How are changes in the HFT landscape impacting IT needs?

By Darren Watkins | 17 March 2016

The stock market and high frequency trading (HFT) have long been the subject of great interest, likely due to their potential to create fortunes in a matter of seconds.

In layman’s terms, high frequency trading is a type of algorithmic trading characterised by high turnover and high order-to-trade ratios. Specifically, it is the use of sophisticated technological tools and computer algorithms to rapidly trade securities.

Historically, the world of high frequency trading (HFT) has been shrouded in mystery, with few people outside the industry understanding what they do or how they operate. In fact, most HFT companies operate in complete secrecy with names unfamiliar to anyone except the employees themselves or the exchanges on which they ply their trade.

However in 2014, Michael Lewis’ Flash Boys lifted the lid on what businesses operating at this end of the equities markets have been doing, shedding new light on this industry but also sparking FBI investigations and comment from the New York Attorney General in the process.

The state of HFT today

High frequency trading has again been under considerable scrutiny in the past year, including a recent announcement from the UK Financial Conduct Authority that algorithmic and high-frequency traders will now be regulated by the watchdog’s certification regime.

Although HFT has traditionally been very popular – accounting for over 70% of trade volumes in 2010 – it has since dropped to below 50 per cent after 2012, indicating a shift in the financial trading landscape.

As a result of the financial crisis, large institutional investors have decided to err on the side of caution, relying less on HFT techniques in favour of longer term trading strategies driven by Smart Order Routing (SOR) principles. This is because SOR principles are seen as more stable, and thus a safer bet.

How can IT systems be optimised for Smart Order Routing?

While high frequency trading focuses on second by second transactions, and is reliant on technology to trade huge volumes and move in and out of trading positions in fractions of a second, SOR does not. Unlike HFT, SOR algorithms don’t rely on the micro-second activities of the HFT world and instead use programmatic strategies to take longer term positions in securities markets, which are also more widely used in multi-asset classes.

This has important implications for the IT systems used by companies involved in financial trading. Rather than the close proximity to trading exchanges essential to HFT, SOR techniques rely instead on deterministic latency connections, which are more cost effective than those used by HFT, and don’t need to be so close to the exchange.

With this in mind and given the distributed nature of the asset classes across the London metro footprint from Slough, through the City and the Docklands, a data centre located within the M25 can just as efficiently offer the low latency connections required to access all the necessary exchanges in a colocation environment. Furthermore, a data centre located within the M25 can do this at a fraction of the cost of the ‘finance eco-systems’ which data centre operators promote at a premium cost.

Choosing the most cost-effective IT for trading systems

It’s true that HFT systems located at exchange locations offer the ultimate performance at a premium, but it is unnecessary for trading firms to operate all of their strategies and back office functions from a premium priced location when they do not all require it. This is an unnecessary cost, which could be better spent elsewhere.

In fact, not only can significant cost savings be made by adopting a distributed IT deployment, but this also comes with the additional benefit of increased resilience as a result of using multiple sites.

With the rapid changes in technology at every level of the IT stack, there is value in challenging the traditional ‘all eggs in one basket’ deployment models of the past. Many of these deployments were implemented because of the belief that it was simpler to keep everything together – a sales and marketing message supported by some data centre operators to their own benefit.

The future of IT for financial traders

As scrutiny increases on financial trading within the UK and globally, traders across all asset classes are becoming more accountable for their operations.

As trading floors disappear in favour of electronic trading platforms, IT infrastructure is swiftly becoming the backbone of the financial trading industry. It is crucial that managers are able to cut through the hype and make informed decisions on which applications will sit in which location and why.

If all data does not need to be stored in a premium-priced location, is there a better, more efficient and more cost effective solution out there? In 2016, the answer is always yes.

By Darren Watkins, Managing Director, VIRTUS Data Centres.

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