Increasing costs for infrastructure, tighter regulation and relentless competition erode profits from high frequency trading. The growth momentum seems to have reached its limits.
Thanks to advances in trading technology, trades can now be executed in micro-seconds and computer algorithms can be used to make investment decisions, submit orders and manage portfolios. Submitting orders and cancelations rapidly, i.e. high frequency trading (HFT), has widespread on equity markets and the market share of HFT has boomed over the last ten years. Electronic market making, such as done by high frequency traders, has become an integral part of markets.
While HFT was on a rise prior to the financial crisis, its market share eroded after the crisis. In Europe, the market share of HFT reached its peak in 2010 with about 40 percent, while in the US, it reached its highest level of about 60 percent in 2009. Since then, the market share has fallen to about 35 percent in Europe and 50 percent in the US. According to Deutsche Bank Research, this is due to numerous factors: First, revenues and profits of HFT trading have decreased due to higher infrastructure costs and competition. Second, alternative trading platforms emerged and third, forthcoming regulation hinders the industry.
Overall, the revenues of HFT firms have fallen from 7.2 billion USD in 2009 to 1.3 billion in 2014. Increasing competition has forced some companies out of the market and let to trading companies disappearing faster. With more competition, price disparities across venues, a source of profit for HFT strategies, are exploited faster and balanced are quickly. Thereby, arbitrage opportunities have become scarcer in the past years. Moreover, in fierce competition, the trader with the fastest trade execution has a competitive advantage. Therefore, HFT firms need to invest in the latest and fastest infrastructure - requirements that erode profits. Overall, average profits per share traded have halved from a tenth of a penny in 2009 to a twentieth of a penny in 2015, says Deutsche Bank.
Another challenge for HFT is the advancement of alternative trading systems, which bring together buyers and sellers outside of registered exchanges. Such allow investors to trade large volumes without altering the price of assets and thereby guarantee pre-trade anonymity as the price is only reported publicly after the trade. By now, there area around 40 of such dark pools in the US and 15 in Europe. While high frequency traders are not per-se looked out of these market trading about 40 percent of all stocks in the US, they are rather active on platforms for small trades and not on those designed for trading large blogs of shares. With growing dark pools, HFT are thus losing an opportunity to apply their strategies.
Finally, policy markets in the US and Europe started to focus on HFT regulation and oversight, for example by imposing stricter regulation on exchanges and trading venues using automated trading by means such as artificially slowing down order speed, preventing high rations of submissions and cancellations or increasing risk controls. This again has negative impacts on HFT strategies.