Solving the HFT Puzzle

Terry Flanagan

Questions persist over what constitutes high-frequency trading.

A method for defining and tracking high-frequency trading employing complex-event processing is being advocated by a member of the Commodity Futures Trading Commission’s Technology Advisory Committee (TAC).

The TAC, which met this week, discussed the question of HFT in the context of derivatives regulatory reforms, with the expectation that HFT and algorithmic trading strategies will migrate from the world of listed equities and derivatives to the OTC world.

Scott O’Malia, a commissioner on the CFTC, has suggested that before the CFTC recommend rules for HFTs, it develop “a precise and reasoned definition of who is and who is not an HFT,” according to a letter he wrote to the CFTC’s Technology Advisory Committee (TAC).

O’Malia proposed a multi -part test to determine what constitutes an HFT, such as the use of extraordinarily high-speed order submission systems with speed in excess of five milliseconds; the use of computer programs or algos for automated decision making, without human direction for individual trades or orders, and very short time-frames for establishing and liquidating positions.

John Bates, chief technology officer at Progress Software and a member of TAC, has proposed a definition and measurement process for HFT that relies on CEP.

“My proposal to the CFTC TAC would use parameters outlined in Commissioner O’Malia’s letter as a control panel to a real-time analysis technology like CEP to analyze the behavior of algorithms,” Bates told Markets Media.  “So for example, filter by all algorithms that place more than 1,000 quotes per second, hold positions for an average of less than 2 minutes and are co-located with a trading venue.”

“It may be that we need to add some tags to quotes to identify trading participants,” said Bates. “But this whole idea is achievable.”

Bates postulated a definition of HFT “as an algorithm that takes in one or more feeds of market data, analyzes the data and looks for patterns that indicate trading opportunities and automatically places and manages orders in the market.”

O’Malia’s definition included more parameters, e.g., co-location to reduce latency, high quote volumes, and short holding periods, but these can be considered by-product of types of HFT.

“You don’t need these to be an HFT,” said Bates. “For example, a cross-asset algo can’t be co-located with all its trading venues”

The Principal Traders Group and the Futures Industry Association have countered with a suggestion that rather than try to come up with a precise definition of HFT, regulators utilize existing data gathered by listed derivatives exchanges such as CME and NYSE Liffe U.S.

They suggested that the CFTC define a new term, “Direct ATS Participant,” characterized by use of an automated trading system directly connected to an exchange.

Bates said that would not meet the guidelines set out by O’Malia, however.

“While the derivatives market does track HFT, the current method leaves a lot to be desired. Any tracking of HFT needs to enable auditors to understand the behaviors of different types of algorithms and detect anomalies and abuse and that is simply not possible under the current setup,” he said.

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