Event Processing Technology

Tuesday, March 22, 2011

An Endless Game of Hide and Seek

Posted by Dan Hubscher

Market surveillance needs permeate financial services firms from pre-trade to settlement, from trading via instant messenger services to exchanges and ECNs like never before in history. Every message, every trade, every conversation, every Tweet must be recorded, taped and downloaded into a database for on-the-spot or future scrutiny. Surveillance is necessary in order to provide full visibility to trading activity, whether via trade order flow, e-mails, Twitter, social media sites like Facebook or phone conversations. It’s invasive, there’s nowhere to hide.

U.S. hedge-fund managers are going so far as hiring security firms to comb their offices and homes for listening devices, according to new reports, reacting to the government’s insider-trading investigations. U.S. prosecutors used cell phone conversations as part of the evidence in the Galleon insider trading case. In the same vein, the UK's FSA has recently extended the recording of cell phones to hedge funds, and expanded taping rules for brokers to include all voice and electronic communications. If authorities are searching people’s homes for evidence against them, this illustrates the lengths to which they will now go to catch insider trading. And compliance officers need to be on top of this in every way they can.

Miranda Mizen, Principal at TABB Group and author of the paper entitled Dynamic Surveillance: Detection, Prevention and Deterrence noted that investor confidence took a beating after the May 6th flash crash, adding to the thumping it took during and after the credit crisis.

"Intentional and unintentional disruption and behavior rocks investor confidence and every crisis and regulatory change increases the demand for better supervisory and monitoring techniques," said Mizen in the report.

Intentional behavior such as spoofing and ramping the market on the close, or insider trading need to be spotted and acted upon in a hurry. Brokers, trading venues and regulators need to know who is trading, what does it mean and is it correlated to something somewhere else?

In theory in an electronic environment it seems more likely that market abusers would be caught since so much data is captured. This, of course, depends upon the data. As monitoring and detection become more sophisticated the abuse bar is raised, but it will forever be a game of cat and mouse. Insider trading, for example, may manifest itself only in the painstaking reconstitution of conversations across multiple media, said Mizen.

The number of different places that trading activity can take place is constantly increasing. What used to be done exclusively in a trading firm's office at the trader's desk can now happen via cell phone - maybe by using a trading application or simply by phoning it into someone in the office.  Or a trader can begin to work a deal at the office, go for lunch and finish it via instant messaging with his broker.

Compliance officers need to have full visibility in order to spot and prevent abusive trading activity - and that vision has to encompass trade order flow, e-mail conversations, Twitter, social media sites like Facebook, and phone conversations - even at home. In Europe, the Market Abuse Directive extends the notion of market manipulation to cover over-the-counter (OTC) instruments that can influence the price of listed instruments.

But even as the compliance side ramps up surveillance, there is a move toward making the front office more responsible. Trading desks will increasingly ensure that they don't do anything stupid, either with fat fingers or with an algorithm that goes rogue. Surveillance procedures can actually help them to trade more effectively, knowing that mistakes will be caught.

Changes in regulation paint a scary picture for brokers, with Dodd Frank, the flash crash, the market access rule and large trader reporting all crashing onto their plates. There is a need for constant monitoring and for the data to be analysed, scrutinized and stored and retrieved on demand.

The market access rule in the US will really change the game plan; brokers will have to apply pre-trade risk controls to every client using their market access, checking order size and credit limits in real-time. Although this is a relatively simple concept at a high level, the devil is in the very high speed details, and it can create a 'speed bump' to the order process, which could damage business. This creates another challenge; the broker needs control, a view across asset classes and client positions, with as little time lag as possible.

With increasing ownership of risk across the enterprise, the growth of social media and other off-trading-floor activity, the scope of surveillance becomes broader by the day. For further insight please go to Mizen's report - Dynamic Surveillance: Detection, Prevention and Deterrence - on the Progress website.

-Dan

Friday, March 04, 2011

Hurry up, Take Your Time

Posted by Dan Hubscher

The Buck Stops At The Brokerage

In Key West there is a famous cat show on the waterfront at sunset where the trainer (yes, cats can be trained) gives his performers their signals and they rush to slowly do his bidding. He says to them, often: "Hurry up, take your time." Such is the nature of cats.

Regulating the financial markets seems rather like herding cats; trying to figure out the legal angles and ramifications to a raft of new regulations while trying to consult with market participants and coordinate between other financial regimes and placate well-meaning politicians is a recipe for confusion. 

After the May 6th, 2010 flash crash there was a three month period where the regulators learned just how much they didn't know, said Miranda Mizen, Principal at TABB Group at a Market Surveillance Seminar on February 22, co-sponsored by Progress Software. And this was after nearly two years of delving into financial market practices in order to reform regulations following the credit crisis. The result of all of these events has been a slew of new regulations, all of which require new or different surveillance programs in order to succeed.

During the intricate dance between market participants and regulators it becomes clear that there needs to be some common ground from which to start. That common ground lies with brokers, concluded Mizen, author of the paper entitled Dynamic Surveillance: Detection, Prevention and Deterrence.

She noted that brokers are sitting square in the middle between client order flow and trading venues. They are the major intermediaries, handling both order flow and information which allows them a top-down view of the markets. This view could help to fill some of the gaps that regulators need to fill. 

The Securities and Exchange Commission has intimated that the buck stops with senior executives at big brokerage houses and operational risk executives, who must prove that they have adequate procedures in place to prevent market abuse. This fate was pretty much sealed when the SEC agreed to propose the Market Access Rule last year, which would effectively prohibit broker-dealers from providing customers with naked access to an exchange or ECN.  

The Market Access Rule mandates real-time risk controls for brokerage clients, but it is only part of the struggles that brokers face. They have to deal with market structure changes such as the introduction of swap execution facilities, regulations in new asset classes and geographies, and regulators' demands for more detailed trade information. The rise of social networks, often used for trading discussions, adds another dimension to monitoring challenges. Plus, their efforts toward surveillance and market monitoring must be deemed "appropriate" by the authorities.

And the sellside will be happy to know that the buyside wants these types of control in place. Mizen's report pointed to recent interviews with asset managers in Europe, 85% of whom said that performance monitoring of their order flow is their top requirement when using algorithms and direct market access. This includes preventing fat finger trades, algos gone wild and market abuse.

No one wants to inadvertently kick the first domino that causes the whole line of dominoes to fall across the market, and most market participants are terrified of being the ones whose algorithm goes rogue. Technology is one - big - part of the solution. But procedures, processes and controls are also important elements of risk evaluation. Best execution and surveillance have to work together to be effective.

-Dan

Monday, February 07, 2011

The Trouble with Algorithms: Wild Children or Reckless Parents?

Posted by Dan Hubscher

Algorithms and high frequency trading have been blamed for everything from the credit crisis to the May 6th flash crash and high speed market abuse, and have attracted unwanted interest from regulators on both sides of the pond. But questions remain whether these tools are really computer models gone wild or whether they are the spoiled children of reckless parents - regulation.

According to Dictionary.com, the definition of reckless is to be utterly unconcerned about the consequences of an action. One could argue that the Regulation National Market System was designed without regard to some of the consequences down the line. Blaming the wild children, algorithms, is to ignore that the parents - RegNMS - were somewhat reckless in designing the system.

In a blog on the TABB Forum on January 24th,  Steve Wunsch of Wunsch Auction Associates explained that the system was working the way it had been designed.

"What really went wrong in the stock market on May 6? Prices aside, all of the plumbing was working fine. Not only were there no fat fingers, rogue algos, manipulators or terrorists at work, there were no significant breakdowns of order routing systems or data systems or any other elements of the stock trading infrastructure," wrote Wunsch.

Meanwhile, the National Commission on the Causes of the Financial and Economic Crisis in the United States released its report (Jan. 27th) and HFT was not mentioned at all. Nor were algorithms, as such, but 'computer models' were vindicated. The report said: "The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire."

And it criticized regulators for not doing their jobs: “Widespread failures in financial regulation and supervision proved devastating to the stability of the nation’s financial markets.”

The result of the credit crisis and market meltdown in Sept. 2008 was the Dodd-Frank Act, which attempts to prevent another Sept. 2008.  But the flash crash insinuated itself into the picture, pointing out that no one had baked that possibility into the market reforms.  And, ironically, the market reforms set the stage for more flash crashes.

At the Tabb Forum Derivatives Reform Event a couple of weeks ago, a lot of people commented that Dodd-Frank puts in place a market structure that injects the equities and futures markets model, along with fragmentation, price transparency, streaming  quotes, into other asset classes. This theoretically invites algorithmic and high frequency trading and the threat of more flash crashes. At the event Peter Fisher of BlackRock said that what keeps him up at night is a flash crash in the interest rate market, citing the market structure argument, but specifically pointed out that this possibility was not envisioned in Dodd-Frank. 

With more and more asset classes becoming tradable electronically, partly thanks to mandated swap execution facilities (SEFs), the possibility of truly wild or rogue algos and market abuse becomes increasingly inevitable. And, as we pointed out last week, the very real possibility of a flash crash splashing across asset classes - we call it a "Splash Crash" - rears its ugly head.

Although the evidence against algos gone wild is thus far anecdotal for the most part, the belief that they can and will go wrong permeates the industry. Market abuse such as insider trading and manipulation are undoubtedly more prevalent. Fat finger errors are easier to prove, and are a fact of life in a high speed, high stress electronic marketplace.

Stay Calm and Remain Vigilant

The antonym of recklessness is vigilance. The regulatory parents must be more vigilant when it comes to their arguably brighter and naughtier children - algorithms and HFT. With algorithms and HFT come the possibility of mistakes and abuse. Many more firms outside of the equities world are embracing HFT and their inexperience can cause market disruptions. A flash crash in oil or other commodities - or even foreign exchange - is not to be scoffed at. In fact, many commodities markets are much less liquid and homogenous than equities, and can be even more vulnerable to mistakes or manipulation.

 There are a number of best practices that can be used to mitigate against algos going wild:

  • Diligent backtesting – using historic data and realistic simulation to ensure many possible scenarios have been accounted for. A backtesting process needs to be streamlined of course – as short time to market of new algos is key.  
  • Real-time risk monitoring - building a real-time “risk firewall” into your algo environment. Just like a network firewall stops anomalous network packets reaching your computer, so a risk firewall should stop anomalous trades getting to trading venues.
  • Real-time market surveillance. Even if trades do not breach risk parameters, they may breach compliance rules, regulations or may be perceived by a regulator as market manipulation.

An algorithm is a tool in a trader's toolkit, not a naughty wild child. If the regulator parents are vigilant, and algos are subject to practical controls and monitored constantly for performance and for errors, market participants can sense and respond to market patterns before the aberrations or errors have a chance to move prices.

-Dan

Thursday, January 20, 2011

Red Flags in Morning, Firms Take Warning

Posted by John Bates

A pattern is emerging within new financial services regulations where regulators and financial services firms deploy monitoring technology to "red flag" potential issues such as risk, position limits, errors and manipulation. The "red flags" raised would then alert the relevant personnel or authorities.......... See the full post here

Monday, December 13, 2010

Calming 'Regulation Anxiety'

Posted by Dan Hubscher

There is a new kind of emotional disorder going around the financial markets - the previously unnamed fear of something ominous now that new financial rules have been laid down. Let's call it regulation anxiety.

Regulation anxiety has led to all sorts of new types of behavior in banks such as laying off proprietary trading staff, hiring ex-SEC lawyers, and laying on extra lobbyists to besiege Capitol Hill. The syndrome is so widespread that it has finally attacked the foreign exchange market - the market that performed the best during the financial crisis despite a lack of almost any regulation. And although the FX market 'ain't broke' it will undoubtedly get 'fixed' under new rules. It is these fixes that are causing panic attacks in the FX industry.

A survey of FX professionals at the Bloomberg FX10 conference in October showed marked anxiety over the impact of regulation and also possible changes to market structure.  More than 80 percent of those polled said they were concerned about the impact of recent regulations on their businesses.  They were also against structural reform and at odds as to which industry model is best for the future.  According to Bloomberg, the majority of the respondents were opposed to an exchange-traded model or a clearing house model, with only 19% believing the FX markets should have both clearing houses and exchange-traded requirements.

FX is a unique asset class in many respects; being (to date) almost totally free from regulation and benefiting from high liquidity on a global scale. Traders - wholesale, institutional and retail - are attracted by the ease and convenience of online currency buying and trading. The statistics bear this out with an average turnover of around $1.5 trillion per day – a clear indication of the strength of the market.

FX liquidity and volatility is growing day by day and trading foreign exchange in fast-moving, highly volatile times carries a high level of risk. As such it may not be suitable for all types of investors, institutions and buy-side firms. As a result, sell-side organizations that are serving the quickly-growing needs of hedge funds, proprietary traders, and other firms that take on these risks take on their own additional risk. There is a need to manage their own increased risk intelligently without erasing their competitive advantages.  

At the same time increased automated order volumes from the buy-side represent revenue opportunities for sell-side firms. But attracting that order flow away from competitors requires unique services, aggressive pricing and the ability to find the best prices in a highly fragmented market - not to mention the speed and scale needed to keep up in a high-risk environment.

There are solutions available which enable sell side institutions worldwide to rebuild their FX eCommerce platforms in line with the requirements of the most challenging customers and prospects. This is with a view to automate and customize their trading operations to become more competitive. There are now technologies that combine FX trading venue connectivity with a bird’s eye view of the market in real time; aggregating fragmented liquidity and including smart order routing algorithms, enabling every element of an eCommerce platform to automatically find and leverage the best prices.  

And, a very few include a rich development framework for both business users and IT. The flexibility for the business user allows traders to create and rapidly deploy proprietary FX and cross-asset trading strategies that help them competitively engage with clients.

There have been numerous recent examples of banks looking to take advantage of these solutions. For example, Royal Bank of Canada (RBC) recently deployed a new FX Aggregation solution to support its foreign exchange dealing operations. The Progress Apama FX Aggregation Solution Accelerator  is completely customizable and has been modified for RBC to meet its specific requirements. RBC's new system has significantly increased the efficiency in which its traders obtain the best FX prices for their clients.

RBC is the latest in a growing list of global and regional banks, which have deployed this type of platform as a foundation for eCommerce. Other organizations that have deployed FX solutions driven by technologies from Progress Software (namely its Apama product) recently include BBVA, UniCredit and ANZ, who can now access multiple sources of liquidity and dramatically improve their ability to handle increased trade volume.

The best way to deal with anxiety is to address the root cause. In this case, regulation. Regulation is coming, change is coming. Since the FX world is now facing looming regulations with dramatic impact, you’re going to need to adapt your business models and supporting applications quickly in order to survive – for instance by building flexible rules within your FX trading systems to identify and manage risks, whatever they may turn out to be.  If you do, you’ll be ahead of the pack and will be able to create competitive advantage.

-Dan

Wednesday, October 13, 2010

New Wall Street film shows that technology never sleeps

Posted by Giles Nelson

After encountering the latest Wall Street film ‘Money Never Sleeps’ earlier this week, it’s apparent that it's not just the then-brick-sized mobile phones that have changed since the 1987 installment.

The movie opens with Gordon Gekko, the man who so famously stated, “greed is good” in the first film, being released from jail. It’s a comical scene contrasting the technology of the ’80s to the tech of today, as the guard returns Gekko’s bulky mobile phone. Gekko is released into a world where the nature of how the financial world is run has completely changed. However, it was only after recently revisiting the original movie, you come to realise just how much advances in technology has fundamentally changed the way in which the trading floor environment operates.

Take High frequency trading (HFT), the use of technology to monitor and submit orders to markets extremely quickly, which has been receiving a lot of bad press recently and is sometimes described as “abusive”. It is no more abusive than two traders making trades using only the telephone, as was the case in a scene from the original Wall Street film.

Yes, it can be used for rogue trading by the likes of Gekko, but so can any other technology. Technology itself is morally neutral. Similarly, algorithmic trading is also seen by some as an industry curse. Credit Suisse has been fined this year by an exchange after its algorithmic trading system went out of control and bombarded the exchange with hundreds of thousands of erroneous orders. However, this wasn’t a deliberate attempt to manipulate the market. It was a mistake, albeit a careless one. There just weren’t proper controls in place to protect the market from what, ultimately, was human error – the algorithms hadn’t been tested sufficiently.

There is no doubting that technology has generated enormous benefits for trading – greater efficiencies, more market liquidity, tighter spreads and better prices for all. To lose these benefits because of perception would be very dangerous. Having said this, technology has also made the markets faster and more complex. Therefore, all market participants need to up their game by deploying modern day monitoring capabilities to spot trading anomalies to help capture the next generation Gekkos.

Monday, October 11, 2010

When Does a Rogue Become a Scoundrel?

Posted by John Bates

Now that the Dodd-Frank Wall Street Reform Act is signed into law, there lies a mountain of work ahead for regulators. Making sense of the 2,000+ page document and turning it into viable recommendations and regulations will be an arduous process.

 

The Commodity Futures Trading Commission's second Technology Advisory Committee meeting titled “Technology: Achieving the Statutory Goals and Regulatory Objectives of the Dodd-Frank Act,” will be held on October 12, 2010 at 1:00 p.m., in Washington, D.C. (http://tinyurl.com/2vfdp4n). At the meeting, my committee colleagues and I will discuss some of these goals and objectives. Specifically, as a result of the SEC & CFTC's report on the May 6th flash crash, CFTC Commissioner Scott O'Malia has said that he wants to take a look at whether algorithms that cause disruption in markets - rogue algorithms - should be treated as if they were rogue traders.

 

Commissioner O’Malia said in the announcement of the October 12 meeting: “While I do not believe that the flash crash was the direct result of reckless misconduct in the futures market, I question what the CFTC could have done if the opposite were true. When does high frequency or algorithmic trading cross the line into being disruptive to our markets? And, along those same lines, who is responsible when technology goes awry? Do we treat rogue algorithms like rogue traders?"

 

This is an interesting topic. When does an algorithm 'go bad'? Is it the algorithm's fault? Of course not, an algorithm does not decide to go rogue. It is down to human error - either in the programming or the execution thereof. In the case of the flash crash a mutual fund chose a 'dumb' execution algorithm preset with inappropriate parameters to execute a large futures sell order in a market that was - by all accounts - ready to plummet. This circumstance illustrates how rogue algorithms can evolve as an unintended consequence of circumstance and/or human misjudgment.

 

When a trader goes rogue it is more deliberate. It can be because he is losing money and hiding it - as in the case of Jerome Kerviel at SocGen, or maybe he had too much to drink at lunchtime and was feeling invincible - like Steve Perkins at PVM. The former lost the bank over $6bn, the latter lost his brokerage $10m. These were very human errors, effectively the work of scoundrels.

 

What rogue traders and rogue algorithms have in common is that both can, in many circumstances, be detected early - or even prevented - through the use of better technology. Comprehensive pre-trade analysis, including backtesting algorithms under a wide range of circumstances, could have prevented the 'dumb' May 6th algo from having its way with the market. Thorough real-time risk management and monitoring could have spotted Kerviel's limit-busting trading patterns and his hiding the trades. Pre-trade risk controls would have kicked the PVM trader out of the system before he got in too deep.

 

It is no longer acceptable to blame rogues and scoundrels for market anomalies or for banks, brokers and buyside firms losing money. The technology is there, it simply needs to be used.

 

Wednesday, September 08, 2010

Algos can get stuffed!!

Posted by John Bates

As regulators continue to look into the causes of the May 6th flash crash, some high frequency trading approaches are coming under scrutiny. In particular the concept of “quote stuffing”, where algorithms send so many orders into the order book that the market cannot possibly respond, has come under fire from market participants and the press.

 

The SEC, having reportedly decided that quote stuffing probably did not have a major role in the flash crash, is now taking aim at the practice to see if it puts some investors at a disadvantage by distorting stock prices (http://tinyurl.com/264kr3o). The CFTC is looking at data from database developer Nanex and mulling how to address quote stuffing in futures markets (http://tinyurl.com/3a7w7sv).

 

Meanwhile, concerning incidents continue to happen in the market. As recently as last week there was an incident that caused Christopher Steiner at Forbes to write a story called “Did we dodge another flash crash on September 1st?” The story describes how on September 1st at 10am quote volumes ballooned - as they did on May 6th. In fact quotes reached 275,000 per second, as opposed to 200,000 on May 6th. Unlike the flash crash though there wasn’t a dramatic fall in prices. However, the bids and offers did cross for a time – leading to high frequency traders taking advantage of arbitrage opportunities. This data was exposed again by firm Nanex – and left the market wondering if quote stuffing by high frequency traders was behind the spikes.

 

The world is waking up to the fact that high frequency and algorithmic trading have quietly become part of the market fabric, and the world does not seem to be too happy about it. HFT and algorithms are being "demonized" said the FT article, and I agree. I also think the hype is overblown.

 

Once trading became automated, trading strategies naturally morphed to take advantage of the available technology and higher speeds. High frequency statistical arbitrage techniques can also mean more order cancellations, some of which may - wittingly or unwittingly - fall into the quote stuffing category. Those involved in intentional quote stuffing as a strategy need to be held to task. But to demonize all strategies or call for banning them is a step backward. What is needed is a framework by which to police them - and to prevent them from going wrong. The technology to do this is already available. For example, an area I’ve had a lot of experience in is the use of complex event processing to provide a platform for high frequency, multi-venue market surveillance. With such a system quotes can be monitored to determine how many quotes per second there are on each ticker symbol, the ratio of quotes to trades, when large spikes are emerging and many other interesting real-time analytics and patterns that it’s useful to track in real-time.

 

But regulation of high speed trading practices has fallen short to date. Regulators have not had the funds, the technology, the power or the expertise to follow and control high speed trading. However, it is good to see that progress is now being made. CFTC commissioner Bart Chilton wrote last week in an article entitled Rein in the cyber cowboys: “There may be some cyber cowboys out there and they could be giving respectable traders a bad name”. His colleague CFTC commissioner Scott O'Malia told Reuters last week that, if traders are flooding the market with orders with the intention of slowing others down, the regulator would consider addressing quote stuffing under new rules in the financial regulation bill that deal with disruptive trading practices.

 

It is possible that quote stuffing is causing more problems that just slowing down the natural flow of trades. Trading behavior patterns suggest that these quotes are a distraction to other traders. There are patterns evident where the quote "stuffer" continuously traded first - possibly by distracting others. And the disruption can cause the bid and offer to cross – providing a nice arbitrage opportunity for those who are not distracted! All of this needs to be looked into further. I fully support the CFTC and SEC's efforts to get to the bottom of not just the flash crash, but HFT and algorithmic trading practices. They are now integral in the equities and futures markets, and increasingly so in FX, fixed income and energy. What we need is better policing of the markets to protect the honest ranchers from the cyber cowboys.

Thursday, August 26, 2010

The Risks of Being Caught Naked

Posted by John Bates

According to the FT, the Financial Industry Regulatory Association is undertaking a “sweep” of broker-dealers that offer direct market access to high-frequency traders to find out if they have pre-trade risk management controls in place for their algorithmic customers. (Read the full story here: http://tinyurl.com/28rg287). Here at Progress Software we have been advocating the use of pre-trade risk management tools for some time. The prospect of High Frequency Trading (HFT) firms running trades directly through broker algorithms (naked access) to exchanges/ECNs without adequate supervision has always concerned us. Brokerage firms simply give their clients an exchange ID number, which the clients then enter into their algorithms so that they can trade directly with the exchange.

Regulators are right to be concerned. Unfiltered access to trading destinations can end up causing trading errors or worse. Anything can happen with naked access; from fat fingered errors, trading limits being breached, even fraud - all of which can cost brokers, traders and regulators big money.

Although the SEC proposed banning naked access in January, and the Committee of European Securities Regulators (CESR) is likely to follow in its footsteps, there has been considerable pushback from brokers and trading firms. They say that adding a pre-trade risk management step would cause a "latency hop" in the trading process, claiming it would make them uncompetitive.  A layer of risk management often adds a third party into the mix, and - consequently - a delay.

But if everyone is required to add real-time, pre-trade risk management, then the competitive disadvantage is moot. The benefits of being able to pro-actively monitor trades before they hit an exchange or ECN far outweigh any microscopic latency hops in any event. The naked access playing field is hardly level. There are trading systems out there that claim to throughput a trade in 16 microseconds from outside an exchange's firewall, while exchange and ECN systems range anywhere from 250 to 700 microseconds (according to measurements by latency management firm Corvil).

Latency is clearly an important issue and complex event processing offers a solution. Brokers can achieve ultra-low-latency pre-trade risk management without compromising speed of access.  An option is a low latency "risk firewall" utilizing complex event processing as its core, which can be benchmarked in the low microseconds.  With a real-time risk solution in place, a message can enter through an order management system, be run through the risk hurdles and checks, and leave for the exchange a few microseconds later.

It is the ideal solution to a tricky question - how do I manage risk before my trade hits the exchange without compromising speed? The benefits are clear - a latency hop of a few microseconds not only saves money, it can also prepare your firm for the regulatory future.

Monday, August 23, 2010

Evacuate the Dancefloor

Posted by John Bates

Looking for all the world like someone yelled "fire" in a crowded nightclub, prop and quant traders are stampeding out of investment banks and headed for the hedge fund world. Some, mainly the prop traders, are being pushed gently out the door as banks prepare for the Volcker Rule (http://tinyurl.com/39ap28d). Others, like the quants (http://tinyurl.com/23c5h6d), are in search of the mega-bonuses that their prop trader or hedge fund manager compatriots are (or were) getting.

 

Impending changes in regulation are prompting banks to spin off proprietary trading activities, many by expanding their operations overseas where Messieurs Dodd and Frank cannot reach them. I’m very concerned about this “regulatory arbitrage” in which firms may move away from the US to find less strict regulatory regions. We don’t want to lose the lead in this important area of the economy.

 

Spin offs and regulatory arbitrage may well leave a herd of US traders looking for work and many may end up working at - or starting - hedge funds. The quants, having slaved over hot computers for the last few years to line bankers' pockets, are forming their own trading companies or joining prop trading firms with a profit-sharing deal.

 

Most of these traders will be in for a rude awakening when they sit down to work. Prop traders joining hedge funds will find that the technology budgets may not be as generous as they were at their last bulge bracket employer's firm. The quants, who are essentially programmers, will face huge challenges in finding firms that have the kind of low latency, scalable architecture that they need to design, tweak and trade with their algorithms. The level of trading freedom is different, too. Hedge fund managers will have something to say about a trader's profits - or lack thereof. Quants may find that designing an algorithm and handing it over to the trading desk is not quite the same as being responsible for the profits that the algo makes - or doesn't make.

 

Make no mistake, these prop traders and quants are highly intelligent and adaptable people. There will be many challenges to face going forward, but technology need not be one of them. There are instantly useable, scalable platforms that quants and hedge funds can use to build and deploy algorithms. These platforms, such as Progress Apama's Complex Event Processing Platform, offer a robust technology infrastructure to successfully create, test, deploy and manage their algorithmic strategies.

 

Algorithmic trading software is constantly transforming. As the volume of real-time market data continues to increase, algorithmic trading solutions demand an infrastructure that can respond to market data with near zero latency. To trade effectively in competitive markets requires rapid, opportunistic response to changing market conditions before one's competition can seize those opportunities. The people that are running for the doors and into the arms of hedge funds or other trading firms, will need this advantage. Competition is fierce, and their previous employers already have the technology advantage.