Commentary

Tim Quast
Traders Magazine Online News

We're All HFTs Now

In this guest commentary, author Tim Quast looks back at the history of HFT and how the market has evolved to where many firms now fit the definition of high-frequency trader.

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April 30, 2004

The Age of Enlightenment: Traders cut costs and find profits again.

By John A. Byrne

Also in this article

  • The Age of Enlightenment: Traders cut costs and find profits again.

In the shadows of the institutional trading world, some of the biggest stock dealers on Wall Street have been quietly assembling the new side of block trade executions. These are the program and algorithmic desks at an elite group of top dealers. And lately these desks have shot up like mushrooms overnight.

If this trend has escaped the attention of some harried Street executives trying to make a buck on penny spreads, that will soon change. These new desks, run by recognized players such as Credit Suisse First Boston, Banc of America Securities and Goldman Sachs, are now publicly riding the trend.

"We like to call 2003 the year of enlightenment," says Robert Flatley, a managing director of electronic trading services at Banc of America. Flatley, an expert on trading technology, is referring to one of the most significant challenges faced by sellside trading desks. These desks are responding to buyside customer demands for cheaper executions. And the creation of more electronic trading tools is bringing this reality of lower commission costs one step closer. Last year, some of the biggest sellside desks loaded up to offer program trading, coming after the buyside as never before.

"The new trading reality and migration toward agency execution forced dealers to add aggregation technologies and develop algorithmic trading strategy servers," according to a report by The Tabb Group, a company that researches the trading industry.

The economics of the agency-driven environment, which led to pricing pressures, propelled the changes. "The sellside said we have to find a way for the buyside to do cheaper trades, for a few cents a share," Flatley explains. "That meant we needed a low-touch, or no-touch approach so the sellside could execute those orders and still make money."

Flatley said the solution the sellside came up with was a sort of "catcher's mitt" - a high technology approach to allow the buyside to personally configure sophisticated lists and portfolio trades, and then send them to the sellside.

To a large extent, this type of trading had been mainly the province of proprietary Street desks. But now it has huge implications for the future of Nasdaq and OTC market making.

Indeed, Flatley estimates that up to 30 percent of Nasdaq and OTC trade executions at his firm - which also supports a separate market making operation - come through program and algorithmic desks. That's the sort of volume that in former times likely would have gone directly to Nasdaq market makers.

As is widely reported, ECN and ATS machines now handle some 80 percent of trading in Nasdaq stocks while the other portion belongs to Nasdaq's SuperMontage. However, it does not necessarily follow that most of the Nasdaq and OTC business has bypassed the traditional market makers. That's because about 50 percent of Nasdaq trade volume is internalized by market making firms. And market makers and order-entry firms account for the lion's shares of the other half.