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There’s been a smouldering story concerning the future of high frequency trading that began four years ago with the ‘flash crash’ that momentarily caused the biggest drop in the Dow Jones Index ever seen.

Since then, high frequency trading has been refined over and over again so that now it is said to give traders with the money and the power to afford the ultra-high speed systems needed to operate it, a huge and potentially unfair advantage.

The technology is complex unless you’re a computer geek. It relies on hardware acceleration, what is called Ultra-low Latency Direct Market Access and PCI Express, a motherboard interconnect that speeds up data transfer in computing.

The questions being asked now are does HFT have a future with the EU and the Fed talking about regulation and how will it affect the private trader?

The first question can be answered quite simply by saying that investment houses and brokers are piling millions of dollars into speeding up an already blistering speed of trading. The latest figures from US developers suggests trades are being undertaken at 98% of the speed of light and, although there is not much leeway left for extra speed, even tiny fractions of improvements on that give traders an advantage.

The speed of deals relies on proximity to the servers doing the deals. One broker moved from Kansas to New York and the reduction in distance equated to nearly half a million dollars of extra profit, simply by being closer. The speed relies on data transfer by light using optic fibers but it also needs fast and comprehensive direct market access.

How high frequency trading works is that big institutions need to buy lots of shares to satisfy portfolios. It’s rare that one shareholder or trader can supply enough so the institution has to buy chunks from several traders to fill the order. The time taken allows high frequency trading platforms to intervene in the transaction, spotting the first trade and realising that there are likely to be more trades in the stock, buy before the institution can buy, selling on to the institution as the purchase order reaches them. The mark up in the price can be fractions of a cent but with a big enough trade, the profit can be substantial and take micro-fractions of a second. Repeat this many times a day and the high frequency trader can make a lot of money.

In terms of whether the individual can profit from this, the answer is for now no, as the speed of home or office computers plus the distance from the trade is so big they would be far behind the completion of the trade.

However, PC speed is gaining daily, new technologies which speed up access to the internet come on line or develop greater efficiently with each version and with the advent of super-fast broadband, it may not be too long before the gains made by individual traders get close to the speeds achievable by the big boys then we have a chance to enjoy the profits of high speed trading just like the institutions.

Guest post by Razi Hammouda of  FXLords