igh-frequency trading firms are facing more problems than ever before. A drastic slowdown in equities trading volume coupled with low volatility has systematically and ruthlessly chipped away at the profits of firms that are used to generating millions of dollars in revenue through rapid-fire buying, selling and rebates.
While the industry faces a slowdown in cash equities for the second year in a row -- volume in the U.S. equities market fell 18.5% last year, according to TABB Group -- it has become increasingly difficult for high-speed trading firms to thrive while continuing to pay for superfast data feeds, telecom lines and other infrastructure that's required to stay in the HFT game.
"An HFT's profits can be thought of as shares times profit per share. HFTs tend to participate proportionately to the volume in the market, so when the latter is depressed, it affects the shares part of this equation and when volatility is low, the profit per share component is reduced as well, so there you have it, rather unequivocal," says Manoj Narang, CEO of Tradeworx, a high-frequency trading firm. "That doesn't mean it's permanently that way, though. Volatility is pretty cyclical. And also, other markets still provide opportunities because they aren't at the saturation point yet as far as HFT participation goes -- which is at around 50%."
A Securities and Exchange Commission filing by Getco, the largest high-frequency trading firm, on the heels of its $1.4 billion acquisition of Knight Capital Group, provided an unusual glimpse into the company's finances. Getco reported an 82% decline in its profits to $24.6 million in the nine months that ended Sept. 30, 2012, from $134.8 million a year earlier.
Last year, Rosenblatt Securities estimated that HFT firms would earn no more than $1.25 billion in profits in 2012, down 35% from 2011 and 64% beneath a peak of about $4.9 billion in 2009. Some high-frequency trading firms have decided to close shop as profits have dwindled. One of them is Eladian Partners, a computerized trading firm that grew to more than 50 employees and had offices in New York, London and South Carolina, but sorely underestimated the shrinkage in U.S. equity trading volumes and eventually succumbed to the market slowdown in October.
Narang believes the high-frequency trading arms race is near an end. First, profits are lower, so there's less money available to subsidize a big research and development budget, and latencies already are close to zero, he says. "Driving them 50% closer to zero costs a lot, and for very little marginal benefit. It's a game of rapidly diminishing returns."
Others, however, believe the chase for zero latency is far from over. The dozens of firms in the HFT game (no one knows exactly how many players there are), particularly the larger ones, are still investing in technology that will enable them to shave microseconds off transactions while complying with the latest regulations, says David Weiss, senior analyst at Aite Group. "You've got to be in [the latency race] to win it. You have to up your game."
The challenge with high-frequency trading is that many people just look at network infrastructure, says William Adiletta, a partner in Capco's technology practice. "But there are other areas, too. Even basics, like firewalls, if you don't have an efficient setup, they can cause very basic delays."
Other fundamental issues for firms in the low-latency game include looking at where you put your data, with in-cache memory technologies now crucial. Flash memory, which can also increase the amount of data on hand, is becoming more popular. The hardware itself, the style of programming, resources used to make algos efficient and the network are all focuses for high-frequency trading firms.
Melanie Rodier has worked as a print and broadcast journalist for over 10 years, covering business and finance, general news, and film trade news. Prior to joining Wall Street & Technology in April 2007, Melanie lived in Paris, where she worked for the International Herald ... View Full Bio