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Big data transforms trading

O’Hara examines high-frequency trading

High-frequency trading, a new and exciting development in the world of trading that has been adopted by many prominent hedge funds (including Citadel and Tradebot), is playing an important and transformative role in the trading universe. Maureen O’Hara, Robert W. Purcell Professor of Finance at Johnson, co-wrote a research paper examining this brave new world and its impact: “The Volume Clock: Insights into the High Frequency Paradigm.”

O’Hara and her co-authors, David Easley, Henry Scarborough Professor of Social Sciences in Cornell’s Department of Economics, and Marcos Lopez de Prado of Tudor Investment Corporation, call attention to the divide between two forms of trading: high-frequency trading (HFT), which is reliant on computers and algorithms; and low-frequency trading (LFT), which tends to be more human-reliant trading. HFT is a form of trading in which computers make trading decisions based on what O’Hara and her co-authors call the “volume clock.” For example, a trading program that detects specified patterns and makes new trading decisions (such as buy or sell orders) every time 20,000 instances of data are received would be operating on a volume clock.

Today, trading activity generates immense amounts of data, partly because data is available on a near-real-time and second-bysecond basis. HFT is a means of cycling through this data in order to find data-supported trading decisions on an ongoing basis. “It’s not people anymore; computer programs are doing certain forms of trading,” O’Hara explains. “Machines work in cycles that are programmed to detect patterns in the market.” HFT practitioners are involved in a sort of arms race, hunting for larger databases, faster supercomputers, and better algorithms to crunch incoming data and figure out what the market’s about to do. In this process, HFT experts are not necessarily driven by long-term fundamental analysis, but by being opportunistic in exploiting unfolding developments.

O’Hara points out that the advent of HFT has fundamentally changed the nature of trading. In the HFT age, how trades are executed has assumed paramount importance. “The Alpha you make comes from both skill in picking investments and skill in executing the trade,” she says. HFT specialists are highly skilled at executing trades with maximum speed, at the right times, and on the basis of the right data. For example, in a situation in which there is a limited number of buying orders on the book, the fastest trader — typically an HFT expert — can place sell orders ahead of LFT specialists and come out on the right side of a price change in a stock, commodity, or currency.

O’Hara is a world-renowned expert on HFT whose modeling work has been used by hedge funds, and whose knowledge has been sought by the government of the United Kingdom, which recently commissioned her to create a report on computerized trading. Her ongoing scholarly work at Johnson is not only opening up new academic vistas into the HFT phenomenon but also providing Johnson students with an edge in the HFT world.