US Equity High Frequency Trading: Strategies, Sizing and Market Structure
High-frequency equity trading is the lovechild of 12 years of SEC rulemaking and advances in trading technology. The combination of these two trends has been necessary and sufficient to unleash an array of new trading strategies. The continued success of these strategies has exchanges and ECNs, brokers and clearinghouses, market data providers and technology vendors launching new business models and offerings to support high-frequency traders or help others adapt to this new environment. Imagining an US equity market structure without high-frequency traders is like trying to remove the “c” from E=mc2.
But, not everyone has a full understanding of US equity market structure, and those that do not necessarily have consistently favorable views of it. In fact, recent events have triggered politicians, the media and even the general public to weigh in on this, using such industry jargon as high frequency trading (HFT), flash orders, naked access and dark pools in their everyday lexicon when taking a position on the fairness of securities trading today. However, while these terms reflect some of the newest changes in the marketplace, their direct association with each other should not be assumed without further clarification.
How much daily trading activity can be classified as high frequency? What comprises this classification? For everything that is not considered high frequency, what portion of activity is affected by it, in terms of related prices and liquidity? What kind of firms include high frequency trading as part of their strategy and how big of a role does it play in the profitability of the industry?
What is a ‘fair market’ and a ‘level playing field’? Should we expect all participants to play on a level field or will professional traders naturally gain greater ability from their experience, intuitive knowledge and advanced technology tools? What is the relationship between these terms?
Once we peel back the layers of the process and examine the tradeoffs that everyone faces, from institutional investors and hedge funds, to retail brokers, individuals and their representatives, the world becomes a series of tradeoffs: market impact versus opportunity cost; price improvement versus information leakage; narrow spreads versus depth of book; good regulation versus unintended consequences.
The appropriate tradeoffs cannot be made unless we have a clear understanding of the participant’s and their role in the market. High-frequency trading is not a homogenous group; it is not an investment style; it is not a unique phenomenon to equity markets or the US. High-frequency trading merely describes one characteristic of a wide array of market participants.
The industry and its regulators must stop looking at participants and start looking at specific mechanisms and practices.
The TABB Group study on US Equity High Frequency Trading is a 32 page report that explores the importance of high frequency trading in our market, defines terms associated with high frequency trading, and explains the relationships among the primary participants. It gives explanations and examples of high-frequency trading strategies, including virtual market making, rebate trading, liquidity detection, and various forms of arbitrage. The report details TABB Group’s methodology for the proportion of equity volume and trades that involve high frequency strategies, as well as drivers for future changes to those numbers.
Included throughout the report are the results of a recent poll of 62 market participants on various components of current market structure such as flash trading, redefining front running, the tradeoff between order exposure and price improvement, and the need for an SEC inquiry into market structure, ability to get a good execution.