High-Speed Trading No Longer Hurtling Forward
Sunday, October 14, 2012
NEW YORK TIMES
The hottest new thing on Wall Street is cooling down. High-frequency trading firms — the lightning-quick, computerized companies that have risen in the last decade to dominate the nation’s stock market — are now struggling to hold onto their gains.
Profits from high-speed trading in American stocks are on track to be, at most, $1.25 billion this year, down 35 percent from last year and 74 percent lower than the peak of about $4.9 billion in 2009, according to estimates from the brokerage firm Rosenblatt Securities. By comparison, Wells Fargo and JPMorgan Chase each earned more in the last quarter than the high-speed trading industry will earn this year.
While no official data is kept on employment at the high-speed firms, interviews with more than a dozen industry participants suggest that firms large and small have been cutting staff, and in some cases have shut down. The firms also are accounting for a declining percentage of a shrinking pool of stock trading, from 61 percent three years ago to 51 percent now, according to the Tabb Group, a data firm.
It is a swift reversal for trading firms that have often looked to other investors like profit machines, thanks to high-powered software and superfast data connections that can take advantage of small changes in the price of a stock.
High-speed trading is far from disappearing from the market, but the struggles facing these firms have been greeted with enthusiasm by some traditional traders and investors who have viewed the firms as formidable adversaries, or worse, market manipulators that create sudden spikes and drops in share prices. Peter Costa, a longtime trader on the floor of the New York Stock Exchange, said the fading presence of the firms could “restore some order to stock markets.”
Regulators are still grappling with whether the rise of high-speed firms has been a net benefit or loss for investors, so it is hard to pinpoint what effect the decline of these firms will have on the markets. Many market experts have argued that the technical glitches that have recently hit the market have been a result of a broader trend of the market splintering into dozens of automated trading services and a lack of human oversight.
The challenges facing speed-focused firms are many, the biggest being the drop in trading volume on stock markets around the world in each of the last four years. This has made it harder to make profits for traders who quickly buy and sell shares offered by slower investors. In addition, traditional investors like mutual funds have adopted the high-speed industry’s automated strategies and moved some of their business away from the exchanges that are popular with high-speed traders. Meanwhile, the technological costs of shaving further milliseconds off trade times has become a bigger drain on many companies.
Among the firms scaling back is the Chicago Trading Company, which this year earned a spot on a government committee formed to explore the emerging phenomenon of high-speed trading. Since then, the company has been making cuts to its New York office, according to people with direct knowledge of the moves. The company’s chief executive, Eric Chern, said some employees had been moved to Chicago and 10 had left the firm. He declined to comment directly on the changes, but he did say that “the market environment always plays a factor in all our decisions.”
Douglas Cifu is the president of Virtu Financial, a big player in the industry. “There was this mythology that you could get 90 computers, some Harvard Ph.D.’s and you would turn on your machines and make money,” he said. “It’s just not the case.”
Virtu has not cut back, but it has acquired smaller firms that were struggling to continue operating on their own. Last month, Virtu bought Nyenburgh, a company that specialized in the most popular type of high-speed trading, known as market making, of European stocks.
At the same time that the firms are making trims, regulators around the world have increased their scrutiny of high-speed traders, and the structure of the financial markets has continued to shift. Executives at the trading firms worry that new regulations could curtail business even more, but so far regulators in the United States have taken few steps to rein in trading practices.
The diminishing presence of these traders in the markets has not hurt the overall performance of stock prices. Leading indexes have been on a steady climb for the last few years. For high-speed traders, rising prices are actually a part of the problem: climbing stock markets tend to be calmer stock markets, providing fewer trading opportunities for high-speed firms.
Several studies have found that the primary impact of high-speed firms has been a steady decline in the cost of placing trades for ordinary investors. Now that the high-speed firms are shrinking from the market, there are some indications that trading costs may again be rising.
For the firms themselves, the declining revenues and climbing costs have led to talk of mergers and consolidation. Bart Lijnse, the head of Nyenburgh, which is based in the Netherlands and was acquired by Virtu last month, said that a small firm like his could not afford the big technological costs of remaining competitive in the industry.
“In order to compete, you need to be like a global firm,” Mr. Lijnse said.
The contraction is also pushing the firms to move into trading of other financial assets, like international stocks and currencies. High-speed firms accounted for about 12 percent of all currency trading in 2010; this year, it is set to be up to 28 percent, according to the consulting firm Celent. But executives at several high-speed firms said that trading in currencies and other assets was not making up for the big declines in their traditional areas of United States stocks, futures and options.
Sun Trading in Chicago bought a firm that allowed it to begin the automated trading of bonds earlier this year. That did not make up for the 40 employees the company cut in 2011. The firm’s chief financial officer, Chris Malo, said his team was preparing for the possibility that the high-speed trading business would only become more challenging.
“People think it’s easy money, and it’s not,” Mr. Malo said.
Like most such firms, Sun Trading is privately held and does not disclose its financial results. But Timber Hill, which is one of the few high-speed firms that releases its financial results publicly, provides a unique window into the trends.
The firm’s founder, Thomas Peterffy, said that firms like his “had a field day” in 2008 and 2009. Share prices were plummeting, and the volatile conditions were ideal for high-speed firms. In addition to the high volume of trades in those years, share prices were moving around wildly, allowing computer programs to take advantage of dislocations in prices. Timber Hill, which trades stocks but specializes in options, made a $328 million profit, before taxes, in 2009.
Since then, though, the amount of stock trading done by Timber Hill fell 27 percent between 2009 and 2010 and 38 percent between 2010 and 2011.
Mr. Peterffy said that the much larger problem had been the rising cost of technology required to stay in a business that is not producing more revenues. One example is the data sold by the exchanges. Until recently, most firms bought a data package from Nasdaq that cost about $1,000 a month and gave traders a feed that includes all orders submitted to the exchange. In August, Nasdaq introduced a new, more comprehensive data package that costs about $25,000 a month. Many firms say that they have to sign up for new technologies if their competitors do.
“It gives no benefit to anyone, that’s what I find so frustrating,” Mr. Peterffy said.
In the first half of this year, Timber Hill’s earnings were only about a quarter of what they were in 2009.
Mr. Peterffy has departed from many of his competitors by calling for regulators to slow down the markets. At the same time, he has been preparing for the challenges by bulking up the other business he leads, Interactive Brokers, which takes and executes orders for retail investors.
The work Timber Hill does, Mr. Peterffy said, “is a good business for us, but there are no barriers to competition and it’s not going to last forever.”