Capital Market Networks

Technological innovations and advances have changed the structure of the industry to a flat decentralized network. Until the late 1990s, the central role was played by the broker-dealers which was the most profitable role in the financial ecosystem back then. The dealers controlled clients' access to the exchanges for a grand money compensation. Different layers of brokers were assigned to different levels of investors. For instance, the institutional investors, were served by the elite class of institutional sales brokers who targeted volume, whereas the individual investors were retail brokers who charged higher commissions.

Today, as computer technology advances further, the markets are even more decentralized, the networks are flattening, and exchanges are giving way to electronic communication networks known as ECNs, also known as "liquidity pools". ECNs optimally match buyers and sellers and transit orders fast thanks to sophisticated algorithms. Which in turn provides never seen before liquidity levels, and provides a higher pool of potential investors, and lower costs of executing trades (Graph 3).

Graph 3: Average Cost of Executing Trades

Source: Elkins/McSherry, institutional investor

1.2 Electronic marketplace

To fully understand the nature and strategy of HFT trading we need to break down the order types and how the trades are made through modern-day electronic exchanges.

When a market participant wants to buy or sell an asset, he needs to fill an order, which is an instruction that contains all the necessary information about the type of the trade the market participant wants to perform. Order types which are allowed differ among the exchanges. We can distinguish the following most common order types:

• Market Order. This instruction has the highest execution