Friday, October 15, 2010

algorithmic vs high-frequency vs low-latency trading

There is a lot of innovation, complexity and key principles in these domains. Below is a novice's observations and hypotheses...In this blog there are other posts on the same topic.

The terms "algo trading", "high frequency" and "low latency" are related, from a developer's perspective. Low-latency is infrastructure optimization and engineering, like juice extraction from an orange (the hardware), which requires deep technical but modest financial or analytical knowledge. Low-latency infrastructure, once constructed, is used by many trading desks across a bank, not only by HF traders or algo traders.

HF and AT both originated on the buy side. Strictly speaking sell side (including investment banks) should seldom/never engage in these risky endeavors, but I know many do, under disguise. LL is needed on both buy-side and sell-side.

Algo trading can use many different mathematical algorithms to decide when to buy or sell (or cancel an uncompleted order) how many contracts at what price, using what type of order, in conjunction with what hedging orders. If a so-called "strategy" competes on frequency, then latency is often a key differentiator. The cold war was both /ideological/ and an arms race. Low latency infrastructure is like the nuclear weapon in the trading "arms race", whereas the math algorithm is (very loosely) the ideology.

Some trading algorithms aren't latency sensitive, and won't be high-frequency. They compete only on the math. I believe most machine trading systems in reality are quite fast. If it's very low frequency, then a human trader can make the decisions herself, aided by a machine with an algorithm

The math doesn't need to be sophisticated or use stochastic PDE, but should match market reality and be faithfully aligned with the strategic intentions.

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New York (Time Square), NY, United States
http://www.linkedin.com/in/tanbin