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Here’s How High Frequency Traders Dominate The Markets

Here’s How High Frequency Traders Dominate The Markets

Vince Veneziani|Dec. 7, 2009, 3:24 PM |

An interesting PDF concerning latency arbitraging in the world of HFT has been released by Themis Trading. In it, they explain just how HFT works with computers doing all the heavy lifting, though that quote about 60% of daily volume is way off. I’ve heard reports of 3 to 5-percent:

Themis Trading: Here’s an example of how an HFT trading computer takes advantage of a typical institutional algo VWAP order to buy ABC stock:

1. The market for ABC is $25.53 bid / offered at $25.54.

2. Due to Latency Arbitrage, an HFT computer knows that there is an order that in a moment will move the NBBO quote higher, to $25.54 bid /offered at $25.56.

3. The HFT speeds ahead, scraping dark and visible pools, buying all available ABC shares at $25.54 and cheaper.

4. The institutional algo gets nothing done at $25.54 (as there is no stock available at this price) and the market moves up to $25.54 bid / offered at $25.56 (as anticipated by the HFT).

5. The HFT turns around and offers ABC at $25.55 or $25.56.

6. Because it is following a volume driven formula, the institutional algo is forced to buy available shares from  the HFT at $25.55 or $25.56.

7. The HFT makes $0.01-$0.02 per share at the expense of the institution.

It is currently estimated that HFT accounts for 60% of all share volume.

December 9, 2009 Posted by | Hi Freq Trading (HFT), Uncategorized | Leave a comment

LSE backs high-frequency traders


LSE backs high-frequency traders Posted by Gwen Robinson on Sep 08 04:35.

High-frequency traders, now under regulatory scrutiny in the US, on Monday gained support from London Stock Exchange chief Xavier Rolet, who said said they were a necessary source of liquidity for exchanges. “We welcome them. They are a source of liquidity and we do not rank any particular source of liquidity higher than any other”, he told the FT, noting that HFT accounts for “in the region of a third to 40%” of equities trading on the LSE.

September 8, 2009 Posted by | Hi Freq Trading (HFT) | Leave a comment

The New Masters of Wall Street



On The Cover/Top Stories
The New Masters of Wall Street
Liz Moyer and Emily Lambert 09.21.09, 12:00 AM ET



Daniel Tierney and Stephen Schuler share a lot of traits with many other enigmatic traders populating the financial world. Their firm, Global Electronic Trading Co., is tucked behind a nondescript door on the second floor of the Chicago Board of Trade’s art deco building. Until this summer, when it added some company specifics, its Web site contained little more than a reading list with recommendations like Reminiscences of a Stock Operator. Not a single photo is publicly available of either of its principals.

What distinguishes Tierney and Schuler is that Getco, as their firm is known, currently buys and sells 15% of all the stocks traded in the U.S., ranking it among the likes of Goldman Sachs and Fidelity Investments. Getco was reportedly valued at $1 billion two years ago and is rumored to have earned roughly half as much as that in net profit last year alone. Tierney, 39, and Schuler, 47, are among Wall Street’s super-nouveau-riche.

“We translate technology innovation into making financial markets more efficient,” Tierney says in a carefully worded interview.

Getco earns its outsize profits buying and selling securities up to thousands of times a second. This frenetic profession has come to be known as high-frequency trading, and in recent months it has emerged as the hottest ticket on Wall Street. Even as financial markets collapsed last year, high-frequency traders collectively enjoyed $21 billion in gross profit, according to Tabb Group. On the NYSE, daily volume surged 43% through June from a year earlier to 6.2 billion shares; high-frequency traders are believed to account for 50% to 70% of the activity and similar proportions in electronic futures and options markets.

In the process they have ushered in the most wrenching, and controversial, transition in the history of U.S. securities markets. For decades the New York Stock Exchange towered over U.S. equity trading, with its market share rarely dipping below 80%. Nasdaq and other electronic rivals slowly chipped away at it. But the real shakeup has come very recently at the hands of high-frequency traders and the band of scrappy exchanges that have popped up in their orbit. In the past two years they have collectively cut, from 50% to 28%, the share of equity volume controlled by the NYSE, even as it has sacrificed its iconic floor to the whims of the electronic crowd.

With their emergence as the predominant source of activity and profits, high-frequency traders have become the new masters of the Wall Street universe, reshaping financial markets in their image, just like the junk bond kingpins, corporate raiders and private equity powerhouses who reigned before them. High-frequency traders and their offshoots–the public trading venues that cater to them and the private “dark pools” that seek to shut them out–have become lightning rods for criticism among frazzled individual investors and grandstanding politicians who are shocked–shocked!–to find Wall Street trying to make a buck at a time like this.

Senator Charles Schumer (D–N.Y.) has demanded that the Securities & Exchange Commission prohibit the high-frequency gang from using something called flash quotes. SEC Chairman Mary Schapiro warned the lack of transparency in dark pools has “the potential to undermine public confidence in the equity markets.” Nasdaq’s Robert Greifeld has called for banning them outright. “America is destroying its capital market structure,” frets Thomas Caldwell, chairman of Caldwell Asset Management, an NYSE investor.

Here’s another viewpoint: All these scolds are missing the bigger picture. High-frequency trading adds liquidity, speeds execution and narrows spreads. This contrary view comes from, among others, George (Gus) Sauter, who oversees $920 billion in investments for the Vanguard Group. “We do think [high-frequency trading] enhances the marketplace for all traders,” he says.

Getco’s story parallels the changes afoot. Tierney, a cerebral economist and philosopher, began trading options on the floor of the Chicago Board Options Exchange in 1993. Schuler, a gregarious futures broker, started out in 1981 on the floor of the Chicago Mercantile Exchange and eventually opened his own firm. Acquaintances from the clubby world of Chicago’s financial markets, they started talking about going into business together in 1999 and set up Getco that year as part of a vanguard of floor traders migrating from the pits to “upstairs” computerized trading rooms.

Early on the firm operated out of space in Schuler’s firm barely big enough for a couple of desks and computers. For trading talent the partners scoured nearby Illinois Institute of Technology in search of skilled videogamers. As Getco grew, they bought gear from dying Internet companies and coded it to operate with ever less human intervention.

High Frequency Who’s Who
Trading for Dummies

Special Offer: Free Trial Issue of Forbes

From the get-go the strategy was to trade fast, furiously and electronically. Getco’s first point of attack was futures, which went electronic early. Tierney and Schuler programmed their computers, and the people manning them, to offer quotes and execute trades more quickly than rivals. Then, when the market moves, to do it again. By posting bids and offers for the same securities simultaneously, they are able to scoop up a spread of a tenth or a hundredth of a penny per share thousands of times a day while limiting the capital at risk. What Getco gives up by capping its risk it makes up for in volume. The company currently trades an estimated 1.5 billion shares a day with 220 employees and offices in Chicago, New York, London and Singapore.

Computerized trading is hardly new nor is the demonizing of its effects. The era of floor-based markets started drawing to a close with the popularization of Nasdaq’s electronic system in the early 1980s. Program traders were the early electronic whiz kids until critics pinned the blame on them for the 1987 crash and circuit breakers limited their influence. A decade ago people working the Small Order Execution System, a.k.a. SOES bandits, began minting money by arbitraging spreads created by lags in the speed at which disparate Nasdaq marketmakers updated their prices; the dot-com bust eventually laid them low.

Others have shown impressive stamina. Former math professor and code cracker James Simons founded algorithmic trader Renaissance Technologies in 1982. But his firm came to true prominence only with the hedge fund boom of the past decade. Last year its flagship Medallion fund (assets: $9 billion) was up 80%. Simons ranked 55th on FORBES’ 2009 list of the world’s billionaires.

Dissatisfied with the duopoly the NYSE and Nasdaq enjoyed, then SEC Chairman Arthur Levitt (now an advisor to Getco and Goldman Sachs) in 1998 pushed through Regulation Alternative Trading Systems. Reg ats gave rise to a plethora of so-called electronic communications networks that made markets in stocks, or simply matched buyers with sellers. Two years later the exchanges began quoting prices in decimals instead of fractions. Overnight the minimum spread a marketmaker stood to pocket between a bid and offer was compressed from 6.25 cents, or a “teenie,” down to a penny.

In classic Wall Street fashion traders set about finding new ways to earn a living. Some were nefarious. In 2004 seven NYSE specialist firms paid a quarter-billion dollars to settle charges of front-running clients.

Others viewed electronic markets as legitimate opportunities. The big wire houses hedged their bets by taking stakes in the various electronic communications networks that emerged in the 1990s. In 1999 Goldman Sachs paid $550 million for Hull Group, which used computer-based algorithms to trade equity options. “An unsustainable model” is how Duncan Niederauer described floor trading to forbes a year later. A Goldman derivatives trading exec at the time, he now runs the NYSE.

The final structural move that set the stage for the current electronic trading revolution was Regulation National Market System, put in place in 2005. Previously brokerages were, in theory, obliged to offer clients the best possible execution of stock orders. But it was left up to each firm to determine whether “best” meant the fastest or at the most favorable price. That left brokerages plenty of wiggle room to match buy and sell orders internally and pocket the spread, or send them to exchanges that paid kickbacks for order flow.

Under Reg NMS, by contrast, the SEC decreed that market orders be posted electronically and immediately executed at the best price available nationally. To Getco and its high-frequency brethren, Reg NMS was like catnip. Many began posting continuous two-sided quotes on hundreds of stocks. Some sought to arbitrage the tiny price spreads that existed at any given moment between buy and sell orders. Others, known as rebate traders, profited from payments for order flow the exchanges offered. Latency arbitragers, like the SOES bandits before them, sought to scoop up price differences resulting from momentary time lags between exchanges.

Today hundreds of firms are vying for a piece of the high-frequency action–huge ones like Goldman and Barclays Capital, hedge funds like Citadel and lesser-knowns like Getco and Wolverine Trading. Lime Brokerage, housed in chic lower Manhattan digs with a rooftop garden, handles trades for 200 high-frequency trading firms and individuals. Like hedge funds in the mid-1990s, high-frequency traders are popping up practically every day and attracting leading talent. Vincent Viola, who headed the New York Mercantile Exchange, recently opened Virtu Financial and lured away Christopher Concannon, former head of Nasdaq’s transaction services. Private equity money is rushing in, too. General Atlantic reportedly paid $200 million to $300 million for 20% of Getco (Tierney, Schuler and employees own 80%) in 2007. Last year ta Associates acquired a stake in RGM Advisors and Summit Partners bought into Amsterdam’s Flow Traders; deal terms were not disclosed.

High Frequency Who’s Who
Trading for Dummies

Special Offer: Free Trial Issue of Forbes

With so many players, high-frequency trading has morphed into a technology arms race. In a well-publicized case, the FBI arrested former Goldman employee Sergey Aleynikov in July for allegedly stealing trading algorithms. Separately, Citadel claims in a lawsuit that Aleynikov’s new employer, Teza Technologies, may have got illicit access to trading software it spent hundreds of millions of dollars developing. Teza has not been accused of wrongdoing by the government.

Making it in high-frequency trading these days requires the latest technology. Lots of it. Getco won’t talk details, but others will. Infinium Capital is the biggest marketmaker in natural gas futures and runs its computers in 100,000 square feet near the Chicago River. The core of its operation is 40 racks of servers overseen by quant traders who man up to a dozen screens each.

Infinium’s operation runs on a piece of the public electricity grid backed up by two separate power substations and 196,000 pounds of batteries. Not safe enough. Infinium is paying to install a 2,000-kilowatt diesel generator just in case. Infinium taps into the CME Group’s computers, housed on the same floor of a data center, via dedicated fiber-optic lines capable of transmitting up to 5,000 orders per second with a lag time of no more than 10 milliseconds. Infinium has other servers strategically situated near exchange computers in New Jersey, London and Singapore.

The high-frequency boom is reshaping securities markets everywhere. Four years ago 13 people from TradeBot, a Kansas City trading outfit, left to form a new ECN called Bats Trading. Getco, Wedbush Morgan, Lime and seven big banks are now investors. Bats was granted full exchange status last year, adding a level of legitimacy and eliminating a time lag in reporting trades through another exchange. It now handles nearly 12% of daily U.S. stock trades. Direct Edge, a rival backed by Goldman, Citadel and Knight Trading, handles another 14%.

What’s not to like? From a narrow perspective, the robot traders seem to be enjoying an unfair physical advantage over other investors. One eyebrow-raising reality is that a big chunk of high-frequency profits derive from jumping into markets before small investors can. In the high-frequency world, the 20 milliseconds it can take quotes to travel from Chicago to Nasdaq’s market site in New Jersey (the flashy Times Square one familiar to the public is a TV prop) is an unacceptable lag. So interminable, in fact, that it gave rise to the entire strategy known as latency arbitrage.

The need for speed, in turn, has led to a rush for real estate as close to securities exchanges as possible. In Chicago 6 square feet of space in the data center where the big exchanges also house their computers goes for $2,000 a month. It’s not unusual for trading firms to spend 100 times that to house their servers, says Scott Caudell of 7ticks, which manages dozens of firms’ servers there. Now even the tradition-bound NYSE plans to open a 400,000-square-foot tech center in New Jersey and is taking orders for server stalls.

Does this institutionalize an unlevel playing field? It does and it doesn’t. Small-fry investors are cut out of the business of making 0.1 cent markups. But this isn’t what the fellow buying 1,000 shares of ExxonMobil should be worried about. For him, the risk is that he pays 5 cents a share too much, only to see the quote fall back a nickel a few seconds later, perhaps because brokers in the middle could see what he was doing but he couldn’t see what they were doing.

For years the regulators have tried to make trading fair by putting bids and offers out in the open. When Levitt took over the chairmanship of the American Stock Exchange 31 years ago, the talk was of a “composite limit order book” that would make it harder for middlemen to pocket undeserved spreads. That idea didn’t fly, but variations of it lived on in all sorts of rules designed to force transparency on the market. The trouble with such rules is that they can’t force anyone to really show his hand. A reg can mandate that a 10,000-share order be put on the tape within a certain number of seconds. It can’t mandate that the hedge fund trader placing it reveals his intentions for his other 90,000 shares.

No surprise that today’s order books are filled with feints and parries, made and withdrawn in a blink of the electronic eye–1,000-share bids and offers that are stalking horses for million-share moves. Unfair to the little guys? Not necessarily. Their salvation comes from volume. If enough shares move every second, it is less likely that they will be gouged out of a nickel spread.

Another controversial offshoot of high-frequency trading is sponsored access, which already accounts for 15% of Nasdaq activity. In the old world traders were required to send every order to a registered broker-dealer who passed it along to an exchange or executed it themselves. With sponsored access, traders send orders directly to exchanges. This has raised concerns that a lack of oversight could lead to the sort of disaster that overtook derivatives during the financial crisis.

Some high-frequency traders are sending out 1,000 orders a second. In the span of the two minutes it typically takes to rectify a trading system glitch, a careless trader could pump out 120,000 faulty orders. On a $20 stock that represents a $2.4 billion disaster. Without better controls, “The next Long-Term Capital meltdown will happen in a five-minute time period,” warned Lime Brokerage in a June letter to the SEC.

While many market centers have adapted to cater to high-frequency traders, dark pools have adapted to evade them. Seth Merrin founded Liquidnet in 1999 as a place where professional money managers can swap large blocks of stock anonymously. It’s the successor to the brokerage work that used to keep block traders at Weeden & Co., Goldman and First Boston busy decades ago, when the NYSE ruled Wall Street but a fair amount of its trading took place upstairs. The goal of Liquidnet is to avoid tipping off the market, including high-frequency arbitragers, that a big order is in the market and moving prices.

Merrin, even as he battles a bad market for new offerings and a legal dispute over patent infringement, aims to take Liquidnet public. The firm already handles 61 million shares a day, and Merrin views himself as something of a crusader who is enabling mutual funds, pension plans and other investors to trade at the best possible prices. All told, crossing systems like Liquidnet and Credit Suisse’s Advanced Execution Services (300 million shares a day) handle about 8% of stock trades and are expected to control 10% by year’s end.

The problem with such liquidity pools is that they are in fact “dark,” meaning they conceal their orders from public markets. What’s more, they piggyback off publicly displayed bids and offers rather than adding to the liquidity pools that determine them. That, in turn, has led to charges that they are depriving investors in both lit and dark markets of the best possible prices. Thus the calls for heavy-handed regulation or an outright ban.

Proponents of Big Brotherism should stop hyperventilating. The high-frequency engineers are already on the case, sniffing out when dark pools are trading at the midpoints between public bids and offers and posting their own prices around them (and, in turn, forcing the dark pools to come up with countermeasures to the countermeasures).

As this cat-and-mouse game plays out, trading is getting ever faster and spreads ever thinner. This probably isn’t the market that securities market overseers envisioned, but it’s working just fine.

Flashpoint of Controversy

High-frequency trading helps small investors by narrowing spreads and speeding execution. The same can’t necessarily be said for flash orders. Market center Direct Edge uses them to give a small group of clients a one-tenth-of-a-second crack at orders before they get sent to other markets. The practice has been criticized for favoring insiders, and the Securities & Exchange Commission may ban flash orders.

High Frequency Who’s Who
Trading for Dummies

Special Offer: Free Trial Issue of Forbes


September 6, 2009 Posted by | Hi Freq Trading (HFT) | Leave a comment

WSJ: Meet Getco, High-Frequency Trade King

One of the biggest players in the hot area of high-frequency trading is one of the least known.

Getco LLC, a private company with fewer than 250 employees, often accounts for 10% to 20% of the daily trading volume of many U.S. stocks, the company has said, including highly traded names such as General Electric Co., Oracle Corp. and Google Inc.

Since its founding a decade ago, the firm has risen to become one of the five biggest traders measured by volume in stocks and other instruments that trade electronically on exchanges, such as Treasury bonds and currency futures, according to firm executives, who spoke with the Journal this week, and other people in the industry.

“They are probably the biggest market maker in the U.S. stock market,” said Justin Schack, a vice president at Rosenblatt Securities Inc. who closely tracks high-frequency trading. A market maker is a firm that always stands ready to buy or sell a stock.

High-frequency trading, in which traders use powerful computers and algorithms to trade at lightning-fast speeds, has grabbed attention after it produced stellar results during the financial crisis and amid estimates that it now accounts for more than half of U.S. daily stock trading.

Critics say high-frequency traders can trade ahead of less fleet-footed investors and squeeze pennies out of their pockets. Defenders say high-frequency shops help markets operate more efficiently by constantly stepping in to trade securities when investors wish to buy and sell. That, in turn, makes trading cheaper for individual investors.

The Securities and Exchange Commission has increased its scrutiny of high-frequency trading, even as exchanges rush to attract the high volumes the trading firms bring. In turn, Getco has increased its contact with the SEC and others as it seeks to influence policy decisions on matters such as rules governing options markets.

Getco’s founders, former floor traders in Chicago’s futures and options pits, say a lot of confusion surrounds the industry they helped pioneer.

“Electronic markets have been the best-performing parts of the financial markets” in the past few years, said Dan Tierney, a co-founder of the company with Stephen Schuler, in a rare interview. By contrast, many securities and derivatives traded over the counter, such as credit default swaps, malfunctioned amid the credit crisis, with devastating consequences.

Mr. Tierney, a 39-year-old who favors jeans, T-shirts and tennis shoes for work, points to volatile stock markets in late 2008 as a way high-frequency trading helps grease the market’s wheels. As investors scrambled to sell stocks, high-frequency outfits such as Getco stepped in to buy.

One day last October, Getco juggled about two billion shares, representing more than 10% of the volume in U.S. equities, according to a person familiar with the firm.

Without high-frequency traders, Mr. Tierney says, the market’s losses could have been much steeper. The Dow Jones Industrial Average plunged 14.1% that month.

All this has been profitable for Getco, which earned about $400 million in 2008, trading mostly with its own money, people familiar with its finances say. Getco, which stands for Global Electronic Trading Co., declines to comment on its profit.

In 2007, private-equity firm General Atlantic LLC invested about $300 million, a deal that then valued Getco around $1.5 billion.

At Getco, traders stare at enormous high-definition screens stacked to the ceiling that display trades in virtually every financial instrument traded electronically on exchanges. Large white boards, thick with scribbled formulas and intricate diagrams, line the walls of its expansive trading hub on the second floor of the office tower that houses the Chicago Board of Trade.

Unlike traditional Wall Street firms, the company holds relatively few securities by the time markets close for the day. Nor does it use much leverage, or borrowed money, to amplify the effects of its trades.

Since it constantly buys and sells, it can move in and out of hundreds of millions of dollars’ worth of securities every day with a relatively small amount of capital. It favors shares that are the most heavily traded.

During the trading day, it can lose money if it accumulates large positions and the market suddenly moves against it, a risk it works to minimize by trading quickly in and out of markets, as well as through hedging strategies.

For example, if Microsoft shares are trading in range of $24.09 and $24.12, an investor may place an order to sell Microsoft for no less than $24.10. On the other side of that trade could be Getco with an order to buy at $24.10. Getco likely also will have an offer to sell Microsoft for $24.11.

If the trade works, Getco will make money on that tiny spread. Sometimes they don’t; the challenge then is to get out as quickly as possible. In this case, if it accumulates a large amount of Microsoft stock at $24.10, however, it will stop buying and offer to buy and sell at lower prices.

Getco depends on the success of its proprietary complex algorithms to help it make money on the transactions more often than not. It also can pick up tiny rebates that some exchanges offer to firms willing to take the other side of trading orders. The company focuses on hiring top computer programmers and technicians, as well as traders.

Messrs. Tierney and Schuler founded Getco over a handshake in a small office at the Chicago Mercantile Exchange on a Friday afternoon in October 1999.

The previous year, Mr. Schuler, now 47, had been trading futures contracts linked to the Standard & Poor’s 500-stock index. His wife was pregnant, and he was considering his future. As he watched electronic trading capture more volume, he concluded floor trading was becoming outmoded.

“I was feeling threatened,” he says.

He started learning more about how electronic markets work. In 1999, he met Mr. Tierney, a floor trader at the Chicago Board Options Exchange, who also had been researching electronic trading.

Later that year, the two set up shop in a small office in the CME and started trading S&P futures contracts electronically. They installed floor-to-ceiling computers that at times became so hot they pushed the temperature in the room to 100 degrees.

Their goal was to create an all-electronic market-making business. By 2001, Getco employed about 20 people and had branched into exchange-traded funds.

Around that time, stock exchanges switched to decimalization, pricing stocks in dollars and cents rather than dollars and fractions, a change that narrowed spreads and boosted the importance of swift trading to capture gains.

In 2003, Getco started trading fixed-income securities such as Treasurys; it expanded into currency markets and, more recently, commodities.

The boom in ETFs in recent years has also boosted high-frequency trading, as moves in and out of the funds can mean hundreds of trades in the underlying stocks. More recently, exchanges have been ramping up their technology platforms, making high-frequency trading easier and more profitable.

Today, Getco operates in electronic exchanges around the world. It has offices in New York and London and has about a dozen employees in Singapore, where it expects to expand soon.

A priority now is trading more on options exchanges. The company says regulations currently in place restrict the ability of options investors to get the best price. If options markets are more open to high-frequency traders, that will make the market more competitive, increase volumes and give investors better deals, it says.

Write to Scott Patterson at scott.patterson@wsj.com

August 28, 2009 Posted by | Hi Freq Trading (HFT) | 1 Comment