Algorithmic Trading, High-Frequency Trading and Colocation: What does it mean to Emerging Market?

Transcription

1 Algorithmic Trading, High-Frequency Trading and Colocation: What does it mean to Emerging Market? Ashok Jhunjhunwala, IIT Madras HFTs are being pushed out of the more established markets, North America and Europe in particular, and being pulled into emerging markets: Dr Richard Bentley The move by HFTs to emerging market exchanges is really part of diversification: help dilute market specific risks, regulatory risks 1

2 How do we look at Investors? Long-term Investors (Fundamental): those who trade infrequently, but invest in companies with a hope to make money as companies they invest in, do well Could be retail and some institutional investors Mid-term Investors: those who will buy /sell shares in three to six-months Invest in select companies, looking at their performance and looking at short-term performance improvements in the companies to make gain (somewhat like fundamental) Will use stop-loss feature to sell if things get bad Could be institutional investors, mutual funds and some retail investors Short-term / day-time traders: those who wish to make money in daily ups and downs of stock-market Less to do with companies they invest in, but more with market / political situations and policy announcements/ global situation 2

3 First Came the Algorithmic Trading Then came the High-frequency trading (HFT) strategies that use computers to generate, submit, monitor and revise buy and sell orders based on decision rules programmed by humans, using publicly available information And then the co-location And gradually they took over It is all for shortterm trades 3

4 HFT traders fight other day-time traders: surely they would gain Earlier, it was humans who would generate, submit, monitor and revise buy and sell orders using publicly available information Computers would process the information better And based on programmed rules, would generate, monitor and revise faster Colocation would make it even faster Gives advantage vis-à-vis those who do not use computer and therefore can process the available information as well Can not generate, monitor and revise order as fast Are not co-located Certainly those who do not have computer / Internet connectivity Today when Computer and algorithms are powerful to defeat the best chess player, what chance a retail investor has in beating a HFT? Add to it the co-location, where HFT could always trade first, retail investor is doomed. Retail short-term traders and Remote Institutional Investors who use less technology or are remote, lose out via-a-vis co-located professional Traders using HFT 4

5 But this is all between short-term investors Since money is to be made on short-term price movements, largely unrelated to company-fundamentals Those who use better technology have an advantage Those who use co-location have an advantage Vis-à-vis those who use less or do not HFT benefits not only if markets have larger volatility, but where there are less algotraders (market is virgin) Does all this make a difference to Fundamental Investors and mid-term Investors? Retail fundamental investors believe less that they can make money in trading mid-term traders trusts exchange less 5

6 HFT is often accused! Before HFT (focused on investing fundamentals) Retail Investors and Institutional investors who invest on behalf of Street Investors Today, the markets are split between the Fundamental investors Valuation agnostic" high-speed traders who buy or sell stock disconnected from the underlying value and fundamentals of the company a lot more to do with what's the minuscule aberrational price move that you can take advantage of because you are co-located and can jump on that in microseconds But is this really TRUE? The split came when the day time-traders and short-term traders entered market (always) HFT hurts other day-time traders who do not use as much technology? Are these arguments by these traders to raise the battle against HFT in the name of Fundamental Investors? 6

7 So let us look at arrival of HFT from view-point of fundamental Investors? Impact of HFT in providing Price-discovery Vs Market-depth Higher Liquidity Vs disappearing liquidity : Market-Makers Knit together fragmented markets: Market Efficiency Greater Stability Vs Adds Volatility Reduced Costs Market manipulations & Exchange-crash risks Attracting Investors in Emerging Market Stock-exchanges Arguments on both sides: Mid-term Investors sufficiently scared that they can make money Getco, one of the world s largest automated trading firms, became the first Western trading firm to gain approval to trade in India, the world s fastest growing derivatives market. The move came months after it closed its Hong Kong office as it seeks more profitable pastures for its trading strategies. 7

8 So what should regulations do? Focus on fundamental Investors and Institutional Investors Leave short-term traders to fight it out amongst themselves? Focus on how HFT can impact fundamental Investors? For example does HFT s induced volatility often trigger stop-loss for mid-term traders unnecessarily? Can such impact be handled by exchange offering more condition options on stop-loss triggers? We have got to get away from the idea that speed equals danger.professional traders trade continuously and are exposed to market movements all the time --Richard Gorelick. Imposing minimum resting times for quotes before they can be cancelled would lead HFTs to widen bid-ask spreads, increasing costs to investors. Charles Li, the chief executive of HKEx: the exchange did not want Ferraris to run wild on the highway. We want speed bumps to be there. 8

9 But will wiping out of small day-time traders be ok? Small day-time traders have been there for over 50 years may not be able to acquire technology and may not be able to compete with HFT traders Large HFT players may jump in Emerging Market today But leave as quickly These small players can not be recreated instantly Do we therefore not need to worry about fairness and equity and regulate HFT? Former head of NASDAQ (Oct2010): HFT Volume in stocks --73%; NYSE: HFT volume 56% TABB group: HFT trades in 83% of stocks, 67% of futures, 58% of options, 36% of bonds and 26% of fx In India: HFT has 25% of volume 9

10 Emerging Markets should not rush to follow developed Markets and copy their restrictions on HFT Impact of HFT on fundamental and institutional investors need more research With an open mind But slow-down till there is larger clarity HFT Volumes can be very high: Can impact smaller Emerging Markets quickly What safeguards need to be placed? Can HFT play havoc in Indian Market? Volumes (per day): NYSE: $110B, HFT: $65-70B BSE trades $ M 10

11 Finally about Technology Can Technology be used to implement any regulations? For example if regulators decide add latency to HFT trades Surely it is possible Exchanges can be quickly programmed as per any regulations Exchanges and Regulators need technologies on par with that used by HFT To sum-up: Should Stock market be a casino, or rather a mechanism to raise capital by private companies to contribute to economic development? should there be slab-transaction tax dependent on volumes and frequency? 11