By Dr. John Bates, general manager of Progress Apama
As someone who has been automating trading systems for over 10 years, the recent attention on high-frequency trading (HFT) is a bit surprising. The latest popular view is that HFT is the primary cause of dangerous trading behavior that manipulates markets, fosters front-running, and other market-distorting behavior.
But to suggest that HFT is the root of all evil is misguided. In many ways, trading is one of the world's purest forms of capitalism, and this expression of capitalism has benefited the markets by making them more liquid. Any regulation should provide a thoughtful intervention. But such careful consideration has been lacking to date, and we run the risk of employing a blunt tool where a finely calibrated one is needed. Where there are imperfections in trading conduct, oversight should ensure that the needs of traders-and the markets overall-are properly served.
Compare today's environment to 10 years ago, when all trading went through established brokers and exchanges, with each intermediary exacting a toll for their services. In some cases, the value offered was marginal and the significant costs proved to be an economic tax on trading that hurt the markets.
Largely due to the emergence of electronic trading and the technology that drives it, the traditional exchanges' control has loosened. Competition has delivered benefits for trading constituents large and small. And by combining the benefits of electronic trading with the impact of decimalization, you can now have an environment in which liquidity is encouraged, and intermediaries (brokers, exchanges, and so on) can no longer impose disproportionate tariffs solely via their role as middlemen.
Regulation and technology have combined to create more markets, produce more market volume, and exponentially more market data over recent years. High-frequency players have had a disproportionate impact. Market participants have had to scale their data infrastructures to cope with rising data volumes, since technology has also proven fundamental to harnessing the volume and managing volatility.
One problem with current commentary is the assumption that technology is available only to a select few in a position to use it to gain advantage. But has the monopolistic behavior of the past been replaced by a new technology monopoly? Large firms do indeed make major investments in trading platforms and staff to create and implement trading strategies. But HFT technology is available to everyone nowadays. The threshold to profits is no longer an expensive trading infrastructure; it is the trader's own insight to understand market behavior, and the imagination to conceive a trading strategy that can capitalize on it.
One industry response to the data volume and market expertise challenges is the event-based model pioneered by innovators such as Apama. This approach provides the capacity to monitor fast-moving event streams, analyze them to identify opportunities and threats, and take automated actions in real time, with graphical event modeling capabilities that empower traders to quickly build unique trading strategies. With rapidly growing data volumes and the constant need to reduce latency, this approach scales much more effectively than static data processing, and therefore lends itself well to HFT.
Rather than fear technology, I would counsel an acknowledgement of the exploding market data phenomenon, and a view of the opportunity that this data offers those with the ability to capitalize on it. Market data is the fuel for trading, and the market data explosion is top-grade fuel for the HFT race car. HFT firms are able to capitalize on a wealth of opportunities when armed with a platform that both handles the data load and provides a way to express a trader's unique knowledge of how to take advantage of that data. The result is massive amounts of order flow generated back to the markets, driving volume and providing liquidity. In addition, the trading community benefits from the contraction in spreads and more efficient price discovery that this liquidity delivers, and the economic tax on trading is reduced for all market participants, not just high-frequency traders.
HFT technology is here to stay. The answer is not prohibition, but rather transparency as to its fair use, where such transparency does not damage the legitimate interests of traders. Banning competitive uses of equally accessible technologies is like throwing out the baby with the bathwater. Instead, regulators mulling the future of HFT should consider policing trading for abusive patterns. The markets are better off than they were 10 years ago, even accounting for the abuses that have been identified. Technology provides opportunities, but with those opportunities come challenges as well.
Intervention, however well-meant, is likely to fall prey to the law of unforeseen consequences, damaging the benefits of technology-based HFT. Markets are better served by real-time monitoring that keeps pace with the technology that is driving HFT, rather than wholesale prohibitions. Banks, trading venues and regulators can monitor trading activity without hindering the benefits that markets and participants realize from HFT strategies, by employing the same technology used for HFT. The platforms that execute HFT are the foundational elements for monitoring trading behavior in ways that can prevent malevolent or collusive trading. Neither the speed of trading nor opacity need hinder proper monitoring.
This article also appears in Inside Market Data
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