High Frequency Trading

What Is It & Should I Be Worried?

Presented by Larry Tabb (Founder & CEO)

World Federation of Exchanges

Cambridge, MA

Nov, 2009

Agenda
What

is high frequency trading does it

Who

Why

has high frequency become an issue

How

does this impact exchanges?

What is high frequency trading?

Wide definition
Firms

leveraging high speed market data and analytics to look for temporal supply and demand trading opportunities. These firms typically are self capitalized and hold positions for very short periods of time (typically less than minutes) Includes
Equity

market making Index arb Options market making ETF arb Stat arb/pairs trading

Narrow and more typically used definition

Equity

market making

Who does it?

Typically
Equity

market makers Proprietary trading shops And a few high frequency hedge funds Many located in Chicago
This

is typically done by self-capitalized firms

This

is market-driven and not PM driven Significant investment in technology infrastructure Not your standard investment strategy

Who trades?
US Equity Share Volume by Market Participant

High Frequency Trading accounts for 61% of Share Volume

Retail, 3%

Long Only, 13% IB Prop, 16%

Hedge Funds, 7% HFT Hedge Funds, 4%

HFT Broker/ Market Makers, 28%

Independent HFT, 29%

Source: TABB Group Estimate

The majority of trading is done by professional traders / liquidity providers

US Equity Share Volume by Market Participant

High Frequency Trading accounts for 61% of Share Volume

Liquidity Providers 4%

28 %

29%

Investors 3% 7%

13%

16%

Investors
Retail Hedge Funds Long Only Investment Bank Prop
Source: TABB Group Estimate

Liquidity Providers
HFT Hedge Funds HFT Broker/ Market Makers Independent HFT

Goal of HFT - first to spot an opportunity & first to take advantage of it

Co-location

Depending upon the firm, the HFT may need multiple locations May also want access to dark pools

Sponsored access

Flash trading
Market data

Direct feed Messaging Low latency time series Back testing tools

High speed analytics

CEP (mostly home grown) to locate trends Execution technology to trade

Why has HFT become an issue?

The floor is empty most trading is done by machines

Electronic Trading Has Caused Steep Decline in Average Trade Size

US Equity Share volume and trades
40,000 35,000
Avg. Shares (m), Avg. Trades(k)

1,600 1,400 1,200 1,000 800 600 400 200 0 Avg Trades Per Day Shares / Trade
Avg. Shares / Trade

30,000 25,000 20,000 15,000 10,000 5,000 0 Avg Shares Per Day (mm)

Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09

Source: TABB Group and Exchange Data

Algos have broken up flow into much smaller executions

Shares by Execution Venue (volume weighted) 2 Year CAGR 07-09
44% 38% Program Desk 12% 11% 11% 14% 9% 9% 22% 24% 31% Crossing Network 15% 11% 12%
-22% -5% 1%

37% Sales Desk

Direct To Exchange

Algorithms

18%

-10%

Source: TABB Group Institutional Equity Trading in America 09/10 Preliminary

2007

2008

2009

Capital usage is down because of credit crisis and advanced trading technology
Percent of Firms Using Capital
% Firms 68%

Directionality of Capital Usage

Up 6%

100%

Percent of Firms Paying More For Capital

84% 67%

Same

63%

Down

31%

Large

Medium

Small

Sales trader flow is declining back to on-trend levels

Percentage of Order Flow Firms Sent to Sales Trader
69%

3 Year CAGR -19%

59% 47% 37%

07-08 +19%
44%

2 Year CAGR -13%

38% 33%

2004

2005

2006

2007

2008

2009

2010e

Source: TABB Group Institutional Equity Trading in America 09/10 Preliminary

Should exchanges be worried?

100%

20%

40%

60%

80%

0%
82 % 83 % 89 % 87 % 88 % 86 % 85 % 85 %

In last 23months, exchanges have lost 20% market share to dark pools and ECNs

Matched US Equity Flow as a Percentage of Total US Equity Matched Flow

BATS / DirectEdge 11% 10% 10% 11% 11% Crossing / 10% 10% 10% 10% 11% 8% 8% 7% 8% 7% 8%8% 9% 9%9% 8% 8% 7% 9%9% 7% 6% Dark Pools 5% 6% 6%6%6% 6% Regional Exchanges
TM

Ja n07 2% 4% M ar 2 5% -0 % 73 3% % M ay 2 5% -0 % 7 2% 6% Ju 7% l-02% 73 8% % Se p - 2% 9% 07 15 4% N % ov 3 14 -0 % % 73 14 % % Ja 14 n- 3% % 08 13 4% % M ar 14 5% -0 % 8 5 13 % % M ay 4 15 -0 % % 84 15 % % Ju 16 4% l-0 % 84 18 % % Se 19 p - 4% % 08 19 4% N % ov 19 5% -0 % 83 18 % % Ja 21 n- 3% % 09 22 3% % M ar 3 22 -0 % % 94 24 % M % ay 25 6% -0 % 9 5 27 % % Ju 27 l-0 6% % 9 6 30 % % Se 29 p7% % 09 28 8% % 59 % 58 % 57 % 53 % 53 % 53 % 73 % 76 % 77 % 76 % 77 % 73 % 74 % 72 % 72 % 71 % 70 % 67 % 69 % 69 % 69 % 67 % 66 % 66 % 62 %

NYSE, NASDAQ, & Arca

Market share of liquidity pools are beginning to converge around 13%

35.00%

US Equity Market Share (includes Internalized) Consolidated NYSE/NASDAQ Listed Equities Jul 2008 Sept 2009
30% 29% 29% 30% 30% 27% 27% 26% 23% 19% 19% 18.00%17.90%18.30% 17% 17.20% 17% 16.40%16.00% 16% 16% 16% 16% 16% 15.10%14.60% 15% 15% 15% 15% 15% 15% 14% 14% 14.00% 14% 14% 14% 14% 14% 13% 13% 13% 13.00% 12% 12% 12% 11% 11% 11% 11% 11% 11% 11% 11% 11% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 9%9% 9% 9% 9% 9% 9% 9%9% 9% 9%9% 8% 9% 8% 8% 7% 7% 7% 7% 7% 7% 6% 6% 6% 6% 5% 5% 5% 5% 5% 5% 4%5% 4% 4% 4% 3% 3% 3% 3% 3% 19.90%20.10%19.90% 21% 20% 20% 20%

25.00%

18.10%18.00% 15.00%

5.00%

08

N ov -0 8

A pr -0 9

Ju l08

-0 9

M ar -0 9

M ay -0 9

Se p08

Ju l09

-0 8

09 A ug -

-5.00%

Regionals

Nasdaq

NYSE

Arca

BATS

DirectEdge

Dark Pools

Internalized

Source: TABB Group LiquidityMatrixTM Exchanges, BATS

Se p09

Ja n0

ec -0

Fe b0

A ug -

Ju n

O ct

Is it worth it?

Benefits

Greater automation Low fees exchange competition Tighter spreads High certainty of execution

Challenges

Finding the needle in the haystack Massive quantities of

Data, IT,& Bandwidth

Greater obfuscation Will benefits remain when only mega-brokers can play?

All of this tilts market toward larger brokers

However Sponsored Access is changing this

Market is becoming more open and accessible (for the technologically advanced)

High Frequency Trading

What Is It & Should I Be Worried?

Presented by Larry Tabb (Founder & CEO)

World Federation of Exchanges

Cambridge, MA

Nov, 2009