High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems

Chapter 19. Post-Trade Profitability Analysis

Trading costs can make and break the profitability of a high-frequency trading strategy. Transaction costs that may be negligible for long-term strategies are amplified dramatically in a high-frequency setting.

If market movements are compared to ocean wave patterns, long-term investment strategies can be thought of as surfers riding the trough to crest waves. High-frequency strategies are like pebbles thrown parallel to the ocean floor and grazing small ripples near the shore. Small changes in the wave pattern do not make a significant difference in the surfer's ability to tame large waves. On the other hand, a minute change in the wave structure can alter the pebble's trajectory. The smaller the pebble, the higher the influence of the wave shape, size, and speed. Transaction costs can be thought of as the market wave properties barely perceivable to the low-frequency strategies seeking to ride large market movements. At the same time, transaction costs substantially affect the profitability of high-frequency trades, seeking to capture the smallest market ripples. This chapter focuses on the transparent and latent costs that impact high-frequency trading. The roles of inventory and liquidity on the structure of a market and on realized execution are discussed, as are order slicing and other trading-optimization techniques that allow traders to obtain the best price. In addition to identification and management of trading costs, the chapter ...