A report discussing trading speed, the macro infrastructure needed, how high-speed traders manage risk and profitability, and what buy-side investors can do to change this dynamic has been published by TABB Group.
TABB Group founder and research chairman Larry Tabb, who authored the report, explains that how quickly you trade is dependent upon your ability to read, analyse and respond to changes in the market and the order book, but understanding where your order is on the book and how that book is moving is also critical.
Tabb says that to competitively manage speed requires a significant amount of infrastructure and is determined by your proximity to the exchange matching engine, bandwidth, communications quality, market data integrality, efficacy of your processing engine, and trading logic.
All of these technologies and services must be managed appropriately to compete with the big players in the space.
“While trading is anonymous, how participants respond to various market factors enables faster traders to differentiate market makers and HFT liquidity from traditional investor flow. Even without market data ‘tells’, a fast and informed trader knows the difference between by analysing reaction times,” says Tabb. “Regardless of how fast the connectivity, how good the data, or how smart the execution engine is, the current market structure will always place the customers’ order at a disadvantage to the very fast/market-maker order. The model used by most all buy-side algorithms is, by definition, slower.”
The report – “Speed: Why It Matters and What Can Be Done” – discusses the limited options available to us if we want to eliminate the structural advantages of speed without giving up the benefits of tight quotes, competition and innovation.
TABB reviews a number of market structure solutions that have been developed to bring parity back to our markets, including auctions, randomised matching, speedbumps and other more structural changes. However, as the report details, the best way for institutions to understand speed and the cost of interacting with liquidity is to measure it, which can only be done by carefully analysing a firms’ routing practices.
Without this analysis, it is very hard for investors to fully understand their cost of liquidity and intermediation, Tabb says.