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May 1, 2011

Defending the Turf

Sellside Moves to Protect Buyside from HFT Onslaught

By Peter Chapman

Talk about the power of television.

On Monday morning, Oct. 11, 2010, the phones in Credit Suisse's Advanced Execution Services department were ringing more than usual. On the other end were anxious customers asking the big broker what it was doing to protect their orders from predatory black-box traders. They had all watched "60 Minutes" the night before, when the popular television program explored the world of computerized trading and the role of high-frequency traders.

Reporter Steve Kroft interviewed Joe Saluzzi, co-head of agency brokerage Themis Trading, who told Kroft that high-frequency traders were using their superior firepower --i.e., speed-to push prices up or down, to the disadvantage of the institutional investor. "They're parasites who exploit technological advantages to suck money out of the market," Saluzzi told Kroft. "They add no value." The trader added that he "spots signs of predatory behavior every day."

The following week was a busy one for AES head Dan Mathisson. "Everyone was calling after seeing that piece," Mathisson said. "We had several clients come to visit us. Many wanted information because they had to make presentations to their boards of directors."

According to buyside traders surveyed by TABB Group, the most important market structure or regulatory issue they face is high-frequency trading. Nearly half the traders interviewed for TABB's 2010 survey felt HFTs were a problem, up from 29 percent the prior year.

Henri Waelbroeck

The biggest concern, according to the traders, was that the marketplace had become an "uneven playing field" and the speed advantage of HFTs worked to their disadvantage. HFT trading now accounts for at least half of all industry volume, according to some estimates. In TABB's study, about one quarter of the traders said the presence of HFTs had increased their trading costs.

The charge most often levied at HFTs is "gaming," or using ill-gotten information to out-trade others. Brokers and analysts caution, however, that the vast majority of trading done by high-frequency traders is not predatory. While stories about prop shops sniffing out institutional orders in dark pools or leveraging co-located trading engines make for juicy headlines, they comprise only a small part of HFT trading, sources say.

The more common HFT trading strategies involve market making or some form of arbitrage. These strategies are considered beneficial for the market as a whole, as they supply liquidity and keep prices close to fair value.

Still, that's cold comfort for the buyside trader trying to get a large order done. Since the market maker or arbitrageur is likely better informed about the short-term direction of the stock, the buysider trades with them at his peril.


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