PeterNabicht HFTR

The High Frequency Trading Review
Information and Commentary on High Frequency Trading and Algorithmic Trading

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HFT Case Study Allston Trading
An Interview with Peter Nabicht

By Mike OHara, 7th July 2011 In this interview for the High Frequency Trading Review, Mike OHara talks to Peter Nabicht, Chief Technology Officer at Allston Trading (http://www.allstontrading.com/), a proprietary high frequency trading firm headquartered in Chicago, IL. Peter joined Allston in 2004, began a state-of-the-art real-time operations desk to support trading activities across multiple asset classes, headed up technology on the Short Term Interest Rates, and became CTO of the firm in 2008. HFT Review: Peter, could you give us some background on Allston Trading? Peter Nabicht: Allston is a principal trading firm that is engaged in some high frequency trading, but like a lot of principal trading firms that do HFT, it is not our only focus. We started out primarily because trading on the exchange floor was too slow, there were times where you would be trading in the pit, trying to let somebody upstairs know what you did so they could hedge your position, but by that time it was too late. So when the CME first started to go electronic, our founders started up the company and now, eight short years later, we are on fiftyplus endpoints around the world and were in almost every asset class. Just like a lot of companies similar to us, we like to be centrally cleared. We like minimal counterparty risk and we like electronic exchanges with central limit order books. So we really don't do much OTC business. We trade options, equities and primarily futures. We started in and work primarily with futures. Its funny, I've been reading all these articles in a variety of publications about high frequency trading, saying the next big thing in HFT is futures and I want to call up the authors and tell them Futures has had HFT for years! HFTR: Would you classify Allston as a market maker?
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2011 Voices in Business Ltd

PN: We do make markets but there are a lot of misconceptions out there as to what a market maker actually is. You have situations where youre making markets on one product on one exchange, you get filled so you have to go to another market to get your hedge off. Just because I'm acting as a taker in my hedge market doesn't mean I'm not a market maker on another. As an industry we have to stop looking at products and markets and asset classes as unconnected entities and start looking at the whole of the global market as the interconnected system that it is. So I prefer not to classify Allston as solely a market maker - even though we do make markets because we occasionally take them, whether for hedging or for some other reason. Primarily we see ourselves as liquidity providers. We might not always be on both sides of the book but more often than not were resting orders. If we have a spread between products for example, we like to rest one side of the spread in each leg, but that might look like only one side on each market, which will immediately make us not count as market makers! Its hard to classify so I'd say liquidity provider is a better way to put it. HFTR: You said that Allston does a good deal of high frequency trading. Can you give us a quick definition of what you would class as high frequency trading? PN: I like to classify high frequency trading as strategy-independent. I think the best definition of high frequency trading is putting on and taking off positions so rapidly that it's really only made possible by using current technology. A lot of people, whether it be the press, regulators or legislators like to talk about the high frequency trading strategy. But HFT is not a strategy; its a means of execution. Its not a trading strategy, it's a business strategy. Its how you want to go about doing business, how you want to execute your trades and how you want to go about making money, but it is not in and of itself a trading strategy. That would be like saying, that pit trading strategy, or, that long term investing strategy that all those mutual funds run. None of those are accurate statements.
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HFT is a way of running any number of strategies. In fact, any company engaged in HFT worth its salt runs scores of strategies. Some of which may be considered high frequency and some not. At Allston, we're always looking for new strategies. I was recently at a US university, talking to a group of kids coming out of graduate school who were looking for jobs in the industry. I suggested to some of them that they should look at becoming quantitative analysts for high frequency trading companies. And it surprised me how many said things like well I haven't been doing that because they have their strategy and they already do everything so what role is there for me? We need to educate people that there isn't just one strategy here. This misconception will go away the more those engaged in HFT talk about it in straight forward and meaningful ways. HFTR: But would it be fair to say that some strategies are only possible through HFT, that there are some strategies that you would not be able to deploy unless you had a HFT infrastructure? PN: Yes, I think the best way to describe it is that high frequency trading lends itself to a lot of strategies, that it improves them. It helps you find an edge within a strategy that may or may not otherwise be possible, but it's no more influential on a strategy than the market structure for example. Actually, low latency is really what makes some trades possible. And a lot of companies wouldn't go down the low latency route unless they were also doing some high frequency trading. Developing a low latency platform is a huge investment of time, people, and money. In order to do so you need to have some consistent profitability from strategies you run, whether HFT or not. It just so happens that HFT requires low latency, so you see the two go hand-in-hand a lot. But speed isnt always the most important factor. I remember running a trade for a while on the energy desk, a very basic spreading trade, between the physical and the cash delivered crude. We automated a trade that one of our guys was running by hand (point-and-click). Then we ran them side by side. Guess what? He was consistently making money when I was losing money. When we looked into it, we discovered he was actually making money because he was slower. HFTR: How could that happen?
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PN: Basically the automated trade was to immediately process every tick of those choppy markets and it was dumping position at our slippage tolerance. But when trading manually he wasn't able to see every tick update and react to every little move so he was missing the market going against him and getting filled on his hedge when the market was coming back. He wasn't dumping as quickly, and that was working to his advantage. Some might say he was more risky because he wasn't reacting fast enough and some might say he was more profitable because of it. Getting back to the point, low latency makes some strategies possible, but it isn't a necessary expense for other strategies. I think it's just how people want to focus on trading. I refer to pit trading a lot to help point out that high frequency trading, or low latency trading, is just the next step, or at least part of the next step. High frequency trading doesn't make trades any more possible than being on the top step of the pit and having a louder voice makes certain strategies possible. HFTR: What is your typical holding period for a trade? And do you ever hold positions overnight or are you always flat at the end of the day? PN: We don't hold anything that isnt hedged overnight, but were trading different products. You might be able to hold something with minimum risk but you're paying money to hold that position overnight and that hurts your efficiency. It's hard to say what our typical holding period is, because FX is different than equities, which are different than futures, which are different than spreading strategies, which are different than options. With options, you might be holding stuff for weeks, that's not to say that your greeks aren't fine and you're pretty much hedged, but you do have positions on for a while. We've got spread trades where the front month of the future is traded against five years out, where the holding time for the long-dated trade is a lot different than the front month. I guess you could say that our holding period is as short as the market and profitability will allow. In a very liquid market, its seconds or less, in less liquid markets it would be minutes and in the far out markets it's hours or more.
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HFTR: You mentioned earlier that most of what you're doing at the moment is in futures but you trade cross asset, so youre trading options, equities, FX, and I guess various other instruments. How typical a high frequency trading shop would you say Allston is? Are you fairly similar to other prop trading HFT firms, or is what you're doing pretty unique? PN: We are all different but all the same. We have different directives and ideas on the market but when you look closely, we all the have the same base. We all have the very fast prop trading groups, we seem to have the same goal, which is to put together a company where you can very, very efficiently execute in the market and your efficiency is such that it allows you to make less profit per trade because you are making so many trades you make it up in volume. And that efficiency is in everything. It's not just in the speed of communicating with the markets or the speed of making decisions. Everything is about being more efficient. The efficiency is in things like your personnel: why have ten people do a job that five really good people can do? Certainly we need to execute with incredible efficiency because that allows us to make less per tick gross and still have good net, and it also allows us to trade a lot. So we're all similar in that regard but we all differ in how we do it. A lot of New York companies are very equities and options centric. The Chicago companies tend to be more futures centric. That makes sense, we all know the CME. Half the companies here have ex-floor traders; it's the market they knew. Were all similar in our quest for efficiency, but the other differentiators that come into play are culture, and what your end goal is. If your end goal is to start a hedge fund and to have a lot of assets under management, you might have a high frequency trading shop that's part of a large hedge fund. Some companies don't want to take on customers; they just dont want to deal with that. It really kind of depends on the stage in the life of the company, what the actual goal is and how you go about doing business.
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HFTR: HFT seems to be getting more cut-throat and the margins seem to be getting smaller and more difficult to capture. How does an HFT firm keep and maintain its edge in that environment? PN: Never stop improving. The second you sit down and you say well, we're good enough, thats when you lose your edge. Good enough lasts a day. I like to compare trading to sports, and over here weve all been watching the NBA finals. If LeBron James woke up tomorrow and said, I'm the best in the world, I'm good enough, next year he wouldnt even be close to the best in the world. The only way to maintain your edge is to keep improving. That means always improving personnel by getting new people, by training the current people, by having an incredible culture so your people aren't burning out. Always looking at the next technological step. Always looking at the next cost efficiency you can make. Its interesting that the two biggest expenses for high frequency trading firms (or for any firm that does any low latency trading), are personnel and technology. If you look at most businesses, what do they do if they need to cut expenses? They cut staff and they don't necessarily improve their technology, they go into maintain mode. With high frequency and proprietary trading, we cant do that. If we cut people (or stop hiring good people) then we lose the intelligence and our ability to work in the market. And if we just go into maintain mode in our software, we lose our edge. So we've got to find the efficiencies elsewhere. We always have to figure how to make more money to maintain our edge. It boils down to that one thing, never stop improving. HFTR: Recruiting (and keeping) the right people in this space must be quite a challenge. Are there any particular skills and talents you look for? PN: Yes, you can always find people who really know their stuff, in terms of programming languages, technology etc. It isn't easy but it is possible. So having people with those skills in and of itself doesn't give you a lot of edge. They need to be self-driven. They need to have an innate interest in learning exactly how something works and then how to push on whatever it is theyve learned to make what they work on better.
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If I get a resume from someone right out of school who did the same projects as everybody else, that doesnt mean much. With most resumes I can guess the school the person graduated from. But if I get a resume from someone who worked on an open source project or started their own business or did their own research on something, that will jump to the top of the pile. On the trading side, if I see people coming right out of grad school who've already started a business when they were in school, it might not be very applicable to trading the markets, but it shows that they are motivated to figure out how something works and to push forward with something and make it work for them. I also want to see people who understand working in a team. I don't mean that in a very generic kind of management school sense that we're all a team. I mean the technologist who realizes, I understand technology left and right, but I need a really good trader who understands the market, or the trader who says, I know that I have this trade idea but I also need to understand how these areas interplay with market microstructure, so I need somebody who really knows the rules and regulations to help me drive it. You need people who have this balance of knowing what they are the best at but also knowing what theyre not the best at, and that's very difficult to find. HFTR: Moving on to the topic of risk. What do you see as the main risks your firm faces, and how do you manage those risks? PN: Almost all of our business is on exchange, which reduces counterparty risk. As we saw two years ago, a main cause of our economic crisis was counterparty risk, its huge and almost impossible to completely quantify. Exchanges are great because there is (almost) no counterparty risk. But like all trading, I think the biggest risk is market risk. You don't know where the market is going to go. You cant always be right, you just hope to be right a majority of the time. I think technical risk is also big, for example if a line goes down. When the S&P started falling during the whole portfolio insurance days, the crash of October 1987, theres some great stories of guys trading in the pits and they run to the phone and they call their broker in New York to get off their equities trade and nobody is picking up the phone.
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HFTR: Indeed, I was down on the LIFFE floor in London in October 1987, I know what it was like! PN: Where people were purposely not picking up their phones, that's very, very similar to the kind of risk we face if we put on a trade at the CME and we want to hedge it with an ETF, but right when we're getting ready to hedge, a backhoe goes through some fiber that's buried in the ground. Thats a kind of infrastructure risk we deal with daily. Granted, it's not unique to HFT, that is something that every trader has to face. Anyone who has to communicate over a large span of space has that risk; it's just more pronounced when you're already making such a slim amount per trade. So weve got that risk, although we do a lot to make sure weve got backup lines and so on. Then there's also capital expenditure risk, which is kind of a new topic for firms involved in HFT. It costs a lot to put these systems together. And youre constantly running the risk of spending the money on the wrong changes or if you're spending the money to make your system better and that doesnt actually help you, you run the risk of really cutting into your profitability. You need to make proper capital expenditures. HFTR: What about regulatory risk? PN: Well I think the SEC & CFTC are net positive in the decisions theyre making generally, theyre doing a pretty good job. Where I see regulatory risk isn't in the intent of the new rules; the risk is in the unintended consequences. There's been a lot of stuff in the Dodd-Frank bill where people talk about socalled toxic trading or malicious trading or predatory trading, but it's all afterthought, its all looking at the historical data of the markets months after the fact and saying if it looks predatory. That's not just bad luck for the person getting blamed, that's bad for the whole of the market. You have to keep in mind that there are a lot of times where a regulator might only have access to certain markets. For example, if a regulator is only looking at the futures market, they might come in and say, you drove down the S&P 10 ticks in half a second, so clearly you're being malicious and attacking the market! But if they're not looking at the ETF, and if the ETF
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naturally fell ten ticks, then theyre not seeing that the trader may actually have added efficiency to the market rather than doing anything predatory! So I think the regulatory risk comes from the scope of data the regulators have and their ability to look at it, but then also this idea of reactionary regulation. The regulators are there to keep orderly markets and to guide the markets, not to have a reactionary punishment agenda. But the way some of these proposals are being vaguely written, I think that could be a risk. You may see people pull out of the markets in some cases because they're not sure how these rules are going to be officiated and regulated. And if they pull out of the markets, that's going to make the markets a little more volatile and we're going to have less liquidity. That's where I see regulatory risk. HFTR: Are there any particular regulatory proposals youre concerned about? PN: Yes. Obligations. One thing that I think is interesting to talk about right now is there seems to be this idea that if youre doing well, if youre successful, clearly theres not enough obligation on you. You often hear people saying, these high frequency traders don't have market making obligations, for example. I'm not too concerned about that personally, because there's other ways to make money than making markets, but it is interesting, I don't think people really appreciate the amount of hard work that goes into making money in the equities markets, putting the technology together, being creative, putting in a lot of time and effort to make it all work. But then the firms that do that work can't interact with something like 35% of the market because it is internalized. That's something that has been concerning me of late. The greater market community mad such a big push for transparency, because transparency in the markets is good, but now it seems to be going back the other way. HFTR: What about the argument that the institutional buy sides, who are investing people's money and pensions and so on, dont actually want too much transparency because they dont like to show their hand and end up with markets moving against them? Dont dark pools help them to shift big blocks and avoid adverse selection?
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PN: Yes, they do but I also think there could be other ways. If you don't want to show your hand then don't show it. People don't have to execute the entire trade at once or in a way that is obvious which is why we are seeing more and more algorithmic trade execution tools on the market. More than dark pools it is the the internalization that gets to me, why not go to the market? It just seems like a hornet's nest, if everybody starts internalizing, then whats going to happen to our markets? HFTR: An interesting question to end on. Thanks Peter.
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The High Frequency Trading Review

Information and Commentary on High Frequency Trading and Algorithmic Trading

HFT Case Study Allston Trading

An Interview with Peter Nabicht

2011 Voices in Business Ltd

The High Frequency Trading Review

2011 Voices in Business Ltd

The High Frequency Trading Review

2011 Voices in Business Ltd

The High Frequency Trading Review

2011 Voices in Business Ltd

The High Frequency Trading Review

2011 Voices in Business Ltd

The High Frequency Trading Review

2011 Voices in Business Ltd

The High Frequency Trading Review

2011 Voices in Business Ltd

The High Frequency Trading Review

2011 Voices in Business Ltd

The High Frequency Trading Review

2011 Voices in Business Ltd

The High Frequency Trading Review

2011 Voices in Business Ltd

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