Finally, evidence that high speed trading makes markets stronger

Since 2010’s infamous “flash crash”, High Frequency Trading (HFT) has been under the continuous gaze of the financial services regulatory authorities. HFT's ability to enable large numbers of high speed trades made it the prime suspect when the Dow Jones Industrial Average plunged 1,000 points in a matter of minutes, before quickly recovering. According to some market watchers, HFT increases volatility and damages the integrity of the markets. From firms being fined millions of dollars for computer errors disrupting the futures market, to commodity traders getting stung for market manipulation and alleged mini flash crashes like the case of Thermo Fisher Scientific and Pall Corporation, in which shares dropped by more than $1 before regaining most of that value in minutes, the practice has come under increasing scrutiny.

A recent report by the Futures Industry Association (FIA), however, shows that instead of contributing to the Dow Jones 1,000 points fall, high speed trading actually absorbed the initial sell orders, with the majority of algo traders continuing to provide market liquidity throughout the drop. Most importantly the study confirms that speed is an essential risk management tool for market participants, specifically electronic market makers. It states that speed enables many organisations to post direct quotes at competitive prices on exchanges, safe in the knowledge that the quote can be updated very quickly if the market moves.

The report’s findings should hardly come as a surprise. In the complex world of HFT, speed, as we have highlighted in previous posts, is of paramount importance in the race for market liquidity. With the majority of firms currently adapting highly sophisticated algorithms to search the stock market for tiny price differentials, trading is no longer about who spots the profit opportunity, but about who gets there first. This is why proprietary trading shops are continuing to invest in upgrading their IT infrastructure and to pay for co-location, putting their servers as close as they can to the local exchange’s matching engines. It is also why these firms invest significantly to maintain the fastest fibre-optic connectivity in a bid to reduce latency, enabling their traders to cut a few milliseconds off order execution times.

This practise is not restricted to Europe alone. The emergence of new markets catering to cross venue arbitrage across the world means that trading firms will have to adapt. If firms are to take advantage of arbitrage - price differences between two or more markets- it is critical for them to have their trading engines physically present in emerging market cities, so that they can exploit price fluctuations. An optimally-located trading facility is an advantage over rivals, who will face greater delays in obtaining information from either one exchange or the other.

FIA’s conclusion that high speed trading has a positive impact on markets should provide a prompt for the industry as a whole to focus on HFT not as something for the few, but as a practice for any trader looking to use technology looking to get faster access to market liquidity. Hopefully, the debate can finally move on from the effects of HFT, to the potential of new technology to progressively raise trading speed and agility.