuit breakers have been in place to respond to rapid single-day declines in the S&P 500 of 7%, 13% and 20%.

Circuit breakers are designed to interrupt panic selling and they’ve been relatively effective. But the 2010 flash crash didn’t usher in the circuit breaker era. That honour goes to an Oct. 19, 1987 sell-off that saw the Dow Jones Industrial Average drop 22% in a single day. The first rudimentary circuit breakers were installed shortly after.

Criticisms of unfair advantage aside, HFT is likely here to stay. Experts liken complaints about the new trading models to those made decades ago when telephones and later computers were introduced to the trading floor. They note the infrastructure that supports HFT is now embedded in the markets, so it’s unwise to expect it to disappear until it’s replaced by the next tool that gives traders an edge on their competition.

Sponsored

Trade Smarter, Today

Build your own investment portfolio with the CIBC Investor's Edge online and mobile trading platform and enjoy low commissions. Get up to $100 in commission-free options until October 31, 2024.

Clayton Jarvis is a mortgage reporter at Money.ca. Prior to joining the Money.ca team, Clay wrote for and edited a variety of real estate publications, including Canadian Real Estate Wealth, Real Estate Professional, Mortgage Broker News, Canadian Mortgage Professional, and Mortgage Professional America.

Explore the latest articles

Can you pay the CRA with a credit card?

Can you pay your taxes using a credit card? Yes, but that doesn’t mean you should. Here’s what to consider before swiping for the taxman

Leanne Armstrong Contributor

Disclaimer

The content provided on Money.ca is information to help users become financially literate. It is neither tax nor legal advice, is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Tax, investment and all other decisions should be made, as appropriate, only with guidance from a qualified professional. We make no representation or warranty of any kind, either express or implied, with respect to the data provided, the timeliness thereof, the results to be obtained by the use thereof or any other matter. Advertisers are not responsible for the content of this site, including any editorials or reviews that may appear on this site. For complete and current information on any advertiser product, please visit their website.