“Trading, isn’t that the same as investing?” It is not. Most of us know a little about investing, but not that much about trading. Especially if you have a major in a non-financial study. So, what is trading, or as many talk about, high frequency trading? And why are trading firms so much focussing on technology? What is market making?
First, let’s elaborate on the main difference between investing and trading. These two are very different methods that aim to profit in the financial markets. Investors mainly look for larger returns through composing a portfolio and holding it for a longer period, talking about years. Traders, on the other hand, take advantage from volatility in the financial markets, taking advantage from both rising and falling markets. Traders tend to enter and exit a position in a short timeframe, aiming to profit from (statistical) arbitrage opportunities.
Traders use different strategies to profit from market volatility. The most straightforward strategy is to buy at a lower price and sell it at a higher price, or vice versa. However, trading involves way more technical approaches in order to profit from statistical arbitrages. Swing traders enter positions that they hold for days to weeks, day traders take positions throughout the day and scalp traders take positions for seconds to minutes. Traders can be active in a wide variety of financial instruments – which we elaborate on in our derivatives course.
What is high frequency trading?
High frequency trading (HFT) is a term that you might have heard more often over the last couple of years. High frequency trading is often also described as algorithmic trading. It is a practice that has been used in the financial markets for some time and it’s becoming increasingly popular. It can be described as the automation of trading strategies, executed by computers. Large number of orders are transacted in fractions of a second. High frequency traders use this automatisation to quickly analyse the market, fit the models for better performances, manage risks and execute orders based on strategies that have been used before.
Better technology leads to a quicker execution of your trades. A quicker execution of your trades leads to a greater profit.
High frequency trading leads to a quick integration of information into the prices of financial instruments, which leads to a greater efficiency in the financial markets. The greater efficiency leads to narrower bid- and ask quotes, since traders have more information on the actual price of an instrument. As a result, high frequency trading improved the market liquidity, making it easier for investors to enter the market.
As much as high frequency trading improved the market liquidity, it’s also criticised for different reasons. The algorithms replace human decisions and interactions by replacing the traders with mathematical models. If a model has the wrong settings, it might cause a lot of harm to the market by performing a lot of irrational trades. Some well known market crashes have occurred over time, caused by high frequency trading models. However, trading firms are more cautious with implementing their models these days, which should lower the risk of a new market crash due to wrong models.
What is a market maker?
A market is maker is an individual or a firm that quotes buy- and sell orders for its own account, with the goal to profit from the bid-ask spread, which is the difference between the best quoted bid- and ask price. Our market making course elaborates on this topic and has an open lesson about this topic. It also contains a market making simulator, which plays a market game that applicants often encounter during their interview process. To find out more about prominent market participants, take a look at the company overview page.
I want to apply, how does the application proces at a trading firm look like?
To find out more about the interview processes, take a look at our blog. It gives a general overview of how most interview processes look like. However, every company has it’s own process, so the described set-up will not hold for all companies. Ready to apply? Check out the vacancies!