Long Term Investment Vs High Frequency Trading

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Long Term Investment Vs High Frequency Trading

A lot of debate and discussion goes around comparing high frequency trading with long term investments. There are various sentiments in the market from long term investors regarding HFT. Instead of going into a debate of what is good or bad that is a highly subjective, let us look at some facts about HFT and long term investment.

High Frequency Trading starts and ends with zero position in the market. The idea is to quickly buy and sell on very small margins to earn extremely small profits. Hence, the positions deployed by HFT are quite small. If a High Frequency Trader has to trade using 50 million cash, he/she would be taking a lot of positions, say 500 million, almost 10 times of capital.

On the other hand, long term investors start with a lot of capital to earn high profits over a long period of time. This requires large capital and results in higher transaction costs but also give higher profit margins and a consistency of profits is expected. The table below summarizes these points:

Contrasting HFT and Long Term Investing

HFT

Long Term Investing

Profit Margins

Small

Large

Transaction Costs

Small

Large

Capital Requirements

Small

Large

Consistency of Profits

High

Low

Total Profit Potential

Small

Large

However, because HFT have small but many trades, they can’t lose too much of capital and they are not the systemic risk to the market. They take opposite sides of trade as long term investment. HFT market making and providing liquidity to the market.

Market-making opportunities arise because long-term investors desire immediacy when making trades.

Market-making opportunities

If there were no HFT market makers, the market would look the top line. Investors would have to wait for hours for their positions to get filled by other interested investors. What market makers do if what is seen in the bottom line. The market maker sells to Investor 1 at 10AM and sells to Investor 2 at 11 AM enabling both the investors to immediately execute their trades. Thus, liquidity is provided to the market which is beneficial for the long term investors as well.

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