High frequency traders look to Asia for growth

CELENT estimates that about 55% of all equities volumes are driven by HFT in US, the number is around 35% in Europe and around 10% in Asia.

MURALIDHAR DASAR

High frequency trading ( HFT) has been in news recently, especially after the US stock market crash, also called Flash Crashof May 6, 2010 which created sudden panic in the market for a few minutes.

Many have blamed high frequency traders and rogue algorithms for suddenly pulling out liquidity, reacting to uncertainty in the market. Quote- stuffing, a phenomenon where traders place large rapidfire orders and cancel them immediately, was highly criticized as a major factor.

The debate over the impact of high frequency trading on market stability has invited the attention of the regulators, who are currently assessing the impact of HFT on the market microstructure and gathering opinions of industry participants.

Academic research investigating the role of HFT has not clearly reached a conclusion on whether HFT is good or bad for the markets, and there are arguments on either sides of the table.

Those in favour of HFT say that it adds liquidity to the market, reduces spread and helps in ironing out price inefficiencies. Those taking the counterview say that HFT reduces book depth, it is unfair to market participants who cannot invest heavily in sophisticated technology, and it contributes to increased volatility.

Notwithstanding the arguments over curtailing the freedom of HFT traders and asking for mandatory reporting among other measures, HFT as a trading paradigm has evolved during the last five years, with adoption rates constantly going up. Celent estimates that about 55% of all equities volumes are driven by HFT in US, the number is around 35% in Europe and around 10% in Asia, as shown in Figure. The rise of HFT in US and Europe was driven by regulations such as RegATS and RegNMS in US, and MiFID in Europe which spurred greater innovation in technology. Asia is now being touted as the next growth driver for HFT. Asia has taken to the adoption of HFT rather slowly, much of which can be attributed to the regulatory environment. Japan is an exception, however. Celent estimates that the percentage of equities volumes driven by HFT in Japan is around 30%. The reason is increased fragmentation in the Japanese equities market, coupled with adoption of sophisticated technology.

Tokyo Stock Exchanges adoption of high- speed Arrowhead trading system is a case in point. Japan is an interesting case, because the increase in HFT adoption coincides with increasing spreads and increasing volatility. However, this should not be understood as an insight about how HFT will unfold in the rest of Asia.

The market for HFT in US is maturing, and Europe is also headed in that direction, which is why investors could look towards Asia and emerging markets for future growth opportunities.

Added to this is also the concern about over- regulation in the Western markets. By maturity, we mean the increased standardization in HFT techniques and reduced diversity in trading strategies to capture unique trading opportunities.

Trading firms and even trading venues are dealing with this by adopting the most- cutting- edge technology which may be cost intensive, such as upgrading hardware and software for achieving the least latency, for instance. This battle to achieve near- zero latency is not a feasible method for winning the market because of the costs involved.

Therefore, the strategy for winning the market in the matured Western markets is moving towards effective trading strategy generation, and development of proprietary trading strategies which can be implemented with the existing trading and connectivity infrastructure.

Japan and Australia are leading the trend in APAC, followed by Singapore, Hong Kong and Taiwan.

China and India are important markets for HFT in Asia, but success will depend on how trading firms find their ways in dealing with the regul