High-Frequency Trading: Alpha Discovery and the New Arms Race
First Published Wednesday, 31st August 2011 02:28 pm from Xand : pcurley
The opinions expressed by this blogger and those providing comments are theirs alone, this does not reflect the opinion of Automated Trader or any employee thereof. Automated Trader is not responsible for the accuracy of any of the information supplied by this article.
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alt="high frequency trading arms race" />Perhaps nowhere more
in the diverse world of hedge fund strategies is the prospect of
alpha decay more unsettling than at high-frequency trading firms.
In many ways high-frequency trading firms are now facing a
reality that other hedge funds with more esoteric strategies may
one day face - too much money chasing a finite amount
of alpha.
The End of the Hardware Arms
Race
The latest figures indicate that
high-frequency trading now accounts for somewhere between 60-70%
of trading volume in the US. This is up from around 35% just five
short years ago. High-frequency trading firms, that in the past
have been among the most profitable on Wall Street, are now
seeing that increased competition has crowded out many of their
traditional strategies. High-frequency trading firms have
responded by co-locating their black boxes and by throwing ever
more expensive hardware at the problem. This approach has worked
for some of the larger, better-funded firms, but only postpones
the inevitable.
What will happen when this
hardware arms race meets the laws of physics? The answer is that
many of these firms will need to develop high-frequency trading
strategies where alpha is still relatively abundant and
competition less fierce.
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New High-Frequency Trading Alpha
Opportunities
The two most common
opportunities that high-frequency trading are now exploring are
as follows:
-
Alpha
outside the US - The US was the first to
develop electronic trading, other regions are still in the
process of building out their electronic trading infrastructure.
A recent Credit Suisse study estimated that high-frequency
trading activity accounts for 35% in Europe and only 10% in Asia
(excluding Japan). Many high-frequency trading firms are now
seeking to port the strategies that worked so well in the US over
to these less developed markets.
-
Multi-Dimensional
Strategies - The traditional strategies
of high-frequency trading have typically been one-dimensional
involving the high-frequency trading in and out of a single
large, liquid name. The newer high-frequency trading strategies
are much more complex and multi-dimensional in nature searching
for arbitrage opportunities across asset-classes, geographies
etc.
The New Arms Race and
Cloud-based Market Data
The common thread
that runs through these new strategies is the need for access to
more diverse and dispersed market data sets. Market data
has always been the lifeblood of
high-frequency trading firms. It has also been one of the real
pain points of this industry with the requirement to build out
large infrastructures to manage and query terabytes of
information. This new world of alpha discovery means that
high-frequency trading must now potentially analyze vastly
greater amounts of data to discover opportunities. Furthermore,
the competition to discover these new opportunities will be
intense. In this new world alpha will also be more fleeting as
firms quickly clone successful strategies. The new high-frequency
trading arms race will be all about alpha discovery and time to
implementation.
As the high-frequency trading
industry's search for alpha switches from a hardware focus, to a
discovery/speed of implementation focus, it is clear that firms
with access to large and diverse data sets, that are easy to
query and work with, will be at a distinct competitive advantage.
The traditional method of downloading vast data sets to a
firm's own data center will not work because of the
cost and time delays involved. The only solution that is flexible
enough to assist in such rapid discovery and implementation is a
Cloud-based approach, where small sub-sets of global multi-asset
class market data can be quickly isolated and analyzed. Xignite
is the only firm committed to this vision of large, diverse sets
of Cloud-based data, all made accessible by our easy-to-use web
services, that require no infrastructure, and that can
implemented in a matter of minutes.
As this
new arms race intensifies and the search for alpha becomes
increasingly more desperate we will see more and more
high-frequency trading firms abandon their in-house data
management infrastructures for the flexibility and breath of data
that Xignite's Cloud-based solution offers.
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