The Gateway to Algorithmic and Automated Trading

Stockholm Syndrome

Published in Automated Trader Magazine Issue 32 Q1 2014

The Swedish word lagom doesn't have a direct equivalent in English. Loosely translated to mean 'in moderation', it's basically all about finding the right balance. Lagom is something of a mantra for Swedes, who seek it in all aspects of life. So, as Adam Cox reports, it should come as little surprise that the concept of lagom appears to have been a guiding principle in the development of the Swedish marketplace.

In 1924, Henry Ford established operations for his burgeoning auto empire in Stockholm's docks area, building a factory to produce his much-sought-after cars. Fast forward 80 years and another company with big ideas, OMX, took over that factory and transformed it into a financial nerve centre for the Nordic region.

It's a fitting prelude for a company that helped usher in the start of algorithmic trading in Sweden. Ford was known for being both conservative and revolutionary, and Sweden's approach to the transformation of its financial landscape has been similar. It has welcomed high-frequency players but at the same time sought to rein in excessive order traffic.

Lauri Rosendahl, senior vice president and head of Nordic equities and equity derivatives at NASDAQ OMX, reckons that Sweden, and the Nordic region in general, has been a bit late to the party in terms of algorithmic trading.

"When it comes to HFT or automated algorithmic trading, compared to the US, I would say that we were slightly behind the development that happened in the biggest European markets, in particular Great Britain," Rosendahl said.

But that hardly bothers Rosendahl. For a start, he said the Nordics -- at least based on NASDAQ OMX's experience -- have been picking up ground quickly in the past few years. More importantly, he sees trends towards healthier trading activity.

Lauri Rosendahl, senior vice president, Nordic equities and equity derivatives at NASDAQ OMX

Lauri Rosendahl, senior vice president, Nordic equities and equity derivatives at NASDAQ OMX

"The order-to-trade ratio that we monitor has actually declined, and it has declined quite substantially..."

"The order-to-trade ratio that we monitor has actually declined, and it has declined quite substantially, so you could clearly see that the kind of strategies that high frequency trading firms typically had, like in 2011, they are quite different in 2013."

Rosendahl said that between 2011, when first generation high-frequency trading strategies started becoming active in Stockholm, and last year, there was a clear decline in overall message traffic. "Those strategies have changed and evolved and you see that in messaging traffic, and (pursuing) that kind of excess order entry (strategy) is not the way to operate anymore," he said.

NASDAQ OMX has been part of that. It changed the terms for excess order-to-trade ratios, going from 250:1 to 100:1 effective this year. Still, even with this change in traffic rates, the share of overall trading from the high-frequency community has been picking up.

"High frequency trading has become, according to our estimates, around 20% of the traded volume on the Nordic markets," Rosendahl said.

Stockholm and Helsinki are both in the 20-25% range, with Copenhagen a bit below. Rosendahl said NASDAQ OMX's launch of INET, the same trading platform used in the US market, was a key reason for growth in high-frequency trading in the region.

The new INET trading system, launched in the Nordics in 2010, has a sub-100 microseconds average latency and has been advertised as the world's fastest, capable of a throughput of more than 1 million messages per second. The INET technology supports multiple markets, including cash and fixed income securities, derivatives and commodities.


This illustration, from a study by Björn Hagströmer and Lars Norden, shows the market maker presence for each exchange member in each OMX 30 stock. Market maker presence is estimated as the fraction of 10 second periods in the continuous trading day that a member has quotes at either of the best bid and offer prices, reported as the mean across all trading days in February 2012. The chart shows the degree to which volume is made up of HFT market-makers rather than "opportunistic" HFT traders (see commentary on p41)

"I would also say that the growth in terms of high frequency trading really happened starting in 2010 and that is of course connected partly to the fact that we changed to the low-latency INET trading system," he said.

Finansinspektionen (FI), the Swedish financial market regulator, began an investigation into HFT in 2011. It met with some 15 sales-trading executives and a similar number of brokerages, as well as other firms. All in all, it spoke to some 35-40 people to understand what was happening in its markets.

Ludvig Sandhagen, who authored a report on high-frequency activity in Sweden for the regulator, said INET was a state-of-the-art platform. "So that in turn attracted a lot of the HFT participants," he said.

"We have a large number of international HFT actors here. The number of Swedish firms is quite limited." - Ludvig Sandhagen, Finansinspektionen

But when it comes to high-frequency trading in Sweden, don't necessarily expect to encounter a stream of firms that feature those distinctive letters å, ä or ö.

"We have a large number of international HFT actors here," Sandhagen said. "The number of Swedish firms is quite limited."

Rosendahl of NASDAQ OMX described Stockholm as a kind of third-level destination for typical international players.

"Most of the high frequency trading firms we have in Europe, are originally from the US. And when they arrive in Europe, or even if you establish a new HFT firm, you typically establish in the UK first, right?" Rosendahl said.

But after establishing operations in the UK, if they find their strategies work, they typically start looking further afield. A firm might start trading the London market, then try Frankfurt, and only after that look at Stockholm or other Nordic centers.

"The Nordic countries are definitely on the map," Rosendahl said.

About three-fifths of trading in the Nordics comes from non-Nordic members of the NASDAQ OMX exchange, one of the highest proportions of remote brokers trading in a specific European market. Today, the Nordic region represents 10% of the total trading in Europe, compared with 6% only a few years ago, NASDAQ OMX says.

For a variety of reasons, many of which date back to the 19th century when sea-faring Scandinavians set out to establish trading deals around the world, the Nordic region has a host of world-beating companies. That in turn means it can be a big market for foreign investors. Also, after the dollar, euro, yen and sterling, Sweden has one of the world's more heavily traded currencies.

Still, within the Nordic market, one thing seems to be clear at this stage of the game. As in other markets, the low-hanging-fruit is gone.

Dr Björn Hagströmer, Stockholm University’s School of Business

Dr Björn Hagströmer, Stockholm University's School of Business

"We find that it is only a handful of HFTs that are market makers according to our definition. There are many more that are doing HFT strategies."

"I would say first of all markets have become more efficient," Rosendahl said, adding that arbitrage opportunities were harder to find. "Even between the kind of venues that trade the same stock. That's definitely tougher."

It is not only for the trading firms that competition has become a lot tougher. Whereas OMX in the past could have enjoyed a virtual monopoly in terms of trading activity, the reality for NASDAQ OMX is intense competition. MiFID ushered in new competition, and MiFID II will bring in more. Still, the Stockholm-based derivatives pioneer says it's thriving.

"Competition is there every day, but actually in 2013 our market share of trading in our Nordic listed companies actually has slightly increased," Rosendahl said.

NASDAQ OMX says it has been focusing on its matching engine latency. "The positive thing here is that when I'm in London discussing our infrastructure with our members, they seem to be very happy with what we have and how we run it."

Connectivity from London is critical and NASDAQ OMX provides it from London and Frankfurt directly into Stockholm. "And when it comes to high frequency trading, practically all of the HFTs, they have their colos with us in Stockholm," Rosendahl said.

Ghost in the machine?

As with a number of markets, one issue that had at one point concerned the authorities in Stockholm was the idea of "ghost liquidity", whereby high-frequency trading firms appear to be providing liquidity but the moment anyone tries to hit a quote it disappears.

"The concern was quite high but no one could sort of pinpoint what was the problem," said Sandhagen of Finansinspektionen."Alternatively, they couldn't provide us with a case of ongoing market abuse, for example. Rather, it was a case of perceived ghost liquidity in that, if you entered an order manually, the order book changed very rapidly and you didn't get to execute all or any of your order."

Rosendahl says that 'ghost liquidity' is not really an issue in the Nordics.

"We haven't really had, I would argue, an issue with ghost liquidity in our markets. And naturally, we constantly monitor that in terms of the market surveillance role that we have. And we definitely are proud of the tools and processes that we have for our surveillance," he said.

Sandhagen says the problem of so-called ghost liquidity is not merely in people's imagination. "I totally agree that it's not just a perception that there's ghost liquidity. I'm aware of it myself when they enter an order that actually changes," he said. "I agree the perception of ghost liquidity is a real phenomenon."

Sandhagen, however, said that the local market is making its adjustments. Mutual funds don't trade as much, but the local brokerage firms have increasingly understood the fundamental changes in the marketplace and are essentially acting in the same way that HFT firms are acting. "Perhaps people are getting a bit used to it," he said.

Dr Björn Hagströmer, from Stockholm University's School of Business, takes issue with the term itself.

"I don't think 'ghost liquidity' is a well-defined term. I think of it as 'limit orders that are cancelled quickly'," Hagströmer said, adding: "It's a natural part of high frequency activity, to post many orders and to revise often and that involves fast cancellations."

Market making strategies, he said, rely on prices being quoted continuously at multiple volume levels. "So it's natural for them to revise orders all of the time. And for someone observing from the outside who can't see what is going on, that looks like noise."

Hagströmer is the co-author of a recent paper on HFT diversity that uses data from NASDAQ OMX to compare market-making and "opportunistic" HFT activity. He said his research is unlike other HFT studies because he and his colleague Lars Norden were able to look at the activity of each individual broker rather than pools of data that lump everything together.

To determine which firms are market-makers, they considered how often they posted the best prices in the market. "And when we're looking for that, we find that it is only a handful of HFTs that are market makers according to our definition. There are many more that are doing HFT strategies," he said.

But when they looked at volumes, they found that the minority group of market makers accounted for about two-thirds of volume and more than 80% of all orders. The market makers' order-to-trade ratios were much higher than those of opportunistic HFT players.

While other academics have been unable to replicate this research because they haven't had the data, Hagströmer said there was no reason to expect Sweden would be that much different to other markets in this respect since market making is such a traffic-intense activity.
"One thing that could lead to a difference is that in Stockholm the hidden liquidity is very rare. To hide an order, it has to be worth more than 50 thousand euros," he said, which contrasts markedly with the United States where there is no such threshold. "The hidden orders in the US are triggering a lot of pinging activity, where traders are trying to detect the hidden liquidity. And we don't observe such liquidity tracking strategies in Sweden."

Peter Fredriksson, chief executive officer, Baymarkets

Peter Fredriksson, chief executive officer, Baymarkets

"The hidden orders in the US are triggering a lot of pinging activity, where traders are trying to detect the hidden liquidity. And we don't observe such liquidity tracking strategies in Sweden."

OTC advances

Peter Fredriksson, the chief executive officer of over-the-counter trading platform provider Baymarkets, said the OTC arena is one area where the Swedish market still needs to do a lot more in terms of automation.

"In Sweden -- apart from equity derivatives or equity trading -- it's manual. It's still un-automated completely. The fixed income market is voice based, they don't want to move. Even Finansinspektionen thought that it was unnecessary for the fixed income market to move to electronic trading," he said.

For instance, he noted one client that used the Baymarkets platform that had been struggling to get its clients in the corporate finance area to trade electronically.

Fredriksson said that outside of equities, the Swedish market would probably need something external to make a more serious move into electronic trading. "They need FI, to actually push and say: 'Now you have to go electronic; there has to be transparency, there has to be a record'," he said.

That push looks inevitable as developed OTC markets across Europe move towards transparency and electronic trading. "The whole regulatory change will happen within two years, right? And Sweden has to stay with that time band as well," Fredriksson said.

Like a number of prominent figures in the Swedish trading scene, Fredriksson once worked at OMX, in his case from 1997 to 2000.

"OMX was the first electronic derivatives market in the world," Fredriksson said.

"And in the wake of OMX, you have all these companies." He rattles off a list of firms such as Orc Software, SunGard Front Arena, TriOptima and Neonet, as well as his own.

Baymarkets provides matching sessions, something it also calls "twilight pools". He said his company is getting a lot of interest from banks, with fixed income being the highest priority and commodities not far behind. The idea is to focus liquidity in less-liquid markets on certain times of the day.

So how did Sweden, a country of just under 10 million people, become a country that manages to dominate in so many of the sectors it operates in? In the case of financial technology, Fredriksson said the OMX heritage has played a big role.

"A lot of us have worked at OMX or in the vicinity of OMX," he said, noting how the Swedish exchange was a pioneering player in the sale of trading venue technology.

"OMX were definitely first in the world to do that. And they had great success during the whole of the 90s and early 2000s," he said. "So then a lot of us followed that wave."

swedish flag

Fact file

Average daily share trading value on NASDAQ OMX Stockholm - EUR 2.2 billion in 2013, unchanged from the previous year

Average number of trades per trading day in 2013 was 322,538, up from 310,219 in 2012

Market cap
Total market cap at NASDAQ OMX Nordic Exchange 931 billion euros in December 2013, up 22% from a year earlier

Order-to-trade ratios
OTR in Stockholm in December 2013 was 7, down sharply from around 20 in the summer of 2011 when markets were turbulent due to Greece and US credit rating worries.

Market share
NASDAQ OMX currently has 69% of the market, down from 95% in 2009

Currency appeal
Crown slips two spots to 11th most traded currency in 2013 BIS survey as share of overall market share slips

Central bank
Riksbank is the world's oldest central bank

Sources: NASDAQ OMX, Bank for International Settlements, Riksbank