Trading
________


Of Note:

Those who process large amounts of data and react immediately stand a better chance of staying ahead or maybe
even on top of the markets.

Although relatively new in Canada, high frequency trading has been around for more than 10 years in Europe and the
United States.

It’s believed about 30 per cent to 35 per cent of Canadian stock trades are HFT transactions.

The stock market is now filled with orders from traders who have no intention of executing those orders.

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High-frequency traders changing the game


MARJO JOHNE
The Globe and Mail
Last updated Tuesday, Feb. 08, 2011 5:03PM EST



Speed has always been critical in trading, where those who process large amounts of data and react immediately stand a better chance of staying ahead or maybe even on top of the markets.

But with the arrival of high frequency trading (HFT) over the last few years, the pace of trading performed by powerful computers running complex algorithms has accelerated almost beyond comprehension. What’s clear is that some results beneficial for investors and others challenging them.

Either way, though, many believe it will lead to a new, far faster version of normal for the market.

“In non-HFT trading, it may take a person minutes to process market data, maybe seconds to make a decision and a few more seconds to execute that decision,” explains Ben Bittrolff, chief financial officer at Cyborg Trading Systems in Kitchener, Ont. “With HFT, all three of those tasks are done in the order of milliseconds or even microseconds.”

Although relatively new in Canada, high frequency trading has been around for more than 10 years in Europe and the United States. It is difficult to measure the size of the HFT market in Canada – high frequency traders guard their information fiercely to maintain their competitive advantage – but it’s believed about 30 per cent to 35 per cent of Canadian stock trades are HFT transactions. In the United States, they account for an estimated 50 per cent to 70 per cent of trades.

The trading community is divided over HFTs. In an October, 2009, survey of institutional investors in Canada, the United States and Europe, 46 per cent of respondents said their firm was “disadvantaged” by high frequency traders while the rest did not think their trading operations were hurt.

The survey, conducted by Greenwich Associates, a research firm in Stamford, Conn., also found that 45 per cent of institutional investors believed high frequency trading poses a threat to the market structure, compared with 36 per cent who thought HFT has a positive effect because it adds liquidity to global markets.

An often-aired complaint against high frequency traders is their use of “latency arbitrage,” a strategy in which computers make “buy” or “sell” offers to move prices and gauge the interest of other investors in the shares.

When the computer learns that other investors want to buy the shares, it withdraws its offer, then quickly resubmits it at a higher price. These moves can all take place in the blink of an eye.

“The stock market is now filled with orders from traders who have no intention of executing those orders,” says Greg Mills, managing director of global equity sales and trading at RBC Dominion Securities Inc.

To minimize their exposure, traders who use these latency arbitrage strategies typically do so with small-share lots.

“HFT is about information collection, about placing orders in the market to get a sense of the direction of the market or the presence of a large buyer or seller,” says Brad Katsuyama, head of global electronic sales and trading at RBC. “You’ll find that a lot of HFT firms trade in 100-share lots to gain that information with the least amount of notional risk.”

Some high-frequency traders have algorithms that can “sniff” and outmanoeuvre other traders’ algorithms. For example, a trader might detect an algorithm put in place by an institutional investor to buy a certain company’s shares at $25. He or she might then manage to snap up a big lot of shares just as they fall a few pennies below this price. The trader then offers these shares to the institutional investor at $25, making a small profit per share.

With thousands of trades executed each day, these small gains add up to big dollars.

Retail investors have also reaped benefits from high frequency trading, which has had the general effect of tightening spreads, the industry term for the difference between the price investors pay for a security and what their brokers offer sellers.

The trading industry hasn’t exactly been complacent in the face of high frequency practices.

RBC is rolling out a smart order router called Thor, which is designed to counter HFT moves by ensuring orders to multiple markets arrive at the same time, leaving HFTs with little or no time to react. “This is something that mitigates many of the challenges brought on by disappearing liquidity and that will minimize the implicit market costs of trading,” says Mr. Mills.

Rizwan Awan, managing director of quantitative execution services at BMO Nesbitt Burns Inc., notes that “everyone in the industry” is developing solutions to trade more effectively in the HFT world.

“Everybody’s been forced to upgrade their technology, which I don’t consider a bad thing because it’s good to always be innovating and striving to do better,” he says.

Still, the HFT-driven push to innovate means higher technology costs for the industry, adds Mr. Awan. And given that these costs can run into hundreds of thousands of dollars, there are bound to be casualties.

“Not everybody is going to have the same resources that a big bank or bigger brokers will have,” says Mr. Awan. “It will hurt the smaller brokers, having to put out a huge investment in technology to keep pace with HFTs.”

Mr. Bittrolff foresees a future where HFT technology is available to everyone. But if and when that happens, wouldn’t high frequency trading lose its competitive advance, since everyone is trading at high speeds?

“It will become standard, just as the Internet and cellphones have become part of what we consider normal life,” says Mr. Bittrolff. “And the result will be that everything will just be faster and no one will think anything of it. This is just how trading is.”



Special to The Globe and Mail



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