By Andrew Actman
Lightspeed Chief Strategy Officer
New technology and greater efficiency have always met resistance from the old way of doing things. Nowhere is this more true than the aggressive and lucrative world of financial markets. Evolving from a 100% person to person floor trading model to a fully electronic, computerized transaction system, the trading world’s old guard has fought most changes every step of the way. This isn’t a bad thing. The challenges to the changes often refine the new methods, creating a better and more effective market. It is actually quite funny the way once vilified ideas are often embraced by the marketplace once fully understood and developed. There are many examples of this in the trading space; the change from full service broker market access to individuals making their own decisions via direct access platforms is just one example of the market embracing something it initially rejected.
Another major shift has recently taken place in the financial markets. As expected, this change is being vilified and aggressively challenged by the protectors of the old ways. The shift is focused on the speed and accuracy with which orders are transmitted to the exchanges. High frequency trading is the name for the various tactics and methods that require ultra fast connections and algorithmic strategies to earn profits. Powered by the growth in technology and computer power, high frequency trading is the latest market evolution to draw the ire of the old guard. Blamed for everything from the reduction in liquidity to flash crashes, the trading traditionalists are scrambling to denounce the strategy. However, research and experience have clearly shown that most forms of high frequency trading are actually beneficial to the market.
High frequency trading adds volume. It’s estimated that as much as two thirds of all U.S. equity volume is from HFT strategies. Imagine the damage that would result by regulating this practice out of existence. HFT also narrows the spread between the bid and ask, effectively lowering costs for all market participants. Arzhang Kamerei of Tradeworx explained it saying, “During the turbulent fourth quarter of 2008, it was high-frequency traders that stepped up and provided liquidity. High-frequency trading provides U.S. markets with better prices and deeper liquidity than markets in any other country or region. It helps smooth the course of long-term investors.”
Opponents will argue that flash orders and the predatory nature of a few HFT strategies is the issue. The anti-HFTers will also argue that colocation is unfair since it gives an unfair advantage to some participants. But if one chooses their broker correctly, anyone can have a similar advantage. The ability to colocate is no longer an exclusive club. While there is a smidgen of truth to these arguments, throwing the baby out with the bathwater is not the solution. Traders need to embrace the new technology and find ways to participate.
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