High-frequency trading

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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 now accounted for between 50 percent and 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 of 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 by regulators trying to determine whether they have 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]

Stealing High-Frequency Code

Within the span between 2009 and 2010, two financial market participants were arrested for stealing high-frequency trading code.

In 2009, Societe Generale trader Samarth Agrawal, 26, was arrested nine months after a Goldman Sachs programmer was arrested on similar charges that he, too, stole his employer’s source code for software his employer used to make sophisticated, high-speed, high-volume stock and commodities trades.^[7]

Regulation

Both the Securities and Exchange Commission and the independent European Commission advisory panel the Committee of European Securities Regulators, or CESR, sought input on industry strategies for high-frequency trading beginning in early January 2010.^[8]

In late July 2010, CESR, which will take on additional regulatory authority when it becomes the European Securities and Markets Authority beginning in 2011, told the EC in a report that the panel will study high-frequency trading to better understand risks.^[9]

CESR also said Europe should develop a so-called consolidated tape, a pricing mechanism for securities that combines prices from multiple trading venues. The U.S. uses a consolidated tape to price securities.^[10]

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.^[11]

On July 14, 2010, Chicago Mercantile Exchange COO Bryan Durkin urged the Commodity Futures Trading Commission to give more study to the role of high-frequency trading and algorithmic trading before increasing electronic market regulation.^[12] Durkin said tighter regulation could limit the liquidity and efficiency boost from these trading methods.

CFTC staff are reviewing 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," according to the Financial Times.^[13]

References

1. ↑ Blame High-Frequency Trading. the Big Picture. Retrieved on May 8, 2010.
2. ↑ High Frequency Trading in the Futures Markets. Aite Group. Retrieved on July 18, 2010.
3. ↑ Options Industry Leaders Discuss Current Regulatory Issues. Futures Industry Magazine. Retrieved on October 30, 2009.
4. ↑ Making Markets: A Conversation With Five High-Frequency Trading Firms. Futures Industry Magazine. Retrieved on February 10, 2010.
5. ↑ SIX Swiss eyes high-frequency traders. The Financial Times. Retrieved on September 14, 2009.
6. ↑ Making Markets: A Conversation With Five High-Frequency Trading Firms. Futures Industry Magazine. Retrieved on February 10, 2010.
7. ↑ Second Banker Accused of Stealing High-Frequency Trading Code. Wired.com. Retrieved on May 8, 2010.
8. ↑ High-Frequency Trading Faces EU Probe, Regulator Says. Bloomberg. Retrieved on July 30, 2010.
9. ↑ Report: Trends, Risks and Vulnerabilities in Financial Markets. CESR. Retrieved on July 30, 2010.
10. ↑ Report: Trends, Risks and Vulnerabilities in Financial Markets. CESR. Retrieved on July 30, 2010.
11. ↑ High-Frequency Trading Faces EU Probe, Regulator Says. Bloomberg. Retrieved on July 30, 2010.
12. ↑ CME against stricter rules for high-speed traders. Financial Times. Retrieved on July 18, 2010.
13. ↑ CME against stricter rules for high-speed traders. Financial Times. Retrieved on July 18, 2010.