Risks of HFT

Terry Flanagan

Practitioners of high frequency trading defend the hazards of their strategy.

Many observers assert that high frequency trading has the effect of adding volatility to the marketplace and as a contributor to the large daily swings in securities prices. It has also been noted that the practice is inherently a high-risk strategy. However, practitioners say that is not the case.

“High frequency trading is inherently a risk management tool,” said Peter Nabicht, chief technology officer of Allston Trading. “They buy and sell a position before something averse happens.”

While practitioners suggest that their own strategies are safe, as they often hold their positions for just seconds, before rapidly trading out of the position, thousands of times a day, others assert that it causes negative effects on other investors, including institutional and retail.

High frequency trading is often the scapegoat for the wild four or five percent swings seen in the markets in recent history, with the “flash crash” of May 6, 2010, chief among them.

While there are arguments to be made on both sides for whether or not HFT brings positive or negative effects to the market, exchanges and trading platforms are increasingly embracing high speed traders.

CME Group recently announced that its co-location services, which will include hosting, connectivity and support services, will go live on Jan. 29, 2012. It is one of among many exchanges worldwide looking to increase the speed and lower the latency of their trading platforms, which most directly benefits high frequency traders. Co-location facilities are located as close to their machine engine as possible, giving trading firms, including HFT firms, nearly instant execution times. HFT has grown to about 75 percent of trading volume in the U.S., according to industry estimates.

The service is expected to become a lucrative source of additional revenue for exchange operators, as they capitalize on the quest for speed sought by active, high-volume traders. CME Group had previously said it expects to generate between $30 million and $40 million from co-location services when they launch next year.

Allston Trading is a Chicago-based high frequency trading firm. The company is a market maker in over 40 exchanges spanning 20 countries, and in several product classes.

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