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Is High Frequency Trading on its deathbed?

November 19, 2012  |  Written by Shawn Kaplan

Over the past decade, High Frequency Trading (HFT) has been the savior of the Capital Markets, driving surges in trading volumes which have breathed new life into the Equities markets and the exchanges in particular. Electronically placed trades are the single biggest revenue driver for most prop and sell-side institutions and now represent over 80% of all transactions on the exchanges.  Rosenblatt estimates that profits from HFT peaked in 2009 at $4.9 billion, but in just three short years have crashed down to something in the neighborhood of $1.25 billion, down 75% from their peak. 

Last month the US Senate pulled together a panel to begin exploring the impact of HFT on the stability of the capital markets.  The panel was called largely in reaction to the high profile trading losses such as Knight’s loss of $400 million in just 19 minutes and the trading glitches of FB and KRFT.  The panel largely recommended that deep reaching regulations would be disruptive to a delicately balanced market structure.  However, just by the mere fact that there was a Senate panel on HFT shows the concerns are mounting in this high profile section of the market.

What brought HFT trading on in the first place, and why the surge and fall of HFT?  Before it was popular, the “Program Trading” departments of the large institutions invested large budgets into technologies which could exploit patterns in institutional and retail trade flow.  Specialist firms such as Getco, Citadel, ATD, and Tradebot quickly caught on that with investments in technology and a bit of insight into market micro-structure they could take advantage of the inefficiencies in institutional and retail trade flow.

But now that HFT strategies have caught the eye of technologists and traders world-wide and low-latency technologies can be purchased for just a few thousand dollars, the differentiators have largely evaporated…and so have the profits.

Is High Frequency Trading dead?  Well maybe not yet…but if the exit of starling Eladian Partners is any indication, it’s clearly under significant pressure.  Firms need to be smart with their spend on technology as the once large profits from HFT are clearly shrinking.