FIN11 Trading and Market Microstructure
The course will be organized in three parallel threads. Thread 1 (50%) consists of class activities based on the textbook by Larry Harris. Thread 2 (30%) consists of trading sessions in simulated markets. Thread 3 (20%) focuses on the current transformation of the US and European markets, which is characterized by rapid market fragmentation and a surge in the use of automated high frequency trading strategies. Representatives of the trading industry will be invited to guest lecture on some of the topics in Thread 3. We plan to have 3-4 guest speakers from the financial industry.
This course is an introduction to the art and science of trading. It will provide you with a good understanding of how securities markets work, experience with trading in simulated markets, and insight into how market structure and regulation are changing in response to innovations in information technology and competition among trading venues.
In terms of knowledge, the students will understand
- How and why market structures differ with respect to organization of trading sessions, execution systems, transparency, and use of intermediaries
- The key concepts of market quality; Liquidity, transaction costs, volatility, information content of prices and the determinants of trading profits
- The risks involved in doing business with informed traders
- The pitfalls devised by front runners, bluffers and market manipulators, and what traders can do to avoid them
- How to evaluate the pros and cons of new market designs and regulatory reforms
In terms of skills, students will be able to
- Use various order types, including market orders, limit orders and stop orders
- Act in various trading roles; Investor, dealer, broker and market maker
- Trade in different market structures, including order and quote driven markets, continuous and call markets, crossing networks and dark pools
- Solve specific trading tasks, e.g. how to work large orders in different market structures under varying market conditions
- Evaluate trader performance
The course will be delivered in 5 blocks of 2 days with 4 hours of activities in each day.
There are no formal prerequisites, but students will benefit from previous exposure to Microeconomics, Finance and Decision Analysis at a level equivalent to the first 4 semesters in the NHH Bachelor program.
Credit reduction due to overlap
Overlap with VOA041
Requirements for course approval
Participation in class trading simulations.
Attendance at guest lectures and active participation in discussions.
Two written notes (maximum 2,500-3000 words each) describing your experiences with two class trading simulations. Each note requires you to explain the trading setup, the main task, your expectations and approach as well as the lessons learned in the experiment. You will have to reflect on and evaluate your behavior and explain why you did/did not succeed in solving the trading task in the simulation. Students should organize themselves in teams of 2 members for the purpose of this requirement.
Providing a 5 minute oral presentation of their written notes if requested to do so.
A term paper on a trading topic of your choice (maximum 6,000 words). Students should organize themselves in teams of up to 4 members for the purpose of this requirement.
There will be no final exam in this course. Your grade will be based on the requirements for course approval as follows:
Written notes on two trading simulations (40%). A good note explains the market setup and the main task as well as critically reflects on your trading skills and the lessons learned in each trading experiment. The notes have to be written in English.
Term paper (60%). A good term paper uses the material in the textbook to analyze a topic (or question, issue, event) that is not explicitly dealt with in the book. The term paper has to be written in English.
Grading scale A - F
The class will regularly meet in a computer lab for the trading simulations. Students are also recommended to experiment with the trading software on their personal computers outside class.
- Harris, Larry, Trading and Exchanges, Market Microstructure for Practitioners, Oxford University Press, 2003. (Main text for the course.)
- Student guide to the interactive trading software (Core reading for trading simulation sessions, will be available on itslearning in week 1 of the course.)
- Lefèvre, E, Reminiscences of a Stock Operator, Wiley 2006, first published 1923. This is the classic autobiography of Jesse Lauriston Livermore (1877-1940). Livermore starting trading in New England "bucket shops" at the age of fourteen, and made and lost several fortunes during his career as a speculator. This book is a delightful read about his personal experiences with many of the trading issues that we will study in this course.
- Schwartz, RA, GM Sipress and BW Weber, Mastering the Art of Equity Trading through Simulation, The TraderEx Course, Wiley, 2010.
- Hasbrouck, Joel, Empirical Market Microstructure: The Institutions, Economics, and Econometrics of Securities Trading, Oxford University Press, 2007. Much more technical than Johnson's book - a challenge. Recommended to those students who would like to specialize in the area and write a technically demanding BSc or MSc dissertation.
- de Jong, Frank and Rindi, Barbara, The Microstructure of Financial Markets, Cambridge University Press, 2009. Only for those with a knack for mathematical/quantitative modeling. The book is praised by Albert S Kyle, the father of market maker models, whose endorsement contains the words: "a clear and accessible discussion of market microstructure [¿] that will prove very useful to both Ph.D. level students and MBA level students."
- NBIM, High Frequency Trading - An Asset Manager's Perspective, Discussion note #1, 2013.
- Harris, Larry, What to Do about High-Frequency Trading, Financial Analysts Journal, March/April 2013, Vol. 69, No. 2: 6-9.
- A short paper summarizing the current issues related to high-frequency trading (HFT), a game where milliseconds matter. Harris¿ balanced view of the topic provides a good starting point by focusing on the bigger picture. A less balanced, supplementary reading is Dennis Dick's comment "An Ugly High-Frequency Mess", CFA Magazine, January/February 2013, Vol. 24, No. 1: 24-25.
- Madhavan, Ananth, Exchange-Traded Funds, Market Structure, and the Flash Crash, Financial Analysts Journal, July/August 2012, Vol. 68, No. 4:20-35. Ask any trader about 6 May 2010, and they will immediately recall what they did on that day. The paper gives a clear picture of the flash crash in context of the interplay between trading, market structure, and HFT as well as some theory and some empirics.
- Lewis, Michael, Flash Boys: A Wall Street Revolt, Norton, 2014. A non-fiction book focusing on the rise of high-frequency trading in the US equity market.
- Lewis, Michael, Liar's poker, Norton 1989. This book describes the experiences of the author as a recruit and bond seller with Salomon Brothers during the late 1980's - an important period in the history of Wall Street. It is a vivid account of the culture, or lack of it, on the bond trading floor, and the cynicism with which the firm's customers were treated. Today, with the recent financial crisis fresh in mind, this book foreshadows the mentality and the "financial weapons of mass destruction" that made things the worst since the Great Depression.
- Patterson, Scott, The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It, Crown Business 2010 (paperback 2011). An insightful and entertaining narrative of the role of quants in the build-up of risk that contributed to the financial meltdown in 2007/8.
- Patterson, Scott, Dark Pools: The Rise of the Machine Traders and the Rigging of the U.S. Stock Market, 2012. Another enjoyable book on automated trading in financial markets.
Autumn. Offered Autumn 2018.
Adjunct Professor Klaus Reiner Schenk-Hoppé, Department of Finance, NHH