While over half of respondents to the latest The TRADE Poll consider the biggest impact of high-frequency trading on institutional equity markets to be a welcome boost to liquidity, a significant minority are still worried about the risk of being gamed.
Almost a quarter (24%) of survey participants listed increased gaming fears as the most significant effect of high-frequency trading’s growth, while 54% noted the benefits of more liquidity to the market. A total of 11% agreed it had lowered transaction costs, while a further 11% said the biggest impact of high-frequency trading was cheaper venue pricing.
The results bear comparison with other recent studies. Consultancy TABB Group’s recently released study, ‘US Institutional Equity Trading report 2009/10: Dark Pools, Transparency and Consequences’, found that 28% of the 66 head traders interviewed felt that high-frequency trading was good for their trading style while 17% said it had a negative effect. Of those that asserted high-frequency trading was beneficial, 94% said this was because of the positive impact on liquidity. Of those who said high-frequency trading was bad for their trading style, 39% said this was because of gaming.
Peter Baillie, senior equity dealer, Martin Currie Investment Management, told theTRADEnews.com, that his firm is “wary” of high-frequency trading. “To take advantage of the liquidity they provide, you have to have confidence in your abilities and the trading tools you have access to.”
Following the important role played by high-frequency traders in keeping the equity markets moving in Q1 2009, when many institutional investors all but stopped trading and a large number of hedge funds went out of business, their role as liquidity providers cannot be overstated. Nevertheless, suspicions clearly remain among some potential counterparties.
“I’m not surprised by the results but am disappointed that nearly a quarter can’t get over their scepticism about the value that these firms bring to the market,” said Eli Lederman, CEO of pan-European multilateral trading facility Turquoise. “People closest to markets recognise that high-frequency trading adds liquidity to the market, just like old-fashioned market-making. But because this is new and somewhat mysterious, and also profitable, the high-frequency trading firms have attracted some suspicion which, on the whole, isn’t warranted.”
High-frequency trading is estimated to account for two-thirds of liquidity in the US and around 40% of European trading flow, but without accurate empirical data on the nature and size of this market segment, trying to distinguish its impact is difficult. Lederman estimates that 30-35% of flow on Turquoise originates from electronic market makers, a proportion he considers less than some other MTFs, but more than most incumbent exchanges in Europe.
“Given that the concept of a fragmented trading landscape in Europe is still relatively young, there is a lack of sufficient empirical information on the effects of high-frequency trading which makes it difficult to formulate firm opinions and this can cause some uncertainty. Where there is uncertainty, it can generate fear,” said Scott Bradley, head of sales EMEA, Electronic Client Solutions, J.P. Morgan. “Until further information becomes available, clients may harbour some concerns about the order flow with which they interact with and it becomes the role of the broker to help educate and inform of developments as appropriate.”
Others note that to equate high-frequency trading activity with gaming is inaccurate and will only serve to perpetuate misperceptions about the trading style.
“If an order is treated with an adequate level of discretion, it is very hard for a gamer to profit directly from your executions,” comments Toby Bayliss, head of algorithmic and program trading, Europe, Sanford C. Bernstein. “Gaming can include illegal practices like market manipulation and front running, which is not the business high-frequency traders are in. They are simply there to capture liquidity and then liquidate it at a favourable level.”
However, Bayliss does admit that his firm does not trade in liquidity pools that have large proportion of flow from electronic market makers.
“A concern of relying too heavily on automated market makers for institutional sized orders is that the market makers are looking to liquidate positions in the same direction as your institutional order and they may have a competitive advantage,” said Bayliss.
With high-frequency traders accounting for a growing proportion of equity trading volumes, the challenge for buy-side traders is to use the tools and functionality available to them to adapt to the evolving market landscape.
“Buy-side traders who find they are being leapfrogged by high-frequency traders simply need to change their trading practices to make sure they are not gamed by any market participants,” said Baillie.
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