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US futures markets in the crosshairs of algorithmic revolution

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The US futures markets have a target on their backs as newer market stakeholders are taking aim using algorithms, according to a report by Tabb Group. 

Electronic market makers, hedge funds and long-only asset managers alike are forging algorithmic trading strategies with futures woven deep into their core. 

These strategies include a new trading concept, multi-dimensional arbitrage that symbolises this rising cascade of automation, representative of the “next generation” of trading opportunities. 

Accordingly, Tabb forecasts that total future volumes traded on an automated basis will increase to nearly 60 per cent by the end of 2010, up from 43 per cent at the end of the third quarter 2009. 

To meet accelerating demand, Tabb says brokers, exchanges and software vendors need to continue delivery of automated solutions to ensure the long-term growth of the futures markets, which, through new levels of speed, liquidity and strategy, are now on a par with the cash equities markets.

Driving the increased futures volume executed algorithmically, says Paul Rowady, a senior analyst at Tabb who wrote “US Futures Markets: In the Crosshairs of the Algorithmic Revolution”, are the growth of high-speed trading, adoption of automation by hedge funds, and traditional managers shifting orders from traditional high-touch to low-touch channels.

High frequency trading in the futures markets is a natural extension of accumulated expertise gained in the equities markets, Rowady says. 

“The surprise is how quickly and quietly the US futures markets have attracted nearly as many high-speed players as equities. Having the expertise to interact quickly, efficiently and intelligently with the futures markets, while maintaining close harmony with other asset-class positions, is now a fundamental competitive imperative.” 

He goes on to explain how automation of the entire alpha “assembly line” is where the competitive advantages now reside, that today’s market pioneers are focusing intently on rapid data assimilation, alpha discovery and strategy deployment in concert with low-latency execution as a key requirement. High-frequency trading firms set the tempo in terms of speed and innovation for the rest of the market, and therefore serve a valuable purpose. 

“Most of the growth in HFT for futures has occurred since the exchanges began making clean, granular data available, a fact that is always synonymous with the birth of automated trading in a given market.”

Evidence of the speed and depth of the algorithmic revolution can be found in Chicago prop shops and elite East Coast hedge funds where high frequency futures trading is already a mainstay. Additionally, many of the leading brokers have extended their execution algo suites and advanced technical infrastructures to the broader hedge fund community. The trade automation now firmly embedded in the futures markets, says Rowady, will provide these markets with continued impressive growth, even in bearish markets.
However, he says, more impactful than these trends is the expectation that traditional asset managers are on the verge of adopting automated solutions for accessing the futures markets.

“Unlike their more proprietary peers, these players will need to lean heavily on a short, but expanding, list of brokers capable of offering advanced algorithmic capabilities across asset classes, as well as vendors capable of seamlessly integrating futures algorithms with existing systems and ultimately a consistent, consolidated multi-asset market view.”

Addressing the future of the US futures markets, Rowady maintains that some of the primary developments in these markets will include greater access to and interaction with emerging market futures, more hedging and position accumulation strategies, especially in commodities-related opportunities, and increased adoption of high speed trading by a broader brigade of market participants.

“Tabb Group predicts that as total market capacity for high speed trading comes into focus, and competition at the ‘tip of the spear’ becomes an even more exclusive club, the hints of consolidation we sense among the high frequency trading shops will be consummated.”

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