Last post on this subject from me so that I don't bore the board.
(Some of the reader comments are worth a read IMO. You'll have to click on the link at the bottom of the post to see those though.)
From ft.com/alphaville:
The Cold War in high frequency trading
Posted by Tracy Alloway on Jul 08 10:10
This April 2009 quote from Rick Bookstaber, with its overtones of Cold War mutually-assured destruction, seems eerily prophetic given recent events involving the alleged theft of Goldman Sachs’ proprietary high-frequency trading code by a programmer of Russian origin:
. . . high frequency trading is embroiled in an arms race. And arms races are negative sum games. The arms in this case are not tanks and jets, but computer chips and throughput. But like any arms race, the result is a cycle of spending which leaves everyone in the same relative position, only poorer.
While Bookstaber, who quite literally wrote the book on financial technology and quantitative trading strategies, was emphasising computer chips rather than code, the sentiment is easily transferable. Banks spend millions developing the types of proprietary trading programmes Serge Aleynikov stands accused of stealing as well as the actual hardware that enables them.
In fact, high frequency trading has boomed in recent years, to reportedly account for an estimated 70 per cent of average daily trading volume. The technology essentially involves automated tick-by-tick, high turnover buying and selling, which relies heavily on the speed and sophistication of the network and computer systems involved. These are lightning fast and voluminous trades to take advantage of minute and fleeting changes in prices. Speed is obviously essential — as is beating the competition to an arbitrage opportunity.
It’s probably (hopefully) not quite front-running, but it’s not far off in terms of speed.
In fact, to give you an idea of just what kinds of times we’re talking about, jck at Alea has dug up the following, showing order latency from BATS — the time it takes to execute a trade. BATS is the fastest of the alternative trading platforms, though the NYSE recently cut its own order latency to five milliseconds.
Unsurprisingly, the technique has not been without controversy.
HFT-engagers often justify themselves as important providers of liquidity to the market, like traditional market-makers, but there are those who see it differently. Here for instance, is Joe Saluzzi from Themis Trading, with his takeaways from a roundtable discussion on HFT held last month:
The panel at this roundtable was comprised of two brokers that sponsor access to HFT’s, one exchange rep that courts the HFT’s and one option market representative. Here are my notes:
1) The high frequency trading business is extremely profitable. Based on the smugness and the smiles on the faces of the panel members, I could tell they were killing it. They reminded me of the “SOES Bandits” from the early ’90’s. But I sensed that they realized that their role in the market place was being squeezed and they were just trying to max out their profit before the game ended.
2) HFT’s claim to be market makers and they claim that the liquidity they add to the market has lowered volatility and helped narrow spreads. But the problem here is , unlike a traditional market maker, they have no requirements. No minimum size to display, no minimum time to display a quote and no capital commitment to a client.
3) There are very low barriers to entry to becoming a HFT. All you need to do is to become a client of a sponsoring broker. This will eventually cause market saturation and reduced HFT margins. Only the biggest, fastest computers will be making money consistently.
And those with the best codes of course.
Goldman has presumably worked hard to achieve its place as one of the leaders in HFT. In fact, Goldman’s dark pool platform Sigma X appears to be the biggest of its kind. The bank has also been the most active programme trader on the NYSE for some time — though it’s not without its HFT competition.
Citadel, for instance, the US-based hedge fund linked via its former head of HFT to Serge Aleynikov, is one of the top players in HFT — claiming to account for up to 10 per cent of global equity volumes in a single day, according to this very convenient presentation by the fund. Aleynikov was due to start work at Teza LLC, a Chicago-based fund co-founded by Misha Malyshev, the HFT expert who left Citadel in February.
It’s little wonder then, that banks like Goldman Sachs are so keen to protect theirs. This is a highly profitable but extremely competitive way of trading. You certainly do not want your proprietary code to go walkies — for both monetary and competitive reasons.
In fact, Goldman Sachs is already claiming it stands to “lose millions” because of the alleged theft. From Bloomberg:
. . . At a court appearance July 4 in Manhattan, Assistant U.S. Attorney Joseph Facciponti told a federal judge that Aleynikov’s alleged theft — the largest breach ever at the bank — poses a risk to U.S. markets. Aleynikov transferred the code, worth millions of dollars, to a computer server in Germany, and others may have had access to it, Facciponti said, adding that New York-based Goldman Sachs may be harmed if the software is disseminated.
“The bank has raised the possibility that there is a danger that somebody who knew how to use this program could use it to manipulate markets in unfair ways,” Facciponti said, according to a recording of the hearing made public yesterday. “The copy in Germany is still out there, and we at this time do not know who else has access to it.”
Cue much outrage about Goldman manipulating markets (again) and calls for regulation of HFT.
In fact calls to regulate dark pools, one of the prime platforms for HFT, are already de rigueur. From the WSJ:
Dark-pool administrators be warned: the regulators are coming.
It may not have been Paul Revere’s historic ride to Lexington and Concord, but recent comments from U.S. Securities and Exchange Commission Chairman Mary Schapiro carried just as loudly to those running non-displayed markets. These opaque trading centers have faced a steady stream of criticism from exchanges, market makers and retail investors, who claim they have been hurt by dark pools’ proliferation. But since these pools provide added liquidity to the market, regulators have been leery to interfere - until now.
HFT also already suffered during last summer’s ban on short-selling and has been threatened by a proposed tax on transactions.
If heightened regulation doesn’t appear, however, those opposed to the HFT method can take some consolation in that MAD strategy.
From Bookstaber again:
I think the days for high frequency trading are numbered. For one thing, high frequency trading is capacity constrained like few other strategies. The high frequency trader is basically a stand-alone market maker; he is sitting there to provide liquidity to others. And one way he provides it is to pull in the positions that others will shortly be demanding — thus the need for speed. If the footprint for high frequency traders gets too large, they become liquidity demanders themselves, and the gig is up. The Renaissances of the strategy will make their way through, but generally we will see a lot of shooting stars
Thanks to Serge Aleynikov, that footprint appears to be growing.
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