High-frequency trading
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WATCH: Raj Mahajan, Allston Trading CEO, Talks HFT and the Business of Prop Trading on MarketsWiki.tv (April 2013) |
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WATCH: HFT Rules: Three Part HFT Harmony and HFT Rules: Rules for the Algo Highway on MarketsWiki.tv (January 2013) |
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High-frequency trading encompasses a variety of trading strategies, all of which involve a high velocity of portfolio turnover and the need for extremely fast, high-capacity market data feeds and trade matching and quoting engines.
High-frequency trades are executed on electronic algorithmic trading systems at lightning speed. This type of trading occurs when traders position very fast computers as close as possible to the market's computer servers. The proximity minimizes the time it takes for an order to pass through telecom lines. Traders program those computers to analyze and react to incoming market data in fractions of a second. If the trades are done in large enough volume, they can add up to significant profits. It was estimated that as of 2010, high-frequency trading accounted for an estimated 50 to 70 percent of trading.[1]
About a quarter of major global futures volume comes from professional high-frequency traders, and the share is expected to increase, according to consultancy Aite Group.[2]
High-frequency traders make markets in cash equities, exchange-traded funds, options and futures, providing liquidity to markets. However, they have no obligation to support liquidity in difficult market conditions.[3] The super-fast electronic trading systems allow them to arbitrage between minute pricing differences on trading platforms.
Rosenblatt Securities Inc. estimated in September 2009 that high-frequency traders account for more than half of the trading volume in the U.S. equity markets, more than 35 percent of the volume in the U.S. futures markets, and more than 10 percent of volume in the U.S. equity options markets.[4]
High-frequency trading can be used for "flash trading," but the two terms do not mean the same thing.
High-frequency trading came under scrutiny in the late summer of 2009 when regulators tried to determine whether this type of trading had too much influence over the markets.[5] Some members of Congress asserted that these types of traders were manipulating prices and "front running" customer orders. Others complained that high-frequency traders have better access to the markets than traditional investors. [6]
Contents |
John Lothian News Interviews
HFT Rules: Three Part HFT Harmony
High frequency trading (HFT) has been in the financial press a lot over the past several years. From the Flash Crash of 2010 to the collapse of Knight Capital in 2012, trading glitches and the negative impact of HFT on markets and investor confidence is well-documented. In this segment of the Restoring Customer Confidence series, Mayer Brown attorney Zachary Ziliak outlines the three sources that will address HFT and help restore customer confidence.
Ziliak says regulatory bodies will likely continue to address HFT guidelines, exchanges are imposing new fees on HFT practices and AT 9000, standards system for HFT practices, will help establish a higher bar for HFT participants. [7] Visit the Restoring Customer Confidence video series page >
HFT Rules: Rules for the Algo Highway
Customer confidence has been hit by a number of different events over the past several years and high frequency trading (HFT) problems have been among them. Ben Van Vliet, assistant professor of finance, Stuart School of Business, Illinois Institute of Technology has been looking the creation of a standard set of rules high frequency trading participants can use to ensure safer markets. Van Vliet has helped initiate the AT 9000 system, which would implement standards for HFT design, backtesting, implementation and portfolio and risk management. Van Vliet says its important that the industry support such a project, rather than wait for regulators to dictate new standards and rules for participants.[8] Visit the Restoring Customer Confidence video series page >
Stealing High-Frequency Code
In 2009 two financial market participants were arrested for stealing high-frequency trading code. First, Goldman Sachs programmer Sergey Aleynikov was arrested for allegedly stealing proprietary code from the bank’s high-frequency trading platform. Nine months later, Societe Generale trader Samarth Agrawal, was arrested on similar charges that he, too, stole his employer’s source code for software used to make sophisticated, high-speed, high-volume stock and commodities trades.[9]
Aleynivov was convicted in 2010, and sentenced to eight years in prison, but the conviction was overturned by an appeals court in February 2012. The overturned conviction has tested the boundaries of the Economic Espionage Act, which makes it a crime to steal company secrets. The challenge came on grounds that Goldman's HFT code was not "produced for interstate commerce," and thus does not constitute a crime under the act.[10]
In May 2012, programmer Bo Zhang plead guilty to stealing software code from the Federal Reserve Bank of New York. Also that month, former Citadel Investment Group engineer Yihao Pu was indicted on charges of stealing HFT code.[11]
In June 2012, Citadel accused HFT firm Jump Trading of stealing some of its trading algorithms. In its court petition, Citadel has asked that Jump turn over its algorithms and trading records. Jump called the request "frivolous" and "an effort to win competitive information through the courts."[12]
Regulation
Both the Securities and Exchange Commission and the independent European Commission advisory panel, the Committee of European Securities Regulators (CESR), sought input on industry strategies for high-frequency trading beginning in early January 2010.[13]
In late July 2010, CESR, which took on additional regulatory authority when it became the European Securities and Markets Authority in 2011, told the EC in a report that the panel will study high-frequency trading to better understand risks.
CESR also said Europe should develop a so-called consolidated tape, or a pricing mechanism for securities that combines prices from multiple trading venues. The U.S. uses a consolidated tape to price securities.[14]
Powers for the proposed European regulator should keep pace "with new technological advances, increasingly fragmented equity markets" and "shortcomings" in post-trade information, Sally Dewar, a managing director at the U.K. Financial Services Authority, said in response to the CESR report.[15]
On July 14, 2010, Chicago Mercantile Exchange COO Bryan Durkin urged the Commodity Futures Trading Commission (CFTC) to give more study to the role of high-frequency trading and algorithmic trading before increasing electronic market regulation. Durkin said tighter regulation could limit the liquidity and efficiency boost from these trading methods.
CFTC staff reviewed the roles of rapid electronic trades in the May 6, 2010 short-term plunge in equity and stock-index futures. At a committee meeting on the matter, CFTC Chairman Gary Gensler, said, "While market participants have the technology to automate trading, we’re really just now moving towards 21st century technology to have automated surveillance looking at trade practices."[16]
CFTC commissioner Bart Chilton also commented on high-frequency trading and regulation, saying that the industry needs to keep up with the "financial cheetahs."[17] In response to this comparison, CME Group chairman emeritus Leo Melamed wrote in January 2012 that high-frequency trading was not only in need of regulation, but also protection.[18]
Definition of HFT
At a meeting of the CFTC Technology Advisory Committee meeting on June 20, 2012, a subcommittee working group submitted its draft definition of HFT. According to the subcommittee, high frequency trading is a form of automated trading that employs:
- algorithms for decision making, order initiation, generation, routing, or execution, for each individual transaction without human direction;
- low-latency technology that is designed to minimize response times, including proximity and co-location services;
- high speed connections to markets for order entry; and
- high message rates (orders, quotes or cancellations). [19]
The commission plans to issue a "concept release" and request for public on the supervision of high-frequency trading later in 2012.[20]
References
- ↑ Blame High-Frequency Trading. the Big Picture.
- ↑ High Frequency Trading in the Futures Markets. Aite Group.
- ↑ Options Industry Leaders Discuss Current Regulatory Issues. Futures Industry Magazine.
- ↑ Making Markets: A Conversation With Five High-Frequency Trading Firms. Futures Industry Magazine.
- ↑ SIX Swiss eyes high-frequency traders. The Financial Times.
- ↑ Making Markets: A Conversation With Five High-Frequency Trading Firms. Futures Industry Magazine.
- ↑ HFT Rules: Three Part HFT Harmony. MarketsWiki.tv.
- ↑ HFT Rules: Rules for the Algo Highway. MarketsWiki.tv.
- ↑ Second Banker Accused of Stealing High-Frequency Trading Code. Wired.com.
- ↑ Court Overturns Conviction of Ex-Goldman Programmer. NY Times DealBook.
- ↑ Breaking the Code Theft Brain Drain. Advanced Trading.
- ↑ Citadel accuses Jump Trading of stealing secrets. Reuters.
- ↑ High-Frequency Trading Faces EU Probe, Regulator Says. Bloomberg.
- ↑ Report: Trends, Risks and Vulnerabilities in Financial Markets (PDF). CESR.
- ↑ High-Frequency Trading Faces EU Probe, Regulator Says. Bloomberg.
- ↑ CME against stricter rules for high-speed traders. Financial Times.
- ↑ “Caging the Financial Cheetahs”. CFTC.
- ↑ Protect HFT cheetahs from regulatory poachers. Financial Times.
- ↑ CFTC Technical Advisory Committee Sub-Committee on Automated and High Frequency Trading. CFTC.
- ↑ CFTC nears comment period on high-frequency trading. Chicago Tribune.
