High Frequency Trading (HFT) is big business. By some estimates, it accounts for up to 70% of trading in the US Equities markets. But how has it evolved to this point? Who are the key players that lead the way in the development of high frequency trading systems?
Let us start by looking at the various types of participants there are in the marketplace. First of all, you can split the participants into the “buy side” and the “sell side”. The buy-side are the firms (or individuals) who actually take positions. They range from individual investors like you and I, who might have a portfolio containing a number of chosen stocks, to multi-million dollar fund managers managing mutual funds and pension funds that contain vast positions. Also on the buy-side are proprietary trading firms who trade for their own account, as well as hedge funds, who manage money on behalf of a select group of investors.
The sell-side consists of the investment banks and brokerage firms who act as intermediaries in the market, that is they take an order from a buy-side client and execute that order in the marketplace. As such, they don’t hold positions themselves but the bigger firms may execute many millions of transactions per year on behalf of their customers.
So, let’s get back to high frequency trading systems. Which market participants are really driving innovation in this area? Well, first of all, you may be surprised to learn that the real innovation is happening at some of the smaller proprietary trading firms. These firms are constantly tweaking their algorithms and quantitative models to ensure they keep their edge ahead of the rest of the market. Typically these firms are not taking a “long view”, they might in fact only hold a position for minutes (or even fractions of a second). Because they are constantly trading in and out of the market for small profits, they have to ensure that their systems are faster than everybody else’s.
Some of the more innovative hedge funds pick up on what those trading firms are doing and adopt similar technology. That then filters through to bigger, more established hedge funds and sell-side firms. Typically the last ones in the chain to latch on to this high frequency trading technology are the asset management firms, mutual fund managers and retail investors, which is probably why they are the ones who are most vocal in their criticism of HFT!
If you would like to find out more about high frequency and algorithmic trading, please visit the High Frequency Trading Review, where you will find a number of interviews with leading practitioners in the field.
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