Debunking Myths Surrounding HFT Tech
(This article first appeared in the Business Standard)
Algorithmic trading in financial markets is essentially machine trading in the purest sense. Machines are perfect for doing repetitive jobs without having human errors.
However, the pitch for algo-trading/HFT (High Frequency Trading) in India has been queered, thanks to unrelated issues. Two very different issues viz. corporate governance lapses and advent of a game-changing technology are being unfairly clubbed together despite not a shred of evidence to conclusively prove that technology is indeed the villain.
Study has proven that algo-trading/HFT is not an unfair advantage. Merely using a machine does not hand anybody any great advantage. The technology for accessing the exchanges ranges from manual order entry through exchange terminals and Order Management Systems (CTCL), Direct Market Access for sophisticated clients (DMA), Internet trading for retail investors and colocation facilities (colo) for proprietary traders and brokers offering lower latency access to clients.
Algos are used for efficient trade execution. Some types of algos employ trading strategies that are more reliant on speed of execution and can be referred to as high frequency trading (HFT) algos.
HFT algos are commonly used for market making. Floor brokers/jobbers offered manual market making in the past. However, technology evolution has largely automated this function and enabled market making in a wider set of the 35000 contracts and securities in India.
Algos do not make any unauthorized use of the market and are operated from the colocation facilities as well as broker and client/investor offices. Algos from non-colo locations largely use CTCL and DMA technology access.
Time is essentially money in the stock trading business. With algos becoming the dominant tool for execution of investment ideas, traders’ success is now tied to adopting algo technologies that are now increasingly available at lower costs as the number of vendors increase.
Brokers too are emerging that offer algo-ready platforms, reducing the need for traders to themselves invest heavily in technology.
According to data available with the market regulator, the share of HFT as a percent of total orders and turnover has been rising steadily.
In 2011-12, HFT orders as a percentage of overall orders in the cash equity segment was at 65 percent. This has gone up to 94 percent in 2015-16. HFT turnover as a percentage of overall turnover in the cash equity segment has gone up from 25 percent to 42 percent over the same period. In the equity derivatives segment, the percentage of HFT orders has gone up from 78 percent to 98 percent between fiscal 2012 and fiscal 2016. The share of turnover has risen from 22 percent to 56 percent.
Globally, collocation is a common feature across all mature markets and the market share of algo-trading /HFT is more than half of the volume.
Electronification of the municipal bond market also presents a large opportunity.
The success of Northbound trading showed electronic execution is way forward for the bond market.
Algorithms have become more prevalent in the spot FX market.
Increased electronification has created useable and accessible real-time and historic trade data.
Buy-side firms can discover liquidity more efficiently and execute on Turquoise.