According to the FT, market forces are catching up with those low latency, speed demons known as high frequency traders. They have been locked in a technological arms race for the past few years and are starting to bump up against physical parameters like the speed of light. Rick Bookstaber, former quantitative portfolio manager and risk manager and now with the SEC, predicted that this would happen almost two years ago. He said in a blog post(Read Bookstaber blog post here):
“But I think the days for high frequency trading are numbered. For one thing, high frequency trading is capacity constrained like few other strategies. The high frequency trader is basically a stand-alone market maker; he is sitting there to provide liquidity to others. And one way he provides it is to pull in the positions that others will shortly be demanding – thus the need for speed. If the footprint for high frequency traders gets too large, they become liquidity demanders themselves, and the gig is up. The Renaissances of the strategy will make their way through, but generally we will see a lot of shooting stars.”
“A second reason is that high frequency trading is embroiled in an arms race. And arms races are negative sum games. The arms in this case are not tanks and jets, but computer chips and throughput. But like any arms race, the result is a cycle of spending which leaves everyone in the same relative position, only poorer. Put another way, like any arms race, what is happening with high frequency trading is a net drain on social welfare.”
So, what’s an HFT to do these days to scalp a few pennies? Just like locusts that have finished stripping a field, HFT’s are now setting their sights on new fields. They are currently looking to emerging markets like Brazil that have yet to be set upon. The Brazilian exchange, the Bovespa, is actively courting the HFT’s. According to the FT (Read FT article here)
“HFT volume is only 6% of overall volume but is growing fast (in Brazil).”. The FT also reported that “Brazil hosted Latin America’s first ever high-frequency trading conference earlier this month, bringing about 230 young “quants”, software developers and mostly buy-side investors to one of São Paulo’s most luxurious hotels.”
But it appears that the HFT’s have two major problems in trying to crack open the Brazilian market. First, there is talk of reinstating a financial transaction tax in Brazil. But more importantly, the Bovespa has a virtual monopoly on stock trading. And High Frequency Traders absolutely hate markets that they can’t fragment to create arbitrage opportunities that shouldn’t exist in the first place. Here is what one prominent HFT had to say:
“The exchange has to change for high frequency to flourish – traders need fragmented markets,” said David Clayden, US director of sales at Automated Trader.
Do traders really need fragmented markets? What is the real benefit of this fragmentation? To our stock exchange friends in Brazil, we say – “Be careful what you wish for, you may just get it.”
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