March 10, 2013

How HFTs Earn Profit in Emini with Exploratory Trading, Adam Clark-Joseph

Adam Clark-Joseph tries to reverse engineer how HFT’s earn profits in the E-mini S&P 500 with exploratory trading.

Gross of trading fees, the 30 HFTs earned a combined average of $1.51 million per trading day during the sample period.
How can others have access to these kinds of profits? 
HFTs in the E-mini market earn roughly 40% of their profits from the transactions that they initiate—that is, from their so-called “aggressive” orders—and I examine the mechanism underlying HFTs’ capacity to earn these profits.
HFTs who profit from their aggressive trading use small aggressive orders to obtain private information that helps to forecast the price-impact of predictable demand innovations. Demand innovations in the Emini market are easy to predict, but the price-elasticity of supply is not, and priceimpact is usually too small for indiscriminate front-running of predictable demand to be profitable.2 However, the private information about price-impact generated by an HFT’s small aggressive orders enables that HFT to trade ahead of predictable demand at only those times when it is profitable to do so (i.e., when price-impact is large).

Adam Clark-Joseph’s paper (link above) is a good overview of the high frequency trading process. He tries to model the strategy used by HFT’s to generate profits.

He is supposed to have used trading data from CFTC for this study.

In response (and due to complaints from traders), the CFTC has blocked further access to CFTC data (Bloomberg).

Tags: high frequency trading, hft, hft exploratory trading, adam clark-joseph paper, how HFT’s earn profits consistently, reverse engineer HFT algorithm, high frequency trading’s secret sauce, hft’s secret sauce, emini trading strategy