FIN11 Trading and Market Microstructure

• Topics

  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 interactive trading in markets, and insight into how market structure and regulation are changing in response to innovations in information technology and competition among trading venues.

  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 interactive trading sessions in different market structures. 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.

• Learning outcome

  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

• Teaching

  The course will be delivered in 5 blocks of 2 days with 4 hours of activities in each day.

• Recommended prerequisites

  There are no formal prerequisites, but students will benefit from previous exposure to Microeconomics, Finance and Statistics/Econometrics at a level equivalent to the first 4 semesters in the NHH Bachelor program. Students will also benefit from knowledge of statistical software.

• Compulsory Activity

  Participation in interactive class trading sessions.

  Attendance of guest lectures.

• Assessment

  A written assignment (maximum 2,500-3000 words) on an interactive trading session in class (30%).

  The assignment can be done individually or in pairs.

  A term paper (70%) 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 the term paper.

• Grading Scale

  Grading scale A - F

• Computer tools

  You will have to bring a laptop computer (1 for each team of 2 students) and install NHH's virtual desktop.

• Literature

  Required literature:

  • Harris, Larry, Trading and Exchanges, Market Microstructure for Practitioners, Oxford University Press, 2003. (Main text for the course)
  • Harris, Larry, Trading and Electronic Markets: What Investment Professionals Need to Know, CFA, Research Foundation Publications, 2015. Available for free at; www.cfainstitute.org/learning/products/publications/rf/Pages/rf.v2015.n4.1.aspx
  • Lecture slides, available via my webpage www.schenk-hoppe.net/NHH/.
  • Financial Trading Systems (FTS) Student Manual and information about trading on their webpage http://www.ftsmodules.com/http://www.ftsmodules.com/ (go to FTS Products, Interactive Markets on the pop down menu on the upper right corner). In particular read the Student Manual http://www.ftsmodules.com/public/modules/trader/StudentPrepFTSInteractiveMarketCases.pdfwww.ftsmodules.com/public/modules/trader/StudentPrepFTSInteractiveMarketCases.pdf
  • For on the Kyle model: Albert S. Kyle (1985) Continuous Auctions and Insider Trading, Econometrica Vol. 53: 1315-1335. [de Jong and Rindi (2009) Chapters 2-5]

  Recommended literature:

  Scientific (ordered by readability)

  • NBIM, High Frequency Trading - An Asset Manager's Perspective, Discussion note 01|2013. NBIM, Sourcing liquidity in fragmented markets, Discussion note 01|2015. NBIM, Portfolio delegation and the effects of benchmarks, Discussion note 01|2020.
  • de Jong, Frank and Barbara Rindi, 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.
  • 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.
  • Foucault, Thierry, Marco Pagano and Ailsa Röell, Market Liquidity: Theory, Evidence, and Policy, Oxford University Press, 2013. Easy to read and very informative. Written by experts.
  • Easley, David and Maureen O’Hara. Market Microstructure Theory, Wiley, 1995. Focusses on dealer/market-maker markets. A classic but quite dated by now. Written by the most cited financial economists in market microstructure.
  • Johnson, Barry, Algorithmic Trading and DMA: An introduction to direct access trading strategies,4Myeloma Press, 2010. Despite its somewhat technical title this book is very suitable for undergraduates and covers a lot of ground: market structures, transaction costs, order placement, optimal execution strategies, infrastructure, multi-asset trading, news trading, data mining and artificial intelligence.
  • 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.
  • Schwartz, RA, GM Sipress and BW Weber, Mastering the Art of Equity Trading through Simulation, The TraderEx Course, Wiley, 2010. (Reading for trading game sessions).

  Non-scientific but excellent background reading:

  • Lefèvre, E, Reminiscences of a Stock Operator, Wiley 2006, first published 1923. Annotated edition by Jon D. Markman.

    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.

  • Lewis, M, Liar's poker, Norton 1989.
  • Lewis, M, Flash Boys, Norton 2014.From the cover: "Flash Boys is about a small group of Wall Street guys who figure out that the U.S. stock market has been rigged for the benefit of insiders and that, post-financial crisis, the markets have become not more free but less, and more controlled by the big Wall Street banks. Working at different firms, they come to this realization separately; but after they discover one another, the flash boys band together and set out to reform the financial markets. This they do by creating an exchange in which high-frequency trading—source of the most intractable problems—will have no advantage whatsoever."
  • Patterson, S, 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, S, Dark Pools: The Rise of the Machine Traders and the Rigging of the U.S. Stock Market, Crown Business 2012 (paperback 2013). Enjoyable book on financial markets. From the cover: "A news-breaking account of the global stock market's subterranean battles, Dark Pools portrays the rise of the "bots"- artificially intelligent systems that execute trades in milliseconds and use the cover of darkness to out-maneuver the humans who've created them."

  Movies/Documentaries

  • Wall Street (1987), Dealers (1989), Boiler Room (2000), Inside Job (2010), The Pit (2010, doc), Quants: The Alchemists of Wall Street (2010, doc), Margin Call (2011), Too Big to Fail (2011, doc), The Wolf of the Wall Street (2013), The Big Short (2015), Equity (2016), The Wizard of Lies (2017), Billions (Netflix), MADOFF: The Monster of Wall Street (Netflix).