New technology spurs focus on ‘the final millisecond’

Traditional investors in the US may be responding to the latest developments in high-frequency trading by changing their trading strategies, new data has shown.

Traditional investors in the US may be responding to the latest developments in high-frequency trading (HFT) by changing their trading strategies, new data has shown.

HFT has boomed in recent years with the proliferation of new venues across the US and Europe creating price arbitrage opportunities for firms with the fastest trading infrastructure.

However, recent US trading data suggests non-HFT firms may be tailoring their trading practices to avoid the predatory HFT players in the last milliseconds of the trading day.

Eric Scott Hunsader, CEO of Nanex, a market data solutions provider, said trends in the US closing auction are showing an increasing divergence between HFT and non-HFT trading 

“We’re seeing a lot of [HFT] activity in the final millisecond and now it’s affecting the depth of book.

“People are adjusting their strategies to trade alongside HFT. The total depth of book sets a peak at five-to-eight minutes before the close, whereas the close used to be the peak,” Hunsader said.

The data suggests non-HFT market participants are conducting their trading slightly earlier in the closing auction to avoid being stung by predatory strategies increasingly being deployed by HFT firms in the last millisecond of the day, evidenced on 31 August, which showed the highest number of trades in the final second this year.

“The people who have that technology are staying to close and those who don’t are getting in before,” Hunsader said.

Trading within the last millisecond of the day offers benefits for HFT firms as they can set the closing price of stock and trade with no market impact. Hunsader points to the adoption of high-speed microwave technology between Chicago and New York, which beams orders between the cities faster than any other means, as a reason for the spike in final millisecond trades. Microwave uses an infrared radio spectrum, which makes it about 50% faster than light through fibre optic cables, and arranging microwave receptors in line, which is harder with cabling, gives added speed advantage.

While many market participants accept HFT as an important source of liquidity, others have called for regulators to take a tougher stance on what they view as the negative impact of aggressive price arbitrage.

Joe Saluzzi, co-head at agency broker Themis Trading, a US agency broker, believes the growth of technology-related problems associated with HFT were evidence of a need for market structure change.

“We’re going to see an increase in these problems, and they’ll happen more often, because there’s more participants and more algos. It’ll get worse,” Saluzzi said.

US market watchdog the Securities and Exchange Commission (SEC) organised a roundtable discussion in September to flesh out possible measures to further control automated market systems, but Saluzzi believes little is being done.

“We’ve seen the SEC put out proposals to regulate dark pools and flash trades and they just sit them on the shelf for years,” he added.

US regulators implemented a number of measures to stabilise markets and investor confidence after the flash crash of 6 May, 2010.

New rules included single-stock circuit breakers, which from next year will be adjusted to a limit up-limit down mechanism, a new rule that requires brokers and their clients to have sufficient pre-trade checks in place before accessing markets and a consolidated audit trail that allows regulators to monitor fragmented equity trading activity more effectively.