High-frequency trading shifts from speed back to strategy

1 November 2017

Faced with diminishing marginal returns and exponential cost increases, electronic high-frequency trading firms that made their fortunes by focusing on low-latency trading strategies are now turning their attention to analytics and smarter trading initiatives in a drive to maintain their competitive advantage.

There is a dawning realisation among all asset classes, including foreign exchange (FX), that a focus on speed is no longer enough to stay ahead of the game. Speed is progressively becoming a commodity and there has been a distinct shift away from simply looking for millisecond-advantages to utilising analytics to support smart, rather than just fast, trading decisions.

Over the past decade, there has been a rapid rise in the adoption of speed-based, low-latency strategies – reliant on the ultra-fast consumption of market data and access to the fastest technology and infrastructure for success.

However, the very same firms that embraced sophisticated computer algorithms and benefitted from speed-based trading strategies are now the victims of their own success. The emphasis on low-latency trading led to a ‘race to zero’, where traders continually sought to overtake their peers by acquiring greater speed, market data and technology merely to gain minimal time-based advantages.

As financial markets and the macro trading environment have continued to evolve, the advantages that technological innovations once provided have begun to erode and the ever-rising costs of maintaining low-latency strategies have, for many, become unsustainable.

The constant need to invest in faster trading infrastructure, such as fibre-optic cables, microwave networks, millimetre-wave and laser technology, adds significantly to the cost of trading, creating a distinct difference between the ‘haves’ and ‘have nots’.

Electronic high-frequency trading groups that made their fortunes by being the fastest are finding it tougher to stay ahead of the curve as transactions unfold faster and faster, and the costs associated with low-latency infrastructure and market data continue to rise rapidly. In addition, reduced market volatility and volumes — essential elements for profitable trading — have dropped significantly.

With these factors in mind, more and more firms trading stocks, commodities and currencies are realising that investment wars are no longer feasible. They are now looking to compete on intelligence; deploying trading strategies that predict market movements over the course of minutes, hours and days, rather than micro-moments.

A flurry of merger and acquisition activity amongst non-bank electronic trading firms - including Virtu Financial’s acquisition of KCG Holdings, and DRW Holdings acquisition of RGM Advisors - highlights how these once-nimble institutions are now taking steps to adjust their operating models to manage costs, introduce new products and trading services, or simply increase in scale and size across new asset classes.

This, coupled with a resurgence in predictive analytics, big data and artificial intelligence, has enabled institutions to look at their operations in a new light and identify other ways the latest technology can help drive trading decisions.

It is clear that all asset classes including FX are shifting away from a sole focus on speed and electronic trading firms have begun to react to the evolving market landscape. While the need for speed will never disappear entirely, firms are reducing their reliance on low-latency strategies, and looking towards a combined approach, incorporating strategic trading methodologies.

Roger Rutherford is Chief Operating Officer at ParFX.

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Related ParFX Team Members: Roger Rutherford