HFT? What’s the fuss?
Are jibes against high frequency traders simply sour grapes by industry laggards?
With some estimates putting high frequency equity trades at close to 70 percent of the market, the storm surrounding the low latency practice shows few signs of abating. As charges of unfair practice abound, FPL asked a panel of London-based experts for their thoughts on the good, bad and the ugly of high frequency trading.
18 months ago the acronym HFT – or high frequency trading – barely registered outside the hardcore of the financial community. Today, the HFT community is being blamed for many of the investing world ailments. To try and sort the hyperbole from the fact, FIXGlobal highlights some of the key points made by those in the know about how firms are reacting to the threat or opportunities presented by HFT firms.
What is it?
Despite the level of expertise across the industry, agreement on what constitutes high frequency trading is hard to reach. To some it is a question of degree. Who in the market isn’t interested in latency? All sorts of algorithmic traders are latency sensitive, but not necessarily HF. Perhaps the cut-off point is when a high frequency trader became an automatic market maker, providing continuous two-sided bid offers.
Adding to the definition, HF traders seem characterised by an obsession with latency (down to the microsecond level); the ability to mix both statistical techniques as well as rapid-fire twoway market making; and also to end up flat at the end of the day.
Finally, it seems most agree that confidentiality was a hallmark of HF traders, with one of the experts in the room commenting, “You can define the HFTs as the ones not in the room right now.”
Is it anything new?
Market makers have always been around, albeit that the technologies have changed. High Frequency Low Latency (HFLL) has been around for more than 20 years, but people are scrutinising it – and other aspects of the market – now because of the extreme market volatility we’re going through. In particular, experts agree that those who had not upgraded their own trading practices fast enough were the main critics of high frequency trades.
How fair is it?
The critics argue that HFT firms have unfair access to execution venues and could front-run slower traders. Concerns over flash orders and unfettered sponsored access or “naked access” have prompted regulators in the US to review these strategies, but any changes could risk making a dramatic impact on a major source of liquidity.
Though, there exists a school of thought that HF traders have an advantage and manipulatory intentions, the consensus appears to be that it is the technology and not the traders that are creating the advantage. Better hardware, better networks and better software – it all gives you a better trading strategy. But these advantages are open to all, providing you have the interest and very deep pockets.
To take another tack. When talking about fairness, there is an implicit premise that everyone is in the market for the same reason. This is simply not true. The HF guys are looking to make miniscule margins on every trade, while hedge funds may be taking a position over two or three months, and the buy-side over one or two years. As an industry, we need to accept that different participants are in the market for different reasons. Then look at benefits that HFT brings such as increased liquidity, reduction in spreads, and increased competition between venues. These things are good for all participants in the market place.
Others argue that debating the “fairness” or whether HFT was too risky was pointless. Instead the focus should be on, whether the practice brought with it inherent risks to the market which needed to be mitigated.
Is it helping the market?
While all may not love HF traders, there seems little support for turning back the clocks. The need for liquidity had been shown in stark relief over the past 18 months and equity markets where HF traders flourish, continued to function where others failed. It appears that a lot of people who complain about HFT are those whose own practices are incredibly inefficient. “If you have someone executing their order flow in a way that leaves them exposed, people will always use this order flow or information to optimise their trades. This is no different whether information flows between people or machines.”
Should we regulate?
It goes back to the difficulty in defining HFT. It’s hard to legislate, or create a framework, for something that we’ve yet to clearly define. If you try to regulate a technology, this would risk forcing the market to move at the pace of the slowest participant. A better approach would be for the regulators to look at the definitions within MiFID, such as best execution and consolidated tape, and look at how we can improve this.
Europe looks likely to follow the US model in banning or regulating the less understood or defined side of HF trading: flash orders, sponsored access and co-location with dark pools. Risk management gateways, on the exchange side, or plug-in risk controls on the broker infrastructure, may come into play to rein in naked access.
Where will it all end?
The speed of light is one immediate answer. “Within 15 months latency will be another commodity.” While the other camp felt it would always be just shy of the ultimate speed. “We will always have a game to play,” they argued.
What all apparently agreed on was the incredible rate of change in the available technologies. However, HF technology comes with a price tag. Ultimately you have to weigh up opportunity relative to cost. Anyone can participate, but cost of shaving microseconds may not be worth it.
Meanwhile, HFT firms were in consensus to aim to stay ahead of the game focusing on growth in Europe and Asia, as well as expanding into other asset classes, including options, futures and foreign exchange.