Definition: Jump trading refers to sophisticated trading strategies, which are implemented by high-frequency trading (HTF) firms.
What Does Jump Trading Mean?
What is the definition of jump trading? Through the use of sophisticated technology, they apply a range of hedge fund strategies, including index arbitrage, merger arbitrage, long/short equity, and others, seeking to capitalize on the fast speed of technology, which allows them to connect to the trading floors of the exchanges in no time.
At the same time, the fact that retail investors underperform the markets, lagging major benchmarks, allows HTF firms to provide a higher growth, while practically eliminating active management. Usually, HTF firms keep a low profile and are reluctant to reveal their trading secrets.
Let’s look at an example.
Example
A retail investor holds 100 shares of a stock, for which the market is rather neutral. No new information is available, and therefore, the stock price is relatively stable at $35.12. However, the price is stable because there are a lot of retail investors, holding the stock, and realizing small trades.
As the time goes by, more investors are interested in the stock because they have heard that some people actually made money. By attracting more investors, the stock price rises to $48.64, yet it is stable again, as the investors who gained from the $35.12 are selling, while new investors are buying the stock, expecting that it will rise further.
If all these retail investors are replaced by large institutional investors who are selling and buying at the same time, the price of the stock will jump to $55.34 because institutional investors will rather trade millions of shares than 100 shares. So, what happens is that profit is realized from the price movements that large institutional investors cause with their trades. The moment that the price goes down because a fund has sold 1 million shares, the HTF firm jumps in and buys the shares low to sell them higher a few minutes later.
Summary Definition
Define Jump Trading: Jump trading means an investment strategy used by HTF firms.
