It is fashionable to blame the events of May 6 on the New York Stock Exchange, when intra-day trading sent blue-chip names like Proctor & Gamble into the ranks of penny stocks, on high-frequency traders and their electronic algorithms.
Although the precise confluence of events that caused the 'flash crash' have yet to be mapped out, industry insiders say that regulators and society, instead of demonising them, should take May 6 as a wake-up call. The crash wasn't caused by the nefarious activity of flash-trading quants. It was caused by their withdrawal from the market.
Today, 70% of NYSE turnover is due to high-frequency traders (HFT). The numbers in Asia are lower, but not as low as most people think. Even markets such as Taiwan and South Korea, commonly viewed as inhospitable to flash traders, in fact derive a significant portion of activity from this segment, often via non-deliverable forwards or interest-rate swaps, says one Hong Kong-based brokerage head of electronic trading.
Worldwide, the percentage is expected to rise.
"The number of new market participants, venues for trading and access to data are changing the way people do business," says Richard Brown, New York-based global business manager for Thomson Reuters' machine-readable news business.
Thomson Reuters last week hosted a seminar in Hong Kong to discuss the development of flash trading in Asia post-May 6, which was attended by broker/dealers, asset managers, proprietary traders and hedge fund managers.
Although the infrastructure, tax system and regulation in various Asian markets means HFT has a long way to go to meet the pace and volume it enjoys in America, it is becoming more prevalent. That is partly because there are different ways to define it.
The ingredient that makes such models possible is data, says Weng Cheah, director and regional head of electronic sales and trading at Newedge. The paucity of data for Asian markets has held up quant activity. But over the past several years, enough of it has been collated and analysed.
This is often factor-based data: What, for example, is the correlation between US interest rates and Korean futures? Other data looks at tick sizes and other matters of infrastructure. As the big American flash traders increasingly gather this data, they learn how to operate in Asian (or other) equity markets. This learning allows a growing number of traders and investors to build quantitative, electronic trading models for Asian bourses, and accounts for a growing portion of foreign participation onshore.
Another reason for the growth of HFT activity in Asia, and elsewhere, is that in 2008 when stock markets crashed, these strategies were virtually the only ones still making money, notes Hani Shalabi, Asia sales head of Credit Suisse's advanced-electronic services division.
That has convinced many prop desks and multi-strategy funds that it's worth adding a team dedicated to HFT, as both a hedge and a source of alpha.
The proliferation of players, HFT strategies (the universe is quite diverse) and trading venues in the US conspired to create the May 6 crash. But Tobias Hekster, director of RVT HK, a proprietary trading firm he recently set up in Hong Kong, notes that earlier that day, the market was already jittery. The crash was in part attributable to algos across venues commanding many HFT accounts to pull out. With the flash-trading community running for the exits in certain stocks, a crash was inevitable.
Kokomo Capital's Bastiaan Van Der Reijt says the 'flash crash' demonstrates the service that HFT provides to markets in the form of liquidity. Without such participants, markets no longer support price discovery. Kokomo Capital is a proprietary high-frequency trader of cash equities and futures and is based in Sydney.
Shalabi adds that HFT is getting blamed for making money out of the flash crash -- and then getting blamed for pulling out of the market. "You're damned if you do, and damned if you don't," he says. He says it is inconceivable that a market order in the US doesn't get filled; the intra-day crash was a true demonstration of the market's dependence upon HFT for liquidity.
The good news is that these participants say the regulatory reaction in the United States has been measured and sensible.
Hekster says regulation that creates a level playing field is welcome, not just for its own sake, but because it will stop the demonisation of HFT. He also notes that, whatever new rules are introduced, they won't stop flash trading. They may even encourage it, once traders understand the new rules of the game.
Van Der Reijt says the industry's players will increasingly focus attention on Asia, not because its markets are as big and liquid as America's, but for the reverse. In markets where liquidity is harder to come by, HFT can provide that liquidity, at a premium. For the savvy players, Asia's market barriers are an invitation to get rich.
This suggests that regulators would be wise to allow institutional players to engage in any trading strategies they like, so long as retail investors enjoy some basic protections. The heavier the government's hand, the more inefficiencies it creates -- and the more lucrative means of exploiting loopholes that traders find.
The best corrective to the flash crash? Do nothing. Hekster says it is now going to be virtually impossible for the same type of event to occur in the US. Why? Because in a free market, people learn. They saw liquidity disappear at a time when they could have been paid generously to provide bids. There's a spread to be made for the trader willing to provide some insurance liquidity to the market.
In America, therefore, HFT is rapidly commoditising. The markets are so efficient, that there's not much more than raw speed to give you an edge. In Asia, the right strategy and clever positioning counts for more. That suggests that high-frequency traders have a bright and big future in the region's markets.