Benefits, High Frequency Trading, High Frequency Trading, The Latest Blog

Why You Should Thank High Frequency Traders for Lower Volatility

New data from Credit Suisse highlights how high frequency trading activity contributes to lower volatility in the marketplace.

As reported by the Wall Street Journal, “Researchers at the Swiss bank’s New York offices posit that HFT activity has helped inoculate large-caps from the effects of macroeconomic market stresses.”

Featuring graphics from the Credit Suisse note, the Modern Markets Initiative has created the below infographic to showcase these findings:

Thank_You_HFT

These findings from Credit Suisse are the latest in a series of research showing the many benefits high frequency trading and professional traders provide to the marketplace and end investors. For more, please visit the MMI’s Research & Studies page.

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High Frequency Trading, The Latest Blog

MarketWatch: "Ban High-Frequency Trading? ‘Absolutely Not!’ Financial Execs Tell Senators"

At a hearing this week held by the Senate Banking Committee on electronic trading and equity market structure, top industry veterans were quick to point out that vilifying one style of trading will not help our markets. In fact, they said, removing it from the markets would be detrimental. Rather, we should examine our current market structure and make necessary changes.

As an article in MarketWatch notes:

“Ban high-frequency trading, anyone? No thanks.

“That was the response Tuesday from witnesses at a Senate Banking Committee hearing to a question from Nebraska Republican Sen. Mike Johanns. The committee held a hearing on electronic trading and market structure, and while controversial, high-frequency trading was defended by three executives and one academic with industry ties.

“’Absolutely not!;’ said Kenneth Griffin, founder and chief executive of Citadel LLC, a financial firm that engages in high-frequency trading, in response to Johann’s question. Kevin Cronin, global head of trading at asset manager Invesco Ltd., IVZ +0.82%  agreed, and also told senators high-frequency trading is “not bad” in and of itself. Jeffrey Sprecher, the CEO of Intercontinental Exchange Inc. ICE +0.04% , which owns the New York Stock Exchange and other markets, as well as Georgetown University Prof. James Angel, who sits on the board of DirectEdge, another stock-exchange operator, agreed the practice shouldn’t be banned.

“But while executives said they didn’t want to ban the trading practice, they did call for changes in market rules. Cronin, for example, called for requiring all high-frequency trading participants to register with regulators. That would give regulators access to records needed for investigations. Sprecher, meanwhile, said markets are too complex and that deters some investors from accessing the public markets.”

 Read the entire article on MarketWatch.com here.

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The Technology Investor: "Indispensable" HFT Mitigates Risk

In a piece for Casey Research’s The Technology Investor, senior editor Doug Hornig zeroes in on some of Flash Boys author Michael Lewis’ most questionable claims about HFT. He also settles the score about HFT’s role in the flash crash of 2010, seeks to settle misplaced fears about HFT, the role it plays and whether or not the markets are “rigged.”

In discussing what actually causes major market disasters – and HFT’s true role – he writes:

Well, consider this: Market disasters generally result from risk that exceeds supportable levels. The collapse of ‘08 was triggered by the trading and re-trading of mortgage-backed securities that couldn’t be accurately valued. With each trade, the risk was magnified some more, until it finally overwhelmed the system. Or take the dot-com crash, which came about because the price of revenue-free startup companies was bid so high that the risk of continuing to hold them blew way past the probability of selling to the next sucker in line.

HFT, on the other hand, is about the exact opposite—mitigating risk.

And on the flash crash:

As a market stabilizer, proponents say, HFT has become indispensable. They point to the infamous Flash Crash of ‘10, which took the Dow down nearly 1,000 points in 20 minutes.

 The trigger for that was a simple human error. HFT quickly re-priced securities and stair-stepped them back up to their proper levels, it is argued, thereby reversing the crash before it could spin entirely out of control.

Hornig’s piece is a frank look at recent HFT criticisms combined with an easy-to-understand translation of what actually occurs in the markets. Through his piece he shows how HFT benefits investors, today’s modern markets and establishes that it is not something to fear.

Check out more of the best lines from his piece, “How I Learned to Stop Worrying and Love High-Frequency Trading” here.

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Benefits, High Frequency Trading, High Frequency Trading, News & Media, The Latest Blog

Chicago Tribune Editorial: "U.S. Financial Markets Need the Freedom to Innovate"

Amid the debate on U.S. market structure, the Chicago Tribune editorial board is urging regulators, lawmakers and industry leaders to recognize the many benefits technology and high frequency trading have brought to the marketplace:

Chicago was once famous for the open-outcry trading floors in which people stood shoulder-to-shoulder, buying and selling by scribbling down trades on paper cards. Computerized trading has pretty much stamped out that form of business….

Computers eliminated the floor trader’s insider advantage. That opened the markets to a wider world. Trading volume soared, much of it from the high-frequency traders.

Not only is high frequency trading making the markets more efficient and transparent than ever before, the editorial rightfully explains the competitive advantage automation technology provides to U.S. businesses and traders:

Approving rules that would drive the high-speed traders out of business, or slapping on a transaction tax that would strip the profit from their high-volume, low-margin trading, as some critics of high-speed trading have proposed, could stifle innovation, push a U.S.-dominated business offshore and, perversely, boost the cost of trading for everyday Americans.

The U.S. financial markets need the freedom to innovate. If they lose that freedom, competitors will supersede them in London, Tokyo, Hong Kong or who-knows-where. Competition has already made high-speed trading less profitable today than it was just a few years ago, as rival market participants invested in new technology and systems to counter the flash boys. Finance is not returning to the days of spit-drenched, open-outcry trading pits. Nor should it.

To improve the markets for end investors, they argue, a more holistic review of market structure is needed:

…No one in the securities industry seriously believes the flash boys should get a special advantage over other traders and investors. The question always has been how to encourage the high-speed traders’ contribution to efficient markets while ensuring fair prices and orderly trading for all.

That requires a balancing of interests and, given the pace of technological change, a continuous review. The exchanges and their regulators have shown a willingness to change the structure and rules of their markets. It is to their credit that they take a holistic, measured approach, rather than trying to tweak a rule here and there every time a big bank complains about the prices it receives on its orders.

Read the entire editorial on the Chicago Tribune’s website here.

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High Frequency Trading, News & Media

Ari Rubenstein: Regulate Me

Earlier this month, the Securities Exchange Commission (SEC) released a draft of its 2014 Strategic Plan for public comment. The plan is technical, but the motivation is straightforward: increase investor confidence in our markets. This is a critical goal, and regulators and the industry alike must work together to achieve it.

It’s hard to think of a sector that hasn’t been improved dramatically by information technology, and Wall Street is no exception. Today, ultra-fast computers and advanced algorithms execute hundreds of transactions in fractions of a second. In 2005, high-frequency trading (HFT) accounted for 21 percent of trades in U.S. equities. In 2012, that figure had more than doubled to 51 percent.

[pullquote]The proliferation of HFT has democratized the marketplace in profound ways. Fierce competition between market participants means far better price discovery and stability.[/pullquote]

Long gone are the days when traders crowded exchange floors to make markets—and that’s a very good thing for the average investor. Here’s why:

The proliferation of HFT has democratized the marketplace in profound ways. Fierce competition between market participants means far better price discovery and stability. Automation has lowered the cost of executing and clearing trades, with broker commissions tumbling from upwards of $70 per trade in 1997 to less than a dollar today. The time it takes for critical information to reach investors has also decreased. And in a fully digitized marketplace—where every order, quote, and trade is electronically stored and easily audited—every thing is more transparent.

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Just Calling it HFT Doesn’t Make it HFT (Part II)

It has become increasingly clear that the term “high frequency trading” (HFT) has been appropriated and turned into a catch-all phrase for electronic trading behavior people just don’t like. That doesn’t mean, however, that correctly using the term HFT should be avoided or that we need another phrase to accurately convey the practice; there is nothing troubling or negative about trading with a frequency greater than others.

But what is troubling is the common practice of conflating negative and even illegal trading behaviors under the term HFT. This promulgates numerous operating definitions of the term, prompting confused and often ill-informed discussions around HFT. To ensure effective discussion and helpful criticism of today’s markets, those instances must be corrected.

The recent comment letters to the CFTC concerning their “Concept Release on Risk Controls and System Safeguards for Automated Trading Environments” contained more than a few misunderstandings and misappropriations of HFT. A letter from Better Markets made a series of definitive statements about HFT that do not accurately reflect the role HFT plays in the markets. Why? Better Markets states in a footnote to their letter that they use the term HFT to refer only to manipulative and disruptive trading practices:

“While there are of course algorithmic trading strategies that are not considered manipulative or disruptive of their given markets, for the purposes of this comment letter “high frequency trading” and “HFT” refer to those disruptive high-frequency automated trading strategies as described herein.”

Better Markets also wrote:

“strategies which count as illegal manipulation when performed over the course of minutes or hours should also not be permitted when they take place within milliseconds. Moreover, practices that are clearly illegal if done by human beings should be equally illegal if done by computers.”

It is very clear that they are addressing manipulative and disruptive behavior, whether done at low latencies or by humans. One would be hard-pressed to disagree. All responsible market participants, many of which use HFT, want to do away with manipulation.  However, by wrongly equating all HFT to manipulative behavior, Better Markets has muddied the water. If we are to successfully address manipulative behavior in the markets, whether executed by computers or humans, we must be clear and precise.

The inaccurate application of the term HFT to only manipulative and disruptive trading practices is not the only place we see the conflation of the term. In recent weeks there has also been a good deal of confusion between news arbitrage and HFT. The number of news releases when compared to overall market activity is small. The number of impactful, market moving releases that come out while the markets are still open is even smaller.

The very fact that these events are infrequent does not allow for them be traded with a high frequency, meaning, by definition, one would not think to apply the term “high frequency trading” to these events. Yet, institutions as esteemed as the Wall Street Journal and the New York Attorney General’s office regularly confuse HFT with an infrequent news arbitrage. AG Eric Schneiderman stated that his office is “committed to ensuring a fair, stable, and transparent market. That means cracking down on the bad actors and encouraging industry leaders to step forward and self-police their industry.” Responsible market participants were encouraged by the statement, as they too want a fair, stable and transparent market that is rid of bad actors.

However, AG Schneiderman went on to say:

 “High-frequency traders who drain the value out of market-moving information in the milliseconds before it becomes available to other investors erode confidence in our markets and skim from the rest of the investing public, which hurts the entire market.”

Unfortunately this statement shows a misunderstanding of the issue at hand, alleging early access when it is unclear that was the case, and conflates HFT, a tool used throughout the industry, with an activity, news arbitrage, practiced by a small group of traders at an infrequent occurrence. Doing so creates two distractions: it distracts from the news trading issue at hand and distracts from the positive contributions HFT makes to the market.

Conflations such as these do a disservice to the investing public by ignoring the many benefits HFT brings to the market and rhetorically casting a common and legitimate trading tool in a narrow and negative light.

All responsible market participants, many of which use HFT, want to do away with the manipulative behavior taking place in today’s markets. The markets should be fair, stable, and transparent, benefitting all market participants. But until we accurately discuss the specific behaviors we need to remove from the market, rather than lumping them under the imprecise mantel of “HFT”, we will continue to struggle to identify the underlying causes of the challenges to today’s marketplace.

Click here to read Part I of “Just Calling it HFT Doesn’t Make it HFT” from MMI.

 

– MMI

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"Don’t Change the Players; Improve the Rules (and Quality) of the Game.”

In a recent blog post, Megan Morgan highlights the work of the Modern Markets Initiative to educate public audiences about the beneficial role of high frequency trading in electronic markets:

“It would come as no surprise that FINRA, the SEC and the CFTC have all stated that high-frequency trading regulation is a top priority for 2014.  In the wake of the Flash Crash, the rogue Knight algorithm and the various market outages in the summer of 2013, HFT and market infrastructure are hot- button issues.

“This could present a great opportunity for the entire industry – exchanges, traders and regulators – to put the proper safeguards in place to ensure that our markets are protected against manipulation and restore faith in a centralized, cleared, electronic financial system. In fact, firms that have been deemed ‘HFT’ by the media and regulators have started to organize groups such as Modern Markets Initiative, which is focused on educating the  marketplace on market structure and the benefits of algorithmic and quantitative trading, to ensure that if and when new regulations emerge, facts outweigh opinions. If regulators continue to use regulation as a way to lynch high-frequency trading, however, the goal to protect investors and increase the safety of the markets may be severely missed.”

In the piece, Morgan – a Vice President of Business Development at Eurex – also draws a distinction between good and bad trading behavior and the responsibility of regulators and all market participants to have a robust, fact-based discussion on market structure:

“Directing the regulations at the infrastructure rather than a particular type of trading may be the better solution. It does not require regulators to define high-frequency trading – which has never before been defined to everyone’s agreement. All market participants fall under the requirements (simple) and, as market conditions change, the rules can change with them. For example,  in Germany, HFT is defined as a firm sending 75,000 messages a day. Ten years ago, this would have been an astronomical number. Today, it can be exceeded by simply making markets; think about an options market maker that has to send quotes across the strip of options and across multiple expiries. Market makers are the very backbone of a stable market, stepping in when there are no buyers or sellers to prevent large swings in the market price – by attempting to regulate a few participants, regulators are essentially throwing the baby out with the bath water.”

Read Megan Morgan’s entire post here.

 

– MMI

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