Quant Trader Looks Askance at HFT

Terry Flanagan

Peter Berdeklis, portfolio manager and head of algorithmic trading at Maple Financial, is a prototypical ‘quant’ — he earned a Ph.D. in physics from the University of Toronto in 1998 and has spent the last 16 years as a proprietary trader in statistical arbitrage, and developing algorithmic trading platforms for trading, arbitrage, and market making.

At Maple, he runs a proprietary trading desk focused on high- and mid-frequency stat arb.

“All of my trading is computer-driven, from identifying alpha to strategy execution,” he told Markets Media. “Developing algorithmic trading strategies and execution systems is most of what I do, so of course I’m not against electronic trading.”

He is against high-frequency trading, however, because it fosters what he terms “adverse selection.”

“HFT is not electronic arbitrage or market making,” he said. “The real business of HFT is the industrialization of adverse selection. HFT is in the business of getting to the front of the queue and getting a free option out of having their order ahead of everyone else’s.”

Although he’s not an HFT trader, Berdeklis knows more about the subject than most portfolio managers. “Because we trade so much we are exposed to adverse selection by HFT more than most, so I’ve spent a lot of time studying HFT trading strategies in order to reduce our vulnerability,” he said.

Peter Berdeklis, Maple Financial

Peter Berdeklis, Maple Financial

He has spent a long time re-developing strategies, going back to fundamental principles, to reduce the firm’s exposure to HFT. “There’s no point in coming up with a great strategy that you can’t execute,” he said. “You have to develop your strategies while considering the realities of execution, and you can’t do that anymore without understanding how markets work in the context of HFT.”

The evolution of modern market structure has given HFTs advantages far greater than what most people realize, according to Berdeklis. “It used to be all about fast technology, but now it’s as much about game theory and using market rules to create an advantage every time the quote changes,” he said. “I’m not sure that even the exchanges and regulators understand just how significant an advantage they have.”

In June 2015, TMX Group plans to introduce a new trading model to address the issue of Canadian dealers looking to execute natural trading flow with wholesalers in the U.S. where, unlike in Canada, customer segmentation and payment for order flow are permitted.

“We have heard and understand our customers’ needs and we are taking action to deliver responsive and responsible solutions that together will provide important benefits, both to individual investors and to the broader market,” said Kevan Cowan, president of TSX Markets and group head of equities at TMX Group, in a release.

TSX is changing its market rules “in ways that it hopes will reduce the advantage HFTs have over institutional investors, and to attract order flow that they have lost to the U.S. in payment for order flow agreements, which are not allowed in Canada,” Berdeklis said. “No doubt this is also partially a response to the Aequitas proposal to create a new competing exchange.”

No matter what market rules exist, “they are still just a fixed set of known rules that lend themselves to game-theory analysis,” said Berdeklis. “Every complex set of rules will have some weaknesses,” he said.

The best way to deal with HFT is for everyone to analyze their own trading systems, identify the weaknesses and create their own unique solutions.

“If everyone comes up with their own strategies then the rules of each individual strategy gets lost in the noise and HFT strategies become less effective,” said Berdeklis. “With the enormous technology costs in that industry it doesn’t take much reduction in alpha to make HFT profits evaporate.”

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