Algorithmic Trading is a term used to describe the use of computers to execute trading orders where algorithms decide, without in many cases human intervention, order parameters including timing, price and quantity. Such automated trading is also referred to as "algo trading", "black-box trading", or "robo-trading". Algorithmic Trading is not restricted to trading in equity shares, but extends to futures, option, foreign exchange markets, and bond markets.
High-Frequency Trading ('HFT') is a term used to describe algorithmic trading executed by computers programmed to make complex trading decisions. Decisions based on information received electronically by those computers and processed faster than humanly possible. Importantly, there is no investment strategy for which algorithms can't be programmed.
From what I have read, but not independently verified, it is estimated that by 2009 HFT accounted for 73% of all U.S. equity trading volume, whereas in 2006 it is estimated that about 33% of all EU and US stock trades were driven by automatic programs.
Algorithmic Trading (including HFT) has received increasing focus after the so-called 'flash crash' that occurred on May 6, 2010 when the Dow suffered its 2nd largest intraday point swing up to that date. Moreover, there is considerable debate as to whether HFT is a driver of the volatility that has recently been experienced in the U.S. equity markets.
Two articles I have read on this are 'HFT Is Not Responsible for Market Volatility - You Are!' - reading time 4 minutes, and 'High-frequency trading a receipt for economic disaster' - reading time 4 minutes.
You might want to read both articles. I have little doubt that Algorithmic Trading and, in particular, HFT which largely entered the scene in 2007 following a change in U.S. Securities Rules, has changed the face of trading versus investing.
Only two weeks ago it was reported that a large number of global institutional investors are concerned about "the broad ramifications of high-frequency trading and its effect on the stock market" - see 'Big Investors Cite Concern Over High-Frequency Trading', reading time 4 minutes.
For the time being, until I study Algorithmic Trading generally and HFT in particular more carefully, I am of the mind that both clearly have been, and continue to be, 'game-changers'. My current thoughts are:
While computers calculate without emotion, their programs are dependent on the inputs, biases and logic of those who program them - or direct the programming of them. Accordingly, once programmed, a computer will execute the trades it has been programmed to execute, but that programming may reflect - for but one example - an underlying belief that the U.S.$ is a 'safe haven'.
All trades driven by that computer's program would then be biased toward trades that supported an underlying thesis that irrespective of U.S. economic direction or results, the U.S.$ will always be the favoured fiat currency. Viewed conceptually, if built into trading program algorithms, such biases (and there could be an infinite number of them) could have short-term effects, and perhaps long-term effects, on financial markets.
On August 22 and 25 I wrote the following commentaries: 'When The Market Isn't The Market' - reading time 4 minutes, and 'Computerized Trading' - reading time 4 minutes. Intuitively, I would rather participate in markets that are skewed more to an 'investment model' than to a 'trading model'.
Again, intuitively, while I have never believed in 'buying the market' (read 'diversification'), had I believed in diversification up to 2008, the more I understood about Algorithmic Trading (including HFT) the less interest I would have in conventional large capitalization diversification investing - and the less comfortable I would be having others manage my capital for me.
Interestingly, this morning I noted a reappearance of a suggested tax on financial transactions. See 'EU's financial transaction tax is feasible, and if set right, desirable' - reading time 5 minutes. I, for one, think the U.S. Federal Government (both Democrats and Republicans) is far too prone to policies that favor what I consider to be a 'super-profit environment' for Investment Banks, Hedge Funds, and others in the 'financial services businesses'. I think that such taxes on financial transactions - where those taxes are paid by those executing the transactions and not included in money management fees - would only make sense. That said, I think that is a rather naïve thought on my part, as I can't imagine a circumstance where financial firms would not reflect a transaction tax in the fees they charges, whether they did that transparently or as a 'hidden cost'.