Hard Times For HFT


Yesterday we wrote about how the HFT community has begun to lobby to eliminate the Order Protection Rule.   It’s no surprise to us that they are trying to change the rules now since their cash machine, which unofficially began in 2007 (with the implementation of Reg NMS), seems to be grinding to a halt. After squeezing every last arbitrage (latency, regulatory, rebate) penny out of Reg NMS for the past 10 years, the HFT community now wants new rules so they can create new arbitrage opportunities. So why now?  Why do they all of the sudden care about the ten year old order protection rule and locked/crossed markets?  Like most issues the answer always comes down to money.

The WSJ just published an article titled “High Frequency Traders Fall on Hard Times” where they examined the profitability of HFT firms.  According to the WSJ, “revenues at HFT firms from U.S. equities trading were an estimated $1.1 billion last year, down from $7.2 billion in 2009.”

Here is a quote from the article from one HFT complaining about the inability to make money:

“In very volatile trading environments like in 2009 and 2010, it was just easier to find trading opportunities,” said Michael Beller, chief executive of Tradeworx, an HFT and financial technology firm in New Jersey. “Now everyone has to work harder to find the trades.”

Sure sounds like the good old days of HFT’s picking off stale quotes seems to be over.

In addition to limited revenue opportunities, HFT costs continue to rise.  Like most other industries, the way that HFT seems to be combatting these problems is to merge and try to capitalize on reduced costs.  Two recent HFT merger stories proves this point:

– Virtu Financial’s bid for Knight

– Quantlabs acquisition of certain technology and intellectual property from fellow HFT firm Teza Group

Just because HFT profitability appears to be suffering doesn’t mean that the SEC should grant them their wishes and change the rules again.  However, if the SEC wants to change a few rules then we think these suggestions are better than eliminating the order protection rule:

–          – Eliminate maker/taker and payment for order flow

–          – Eliminate individual order data feeds and instead use aggregated data feeds by price level

These two suggestions alone would get rid of a lot of the noise and games that currently plague the equity market.

We are by no means big supporters of Reg NMS.  In fact, our 2012 book “Broken Markets” singled out Reg NMS as the rule which caused many of today’s market structure problems.  Reg NMS created fragmentation which is now causing the cost problems for the HFT community since they need to connect to all of the exchanges.   But rather than focusing on fragmentation and payment for order flow, the HFT community is trying to misdirect the fixes for Reg NMS.  And they are doing this conveniently at the time that their cash machine is ending.