How High-Frequency Trading Is Conquering Emerging Markets
WHY YOU SHOULD CARE
Because machines are destined to win the race.
By Farah Halime
In 2014, a mystery investor wielding the power of multiple traders rattled Turkey’s stock market when he dropped $450 million of bets in a single day. “Herif,” or “the Dude,” as the investor was nicknamed on the Borsa Istanbul, now regularly executes such large transactions at high speeds that he has lifted the average trading volume on the entire exchange by more than 8 percent. And competitors can’t predict when the Dude will strike next.
It’s a far cry from the days of traders on the floors of stock exchanges, screaming orders. When trading officially became automated in 1995 on the New York Stock Exchange, Michael Einersen, who designed the system, executed 1,000 shares of IBM with a wireless handheld computer in one day, ending two centuries of paper transactions. Today, close to 80 percent of trading is electronic, nearly all of it occurs in data centers (not on trading floors), and firms can execute multiple millions of buy and sell orders in nanoseconds, picking off profits across dozens of electronic markets at nearly the speed of light. Although algorithm-driven trading, also known as high-frequency trading (HFT), dominates U.S. markets, the practice is still a growing trend in the developing world. “HFT is nothing but a duration,” says Aman Kokrady, 35, chief executive and co-founder of Acceletrade, an algorithmic trading firm based in Bangalore, the Silicon Valley of India. “We went from a few seconds to a few milliseconds. But slowly people are realizing these companies can provide significant value.”
Electronic trading, including HFT, will eventually replace traditional trading models. That’s going to happen everywhere in the world, even in the most illiquid [markets].
Larry Tabb, CEO, TABB Group
Advocates claim that speed trading empowers local exchanges and regulators to expand their markets, boosts liquidity by bumping the volume of trades and turnover, and improves efficiency by reflecting market information faster and more accurately. The use of algorithms also has meant the price of securities (stocks) is much more accurate, creating highly competitive price points. The major emerging players are now a big deal, especially Brazil and Russia, where HFT markets are well established. “You can’t skip over them,” says Danielle Tierney, an analyst at the Aite Group, a Boston-based market research outfit. “If you’re a large HFT trading firm, they’re as important as London, Singapore and New York.”
Virtu Financial, one of the world’s largest electronic market makers, has millions of dollars of capital allocated to each market in the BRICS group, with a larger chunk dedicated to Brazil and Russia, says Douglas Cifu, the company’s chief executive. What makes these two countries particularly appealing, says Adam Nunes, head of another HFT giant, Hudson River Trading, is the fact that the “markets are open to foreign investors, and they don’t have things like stamp tax that can make it unattractive.”
Not everyone’s rah-rah about all this go-go. Some regulators, especially those in the U.S., argue that the practice increases risk, making markets brittle and prone to “flash crashes” — lightning-quick, panicked sell-offs like the one in May 2010 that wiped $1 trillion off the value of the U.S. stock market in a matter of minutes. “The initial reaction is that it’s not clean,” notes Acceletrade’s Kokrady, whose team of 50 includes a 10-person “quant” squad that manages the quantitative, or computer-based, trading. “It’s a little gray area for almost everybody in the community.”
Ambivalent or not, HFT analysts and traders are confidently accelerating into an electronic, automated future they see as inevitable. Larry Tabb, the founder and chief executive of the TABB Group, a U.S.-based research and advisory company focused on capital markets, notes, “Electronic trading, including HFT, will eventually replace traditional trading models. That’s going to happen everywhere in the world, even in the most illiquid [markets].”
It’s already happening in Asia. According to the Aite Group, algorithmic trading there accounted for an estimated average of 32 percent of market volume in 2015 — the highest of any developing market. The main Asian players: India and China. Elsewhere, the HFT trading volume in Russia is 36 percent of equities and 40 percent of derivatives; in Brazil, it’s 21 percent in equities and 18 percent in derivatives. The percentages from those two emerging powerhouses, however, still are dwarfed by the practice’s dominance in the U.S.’ 13 stock exchanges and 40-plus darks pools — private trading venues mostly operated by large banks — where it accounts for an estimated 50 percent of total trading volume.
As computerized trading booms around the globe, developing countries are forging ahead at top speed — but with a dollop of caution, recognizing that more sophisticated trading systems can lead to harsh swings in the market. China, for example, is cracking down on market irregularities following its own flash crash last year. In the U.S., the Securities and Exchange Commission licensed the IEX in June as America’s newest stock exchange and approved its “speed bump” of 350 microseconds, which is intended to slow down traders who rely solely on speed. A representative from Borsa Istanbul tells OZY that after introducing a new trading system designed to attract business from automated traders, regulation has become a priority. “It is important for us to take part among developed capital markets,” says Ahmet Cedimağar, director of Borsa Istanbul’s equity market.
“Technology is a powerful tool, and if your capability does not match up with the power in your hands, it can be dangerous,” says Sandeep Tyagi, chairman and chief executive of Estee Advisors, an India-based electronic market maker. “There are people who are taking risks and doing it at a high speed.” Still, as developed markets have shown, the machines almost always win this game.