High Frequency Trading What Is It & Should I Be Worried?

1
High Frequency Trading What Is It Should I Be
Worried?

• Presented by
• Larry Tabb (Founder CEO)

2
Agenda

• What is high frequency trading
• Who does it
• Why has high frequency become an issue
• How does this impact exchanges?

3
What is high frequency trading?

• Wide definition
• Firms leveraging high speed market data and
  analytics to look for temporal supply and demand
  trading opportunities. These firms typically are
  self capitalized and hold positions for very
  short periods of time (typically less than
  minutes)
• Includes
• Equity market making
• Index arb
• Options market making
• ETF arb
• Stat arb/pairs trading
• Narrow and more typically used definition
• Equity market making

4
Who does it?

• Typically
• Equity market makers
• Proprietary trading shops
• And a few high frequency hedge funds
• Many located in Chicago
• This is typically done by self-capitalized firms
• This is market-driven and not PM driven
• Significant investment in technology
  infrastructure
• Not your standard investment strategy

5
Who trades?
US Equity Share Volume by Market Participant
High Frequency Trading accounts for 61 of Share
Volume
Source TABB Group Estimate
6
The majority of trading is done by professional
traders / liquidity providers
US Equity Share Volume by Market Participant
High Frequency Trading accounts for 61 of Share
Volume
4
28
29
Liquidity Providers
3
7
13
16
Investors
Investors
Liquidity Providers
Investment Bank Prop
Source TABB Group Estimate
7
Goal of HFT - first to spot an opportunity
first to take advantage of it

• Co-location
• Depending upon the firm, the HFT may need
  multiple locations
• May also want access to dark pools
• Sponsored access
• Flash trading
• Market data
• Direct feed
• Messaging
• Low latency time series
• Back testing tools
• High speed analytics
• CEP (mostly home grown) to locate trends
• Execution technology to trade

8
Why has HFT become an issue?
9
The floor is empty most trading is done by
machines
10
Electronic Trading Has Caused Steep Decline in
Average Trade Size
US Equity Share volume and trades
Source TABB Group and Exchange Data
11
Algos have broken up flow into much smaller
executions
Shares by Execution Venue (volume weighted)
2 Year CAGR 07-09
Source TABB Group Institutional Equity Trading
in America 09/10 Preliminary
12
Capital usage is down because of credit crisis
and advanced trading technology
Percent of Firms Using Capital
Directionality of Capital Usage
Percent of Firms Paying More For Capital
Source TABB Group Institutional Equity Trading
2008
13
Sales trader flow is declining back to on-trend
levels
Percentage of Order Flow Firms Sent to Sales
Trader
3 Year CAGR -19
07-08 19
2 Year CAGR -13
Source TABB Group Institutional Equity Trading
in America 09/10 Preliminary
14
Should exchanges be worried?
15
In last 23months, exchanges have lost 20 market
share to dark pools and ECNs
Matched US Equity Flow as a Percentage of Total
US Equity Matched Flow
NYSE, NASDAQ, Arca
BATS / DirectEdge
Crossing / Dark Pools
Regional Exchanges
Source TABB Group LiquidityMatrixTM
16
Market share of liquidity pools are beginning to
converge around 13
US Equity Market Share (includes
Internalized) Consolidated NYSE/NASDAQ Listed
Equities Jul 2008 Sept 2009
Source TABB Group LiquidityMatrixTM Exchanges,
BATS
17
Is it worth it?

• Benefits
• Greater automation
• Low fees exchange competition
• Tighter spreads
• High certainty of execution
• Challenges
• Finding the needle in the haystack
• Massive quantities of
• Data, IT, Bandwidth
• Greater obfuscation
• All of this tilts market toward larger brokers
• Will benefits remain when only mega-brokers can
  play?
• However Sponsored Access is changing this
• Market is becoming more open and accessible (for
  the technologically advanced)

18
High Frequency Trading What Is It Should I Be
Worried?

• Presented by
• Larry Tabb (Founder CEO)