Related Concepts OF High-Frequency Trading


3.3.1 Market Making The term market making refers to the strategy of quoting a simultaneous buy and sell limit order (quote) for a financial instrument in order to profit from the bid-ask spread. This can be either imposed by mandatory requirements set by market operators/regulators for entities covering that role (e.g. an official market maker such as the Designated Market Maker at the NYSE or Designated Sponsors at the Frankfurt Stock Exchange via the trading system XETRA), or voluntarily, i.e. without a determined obligation to quote. Several different terms are used to denote this kind of designated liquidity provision, e.g. market making with obligations, designated market making and registered market maker. Market makers frequently employ ―quote machines‖ which provide the respective electronic markets with their quotes. Quote machines are programs which generate, update and delete quotes according to a pre-set strategy. Due to the varying degree of sophistication among these programs, some of them employ techniques similar to HFTs, while others rely on the involvement of a human market maker. Since market making is a well known HFT strategy (Tradeworx 2010a), the following Figure 3 highlights the relationship between HFT and market making. Figure 3: Market making and HFT17 The figure shows the interferences denoted by numbers from one to three that span the activities of HFT in market-making18: (1) represents all other HFT strategies apart from market-making (for details see section 4.2), (2) represents HFT that applies market making strategies without acting as a designated liquidity provider and (3) represents HFT that applies market making and is registered as a designated liquidity provider, e.g. GETCO is a Designated Market Maker at NYSE (Bunge and Peterson 2010). 17 Areas without numbers refer to the part of market making and designated liquidity provision that is not undertaken by HFT. 18 As Figure 3 is not based on any numbers such as traded volume, the purpose is to illustrate the different possible combinations of market making and HFT and not to signify the proportions or dimensions of these combinations. Fragmentation makes HFT market making strategies more relevant as it enables market participants to quote on less active venues based on reference quotes/limits available, e.g., on the most liquid market for that instrument. Delineation of market making/quote machines to AT/HFT: quote machines originally supported market makers in fulfilling mandatory quotation obligations. Both mandatory and voluntary market making may apply HFT as a supporting technology. 3.3.2 Quantitative Portfolio Management (QPM)19 Quantitative portfolio managers use quantitative models to form investment portfolios. Chincarini and Kim define quantitative (equity) portfolio management in the following way: “The central, unifying element of quantitative equity portfolio management (QEPM) is the quantitative model that relates stock movements to other market data. Quantitative equity portfolio managers create such models to predict stock returns and volatility, and these predictions, in turn, form the basis for selecting stocks for the portfolio.” (Chincarini and Kim 2006)20 In contrast to HFTs, QPMs frequently hold positions for extended periods of time, whereas HFTs tend to liquidate their positions rapidly and usually end trading days without a significant position (―flat‖). Compared to AT and HFT, QPM has a higher degree of human intervention. QPMs use algorithms to generate trading decisions based on statistical calculations and data analysis techniques. While QPMs automate the process of portfolio selection and the generation of trading signals, a human portfolio manager will usually validate the results of his quantitative model before transferring it to a (human or automated) trader for execution. 19 Also known as Quantitative Investing. 20 An alternative definition of QPM is provided e.g. by Quoniam: “Quantitative portfolio management means the analysis and evaluation of situations relevant for the capital market using statistical methods.” Quoniam Asset Management GmbH (2010)

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