2 Great Articles on High-Frequency Trading and Gold Prices

The May issue of Futures Magazine arrived in our mailbox yesterday. This month's issue sports a new look, including sturdier paper, higher quality photographs and charts, and a fresh new page layout. It's really beautiful. However, it's the content of a few articles that really stood out this month. They clearly have a finger on the pulse of the financial industry.

In fact, we're starting to wonder if the staff at Futures Mag has a crystal ball in their office. Today (May 6, 2010) we saw massive price action and volatility as the DJIA swung down nearly 1,000 points before recovering to end the day down ~350 points. High frequency trading (HFT) and gold were the topics of the day, and in this month's issue, Futures Mag offered some great articles that are exceptionally relevant considering today's developments.

High Frequency Trading

This month issue has a great article on high frequency trading (i.e. computers that place a high number of trades very rapidly in response to changing market conditions). Many of these algorithms (computer programs) attempt to take advantage of price action by getting out in front of manually-placed trades and leading the price down.

For example, if the computer program (the algo) sees that prices are falling on high volume, they will create a false market by rapidly placing and cancelling buy orders at a lower and lower bid price. The manual trader attempts to place market or limit orders at lower and lower levels to sell his/her holdings, but finds that the sell orders cannot be filled. The order is finally filled at a level considerably lower than when the exercise started and the manual trader is left asking "Why did my offer finally get accepted at $25.00 when there were plenty of buyers around at $25.50?" The answer is that most of the "buyers" at $25.50 were never really willing to buy in the first place. In fact, the orders were "placed" by computers that were programmed specifically NOT to buy at $25.50 and to cancel those buy orders as the trading price approached that level (for example, when the last trade was at $25.51.)

This is one example of how HFT's can take advantage of market inefficiencies (i.e. big spreads) and there are other strategies that they can employ as well, including arbitrage plays. These methods appear to be getting more and more common. According to Futures Mag, more than 60% of US equity trades in 2009 were conducted by HFT's although they are used by a relatively small number of funds.

The Role of Gold In The World

There are 2 articles in this month's issue of Futures Mag that deal with the gold market and the timing could not be better. During today's worldwide market meltdown, the price of gold rose above the $1,200 level and appears to be headed higher as a "flight to safety" takes hold (gold has always been recognized as an alternative currency and thus is used as a hedge against the devaluation of national currencies).

The first article is an interview with a precious metals expert who has over 30 years in the industry. The interview offers some good information on the history of gold prices, how gold is correlated to the dollar and to the Euro, and the possible effects of regulation on the gold market.

The second article gives some great insight into how gold is valued fundamentally, including a nice set of charts showing the forces of supply and demand.

One of Our Favorite Trading Tools

Out of all of the monthly trading magazines out there, we have always considered Futures Magazine to be one of the best. The articles are well-written and easy to understand, and they tend to be oriented towards the intermediate and advanced market trader rather than the casual investor.

Not that the other monthly magazines are bad, but Futures Mag stands out, combining insider news about the trading industry with such advanced topics as investor computing, option pricing theory, and quantitative analysis. Whether it's the brainy topic of high frequency trading or the issue of gold as a global currency, they always seem to be out in front of the latest issues to face the financial markets industry.