06.08.2012
By Terry Flanagan

Study Sees Bright Future For HFT

High-frequency trading continues to divide opinion in the industry, with regulators, in particular, taking a dim view of it, but new research claims that the algorithmic trading practice actually brings positive benefits to the futures market.

Having already discovered similar findings in a study of equities markets last year, the Capital Markets Co-operative Research Centre (CMCRC), an independent academic body based in Australia, applied the same models it had used in the equities arena to examine the impact of HFT on liquidity and volatility in futures markets.

“HFTs appear to assist in decreasing excessive price volatility,” said Alex Frino, chief executive of CMCRC and professor of finance at the University of Sydney Business School. “This is partly due to the way HFT algorithms identify trading opportunities—they’re built to recognize when prices are abnormally high or low, and respond in a way that naturally pushes prices back towards the middle.”

Professor Frino’s models looked specifically at liquidity from ‘make’ and ‘take’ perspectives—how often a quote is hit, and how often HFTs hit existing quotes. The team found that HFTs are overall net providers of liquidity, and that their liquidity is used as readily by other market participants as any other type of liquidity. The study also found that co-location of trading firms’ servers under the same roofs as market centers’ matching engines greatly increased the amount of HFT activity, thus enhancing market liquidity.

However, some European market participants are still skeptical of the true benefits of HFT in capital markets.

“In seeing the speed in which you can see market dislocations happen with HFT, I think there are dangers associated with that,” Jon Payne, manager of sales engineering at technology vendor InterSystems, based in London, told Markets Media.

And given that high-frequency trading now accounts for over half of all market volumes, by some estimates, as other long-only players and institutional investors continue to bide their time and stay out of volatile markets, waiting for the right time to re-enter, HFT may also be constructing a battleground where algos are magnifying the outcome.

“You are seeing increasingly HFT playing one against another, creating a market for guys to fight, and no other volume in the market because asset managers and long funds are not coming to the market because they haven’t got a clue what to do,” one market source, based in London, told Markets Media.

“But you will never have a clear answer as to whether HFT is good or bad because of the state of the market in Europe—fragmentation, lack of visibility or an understanding of how the market functions.”

Proponents of HFT, meanwhile, say that the practice brings other benefits to the marketplace.

“Reducing the latency of trading also reduces the risk of trading,” said Mark Spanbroek, vice-chairman of the FIA European Principal Traders Association, a proprietary trading lobby group, based in Brussels.

“If you minimize the amount of time it takes to trade, your market becomes a lot more efficient and that is reflected in narrower bid/ask spreads. If you are exposed for a longer time, you actually increase the risk for the firm that puts that order into the market and that equates to cost. All the evidence shows that algorithmic and automated trading have decreased bid and ask spreads tremendously.”

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