A postcard to Jeremy Grant
Posted by Giles Nelson
Jeremy Grant, editor of FT Trading Room at the Financial Times, recently asked for explanations "on a postcard" about why speed is a force for good in financial markets, or put another way, to explain what the benefits are of high frequency trading. I've just come back from Mexico where I was addressing the Association of Mexican Brokers and during my visit I thought I'd write that postcard. So here it is:
I saw your request for postcards recently, and as I'm travelling I thought I'd drop you one. There's not a lot I like doing more than explaining the benefits of so-called "high frequency trading".
I would suggest that you think of high frequency trading, or HFT, as being just the latest stage in the evolution of electronic trading. And this, as you know, has evolved very rapidly over the last decade because of cheaper and faster computers and networks. It's led to many innovations and benefits: electronic crossing networks, algorithmic trading, online retail trading, smaller order sizes, the overall increase in trading volume, more price transparency, greater trader productivity, more accessible liquidity, spreads between buy and sell prices tightening, broker commissions reducing, competition between exchanges and so smaller exchange fees - none of these things would have happened without electronic trading. MiFiD couldn't have happened; it simply wouldn't have been financially viable for the many alternative European equity-trading venues to launch without cheap access to networks and computers. Without these we would still have greedy, monopolistic exchanges with high transaction prices.
HFT is just the latest step in a technology driven evolution. You can't just look at it in isolation.
"Ah", you exclaim, "but high frequency trading is a step too far. Trades happening far faster than the blink of an eye. Surely that can't be right?"
So what if trades happen quickly? Things "going too fast" is a common concern. In 19th century Britain, people were worried about trains going faster than 30mph. They thought that passengers would suffocate or that as the train reached a corner it would simply come off the rails! And to those that say trading happens too quickly, at what speed should it occur? If not micro or milliseconds, should it be a second, a minute, an hour? Who's going to decide? Any choice is entirely arbitrary anyway; time is infinitely divisible.
There are plenty of things that happen too fast for humans to comprehend - human nerve impulses travel at more than 100m per second, yet we function successfully. Why? Because we have the monitoring systems in place that ensure the information from the nerves is processed correctly. Put a finger on a hot coal and it will be retracted immediately - quicker than we can consciously think. And if a 200mph train goes through a red light then warning bells will ring and the train will be automatically stopped.
And so to the main point. Trading speed, per se, is not the problem. But, yes, problems there are. Markets, particularly in Europe and the US are now very complex. These markets are fast moving, multi-exchange, with different, but closely interlinked asset classes. It is this complexity we find difficult to understand. Speed is only one facet of this. We imagine that an armageddon incident could occur because we know that the markets are not being monitored properly. Regulators freely admit this - Mary Schapiro recently said that the SEC was up to two decades behind in its use of technology to monitor markets. And because we know that the people in charge don't know what's going on, we get scared.
It doesn't have to be like this. The same technological advances that led to the evolution of HFT can be used to ensure that the markets work safely, by ensuring that limits are not exceeded, that an algorithm "going crazy" can't bring down an exchange, that a drunken trader can't move the oil price and that traders are dissuaded from intentionally trying to abuse the markets.
Doing things faster is a human instinct. Faster, higher, stronger. The jet engine, the TGV, the motorway. Would we really go back to a world without these?