Some would call it poetic justice. The high frequency trading business is in trouble and depending on who you ask, that will either make for more orderly markets or cause trading costs to rise.
Just four years ago, the HFT business was akin to a cyber-gold rush. Today, it’s looking like one of those old west ghost towns. As much as three quarters of HFT revenue has evaporated for some firms. What has changed in the past four years?
The Market is Better
When the market is trending higher, as it has for the past few years, everybody makes money—except high frequency traders. If you read Monday’s HFT primer, you know that these firms don’t look at long term market trends in the same way as traditional traders.
High speed computers attempt to capitalize on the spread between the bid and ask price. This spread may only exist for microseconds but those spreads are more common in volatile markets.
As markets rise, the volatility that produces these spreads drop. The volatility indicator known as the VIX was higher than 80 during the 2009 market collapse. (the higher the number, the more volatility) As of Tuesday, it was just below 13.
Technology Costs Rising
HFT is a speed business. In order to keep up with competitors, HFT firms have to purchase the latest (and fastest) equipment and data.
In a New York Times article, Thomas Peterffy, CEO of HFT firm Timber Hill, said that the company used to purchase a data packet from NASDAQ OMX Group(NASDAQ: NDAQ [FREE Stock Trend Analysis]) for $1,000 per month. But NASDAQ created a more comprehensive package that now costs $25,000 per month—a cost that’s hard to absorb in the midst of dwindling profits.
Overall Volume Down
The largest reported challenge to HFT firms is the lower trading volume in global markets. In each of the last four years, overall volume has dropped globally. Largely fueled by a general anxiety created from the 2009 financial crisis, investors are still reluctant to go all in on a market that has proven itself capable of robbing retail investors of wealth in a matter of hours or days.
Lack of volume creates less trading opportunities and that has caused some HFT firms to lose as much a three quarters of their revenue, lay off staff, and consolidate into fewer firms much like what has taken place in the airline industry.
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