Lakeview Capital Market Services’ Peter van Kleef relates the state of high frequency trading (HFT) in Europe including which trades are overcrowded and where the next breakthrough will come from.
Is high frequency order flow in Europe coming from Tier 1 banks or prop desks?
High frequency order flow in Europe comes mainly from proprietary trading firms and hedge funds as well as bank proprietary trading desks.
How is MiFID II changing the mood for HFT? In particular, how will a consolidated order tape affect HFT traders?
High frequency traders were already using a consolidated order tape for their strategies, so the only difference is that MiFID II might make that data cheaper and more readily available. Also, having a consolidated order tape will improve transparency, but that may indirectly cause problems for prime brokers. For example, if a prime broker’s client sees a price in the market data, their execution partner might not be in that market or might not be fast enough to get the price that their client has seen.
What are the most popular instruments for HFT in Europe? Are there any favorite HFT trades that are becoming potentially too ‘crowded’?
Most people who are new to HFT, trade the most common items such as Eurostoxx, DAX, CAC, AEX, FTSE, Bund, Bobl Schatz Futures, etc. This is counterintuitive, however, as the new traders are entering the most crowded trades and most competitive products. There are crowded trades around Eurostoxx, for example, and as a result, there will always be mini Flash Crashes and disruptions of that kind. The real thing is not to keep people out of these trades but to set up better systems in the exchange to maintain liquidity.
People at buy-sides institutions are often uncomfortable with HFT in markets because they want to trade a large amount, yet they do so in a way that is evident to the market and especially to high frequency traders. If there is an impression that there is a buildup of pressure to sell, then traders will lower their price. Some may complain about this process, but it is not the fault of the high frequency trader. Buy-side institutions need to learn more about interacting with HFT in the market. Institutional investors will find that they enjoy more liquidity when they become more sophisticated in terms of how they interact with high frequency traders.
It is incorrect to view HFT as artificial liquidity. Volume is liquidity. It might not always be liquidity in the direction you want, but it is liquidity. It makes it easier to trade, but people are unfamiliar with how to interact, so they simply need to become more familiar with it.
What are exchanges and MTFs doing to attract HFT order flow?
Many exchanges are supporting volume discounts. Many of the new MTFs want to attract volume, so they offer volume discounts for HFT. If you provide liquidity, you are paid for that liquidity; if you take liquidity, you pay. This model is common in all industries. If you buy more cars, cars become cheaper; if you buy more shirts, they get cheaper. In addition, many new exchanges claim to be faster than their rivals.
On the other hand, the older more traditional exchanges have restrictions for liquidity providers and naked access, which is a disadvantage for market makers who wish to interact with institutions or directly with exchange members. An unintended consequence of these restrictions is that by banning naked access, they disadvantage those very people they want to protect; i.e. the non members.
Regulators should put more pressure on the exchanges to deploy additional safety features – something you see in new markets. New markets take more care to provide safety features for their market places, which is essentially saying that we want to avoid Flash Crashes and miss-trades on our markets by having features and functions in place at the start. New markets also have the chance to learn from older, more established markets, which are often quite slow in adapting to those features.
Where will the next breakthrough in HFT come from: hardware, data, connectivity, exchange engines?
What you see now is – finally – an adoption of hardware. We have been looking at this for over ten years, but there was not the hardware to make HFT reasonably easy. This type of hardware is now becoming much easier to acquire and use because every few months, new tools and companies are launched. Hardware is the way forward for HFT because it is the only way to really make it quick. Hardware will always be faster than software when it comes to simple things. By definition, HFT cannot be very complex, as complexity slows things down.
The other hot topics at the moment are new or alternative information streams; for example, social networks and other types of information, such as tagged news. High frequency traders are examining those areas that will give them an edge to identify price movements before they actually happen, rather than simply reacting to the movements as they happen. Those are the two biggest trends right now, hardware and news.
What’s Fast in Europe? High Frequency in Depth
