Volume clock

From the paper of Easley.

LFT’s decisions are typically made in “chronological time”, leaving footprints that can be tracked down easily. The surface above shows a large concentration of volume (over 8%) traded in the first second of every minute around the close of U.S. equities. Because HFTs operate in “volume clock”, they can act as soon as the pattern is identified and anticipate the side and sign of LFTs’ massive orders for the rest of the hour 

This is particularly true at 02:00- 03:00 GMT (around the open of European equities), 13:00-14:00 GMT (around the open of U.S. equities) and 20:00-21:00 GMT (around the close of U.S. equities). This is the result of TWAP algorithms and VWAP algorithms that trade on 1 minute slots. A mildly sophisticated HFT algorithm will evaluate the order imbalance at the beginning of every minute, and realize that this is a persistent component, thus front-running VWAPs and TWAPs while they still have to execute the largest part of the trade. 

This is just one example of how vulnerable the “chronological time” paradigm has made LFTs, but there are dozens of instances like this. Easley et al. [2012b] show that about 51.56% of E-mini S&P500 futures trades between 11/07/2010 and 11/07/2011 were for one contract. For example, orders of size 10 are 2.9 times more frequent than orders of size 9. Size 50 is 10.86 times more likely than size 49. Because ‘GUI traders’ tend to submit round order sizes, ‘silicon traders’ can easily detect when there is a disproportionate presence of humans in the market and act on that knowledge. These behaviors are a likely cause of the increasing number of short-term liquidity crises over the past few years. 

Predatory algos exploit humans’ inclination for seasonal habits, such as end-of-day hedges, weekly strategy decisions, monthly portfolio duration rebalances, calendar rolls, etc. Seasonal effects are easily predictable and are a favorite of HFT algos. Smart LFT trading will avoid these easily exploitable seasonal habits. 

LFTs are not completely defenseless against HFTs. Whenever a new predator makes its appearance in a habitat, there is a shock period until the hunted species adapt and evolve. There is a natural balance between HFTs and LFTs. Just as in nature the number of predators is limited by the available prey, the number of HFTs is constrained by the available LFT flows. Rather than seeking “endangered species” status for LFTs (by virtue of legislative action like a Tobin tax or speed limit), it seems more efficient and less intrusive to starve some HFTs by making LFTs smarter.