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Dimmer Growth Prospects Ahead For High-Frequency Trading Firms

With regulators determined to slow down the practice of rapid-fire trading, HFT operations traditionally focused on speed will need to turn more attention to strategy development, market research firm IBISWorld says.

After enjoying a five-year period of soaring revenues, the growth prospects for the high-frequency trading industry are on the wane, and firms that once emphasized speed now need to focus on strategy, according to market research firm IBISWorld.

Since 2007, revenues for HFT firms climbed 11.6 percent per year on average to the tune of about $28.1 billion through 2012, IBISWorld said in its latest report. That figure includes an expected increase of 6.2 percent this year.

But IBISWorld cautioned that most of that growth came in the early portion of the five-year period ranging between 2007 and 2012, with revenues now beginning to slow down. The firm said much of that growth was driven by HFT firms snapping up shares of stocks that traditional investors were unloading ahead of the financial crisis.

Now the industry could be constrained by the Dodd-Frank law, the Volcker Rule in particular, the report said.

"The enactment of the Dodd-Frank Act in 2012 placed a blanket of scrutiny and uncertainty over the industry," IBISWorld's report said. "This legislation's Volcker Rule banned banks from engaging in proprietary trading. As such, banks have begun to sell off their proprietary trading operations to individual high-frequency trading firms, limiting the size of the industry."

Between 2007 and this year, the number of HFT operations has remained relatively flat, rising only 0.3 percent a year to 459 firms, the research noted. IBISWorld also predicted the number of firms is likely to drop in the wake of consolidation. Meanwhile the remaining firms will need to deemphasize speed to an extent, the research added.

"Current major players Getco LLC and Renaissance Technologies for example, will have to shift their focus to strategy development - and away from speed, an issue that is mostly under control - in order to thrive in the highly regulated industry."

However one benefit to the new landscape will be that employees at HFT firms will become even more valuable and that salaries should rise, IBISWorld said. The report comes a day after SEC Chairman Mary Schapiro admitted to reporters that she is worried about the rise of high-frequency trading, while revealing that the nation's largest securities regulator still has much to learn about the practice.

From the Washington Post:

Schapiro expressed concerns of her own Wednesday, lamenting the current volume of trading that is "unrelated to the fundamentals of the company that's being traded."

"It's got very little to do with whether you think IBM's got a great business plan and solid earnings growth in its future .. and a lot more to do with what's the minuscule aberrational price move that you can take advantage of because you've co-located your computer with the exchange and can jump on that in microseconds," she said.

"And that worries me in some ways."

The SEC has taken some steps to address the issue, such as mandating a new reporting system that will require brokerage firms to track transactions by their large traders.

"That data is going to be critical to our ability to justify further changes in the equity market structure," Schapiro said.

As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced Trading in 2010, Grant's news analysis has touched on everything from the latest ... View Full Bio

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