Mike O’Hara has interviewed scores of traders, connectivity providers, academics and exchange operators for his web site, the High Frequency Trading Review. He always opens his interviews with the same question: "What is high-frequency trading (HFT)?"
He never gets the same answer twice.
"The problem is that ‘high-frequency’ is a relative term," says O’Hara, a former floor trader at the London International Financial Futures Exchange (Liffe). "There are, however, some common threads in all definitions: It’s computer-driven; it generates a large number of orders in a short space of time; it’s dependent on low-latency, fast access to execution venues; its positions are held for short periods of time; it ends the day flat and it’s characterized by a high order-to-trade ratio."
Armed with those common threads, scores of researchers, regulators and practitioners have been examining the impact this new breed of algorithmic trader is having on the markets. Papers released in the first few months of this year (many of which are available via O’Hara’s site) alternately have credited HFT with making upstart exchange Chi-X a success, accused HFT practitioners of introducing new and dangerous types of volatility into the markets and vindicated HFT for the May 6, 2010 "flash crash" that sent the Dow Jones Industrial Average on a yo-yo ride of more than 900 points in a matter of minutes, and pushed some individual equities to a penny.
By extrapolating from the findings of several papers, you easily can conclude that "good" HFT both delivers liquidity and makes money, while "bad" HFT disrupts markets, extracts liquidity and loses money. If that’s the case, disruptive trading strategies will pass away like last year’s summer cold. If bad HFT strategies prove more virulent, however, they may require more aggressive treatment.
What is disruption?
Aite Group analyst Paul Zubulake is an unabashed defender of HFT. He even wrote a book called "The High Frequency Game Changer: How Automated Trading Strategies Have Revolutionized the Markets" (Wiley Trading).
"If you’re the kind of trader who sits there looking at charts and clicking when he sees an opportunity, then you will say the market has been disrupted, because the kind of behavior you trade on may have changed," he says. "But if you’re a longer-term trader, or a hedger, you’ll find that tighter spreads and better liquidity make it easier to unload large positions than it’s ever been."
That, he says, is the true measure of the market’s success — at least in the case of futures — because futures markets exist to provide a vehicle for hedging and price discovery.
Niki Beattie, who founded and now runs Market Structure Partners, agrees. "In general, HFT is not the great concern that everyone thinks it is," she says. "New technologies always are disruptive and cause worry to those who don’t understand them, and they challenge the incumbents by being innovative, but they usually lead the way in terms of how the whole industry will change and we should not be afraid of change."
Hirander Misra, chief executive of connectivity provider Algo Technologies Ltd. and former chief operating officer of Chi-X, adds that mechanisms are in place to purge those activities deemed disruptive.
"At Chi-X, we used to monitor and audit trade ratios and if we found a firm doing anything funny, we’d ring them up, and they’d stop," he says. "If we hadn’t done that, other algos would have come up with strategies that bait bad behavior and punish it."