Democracy and High Frequency Trading
Posted by Jeff Wells on Tue, Oct 12, 2010
The CBS 60 Minutes report, How Speed Traders Are Changing Wall Street, aired Sunday, October 10th and provides plenty of content for many market data related blogs. While all of us will view the report from our own role and perspective I was struck by how dated the entire debate must seem to participants in our industry.
The underlying premise to the anti-HFT side of the argument is that the HFT shops have access to lower latency market data. In this version of the argument, the high frequency traders see the bids and offers first. This advantage is obtained by physically colocating near the matching engines and using high-speed computers to process the data very quickly. The argument is made that only a few firms can afford the tremendous expense in trading technology to compete for bids and offers at this speed.
There are at least three countervailing positions which I think overwhelm these arguments.
First, the high frequency trading business is very competitive. Dozens of firms participate in this space and new shops are opening all of the time. No one would describe the environment for bids and offers as anything other than intensely competitive. This has dramatically narrowed spreads and enhanced liquidity for every participant in the market.
Second, technology is democratizing this business. The cost of building a competitive infrastructure is dropping very rapidly. A few years ago it may have cost $100,000 or more a month (and long term facility lease commitments) to set up the market data infrastructure at a single colocated facility. Today, that cost is $5,000 per month on a month to month lease for our Exegy High Speed Data Tone solution. Latencies are the same as platforms we lease to the HFT community. The advantage that any trading firm has in this space is the cleverness of their people in designing trading strategies that work in a very competitive environment. This has always been the case.
No one in the industry believes they have a business model with a sustainable infrastructure advantage. This is an arms race and the price of competing is dropping rapidly for all participants.
Third, retail order flow is frequently aggregated and executed by electronic order routers that are colocated and use the same sophisticated equipment used by the high frequency trading community. This is true for retail investors that execute orders through online broker dealers and for the largest mutual funds that rout orders directly to electronic trading platforms. Many non-high frequency traders execute orders over identical infrastructure as the HFT shops.
This market system is the envy of every country in the world. The costs of trading and the depth of liquidity in our system are unmatched anywhere. Technology moves very fast in this space and many participants, large and small, have been beneficiaries of these developments. There will always be participants with dated business models that want to return to an earlier state. The history of the market system doesn’t offer them much hope.