The faster a trader reacts to news & events determines how well they perform
Times Live - Sep 27th 2011, 09:26
A recent research paper by the UK government's foresight panel indicated that the number of human traders around the world may drop sharply in the near future. The report said more than a third of all UK trading and nearly three-quarters in the US were generated by high-frequency automated computer programs.
Foord Asset Management's Darron West recently claimed that volatility in world markets was not simply down to sentiment and behaviour. In fact, technology was partly to blame through the involvement of computers programmed to trade according to certain rules and patterns.
West said that while such speculative trading was inherently short term in nature, the first problem was distorted volatility that could distort both value and risk for other traditional investors in milliseconds, making it almost impossible to discover the true fundamental value of a share because of the sudden changes by trading programs purely dependent on price.
Secondly, he pointed out that exchanges were perhaps content to have this status quo because it brought in higher revenues for inflated trading volumes. Thirdly, he argued that computers were assimilating and acting on legitimately obtained information, but faster than any human being could react, giving them an unfair "front-runner" advantage.
Leanne Parsons, chief operating officer at the JSE, said algorithmic trading encompasses a number of different and quite successful strategies and has existed for quite a long time.
"Traders using a particular strategy could input orders over the course of the day, according to certain parameters, and to achieve a desired output. So, algorithmic trading does not always mean the same as latency-sensitive or high-frequency trading."
Parsons said she didn't believe any investor had yet been disadvantaged by the increasing use of technology.
Stock exchanges were not set up to incentivise high-frequency trading, she said. "The more trading activity (value, volume and number of trades) done on the exchange, the more liquidity available in the marketplace for all investors. The JSE thus encourages increased trading activity, as it benefits both investors and the exchange. The JSE believes that parties that employ high-frequency trading strategies contribute positively to overall market liquidity if an exchange doesn't have a billing model that incentivises uneconomic trading behaviour, for example, a maker-taker billing model where the exchange pays the 'makers' to trade in the marketplace. This type of billing model results in a number of trades increasing in the market, however, does not necessarily lead to overall trading activity or real liquidity increasing.
"The JSE encourages increased trading activity through its hybrid, value-based billing model applied to equity market trades. A percentage is applied to the value of each trade, and there is a minimum or 'floor' charge and a maximum or 'ceiling' charge. The JSE has decreased the floor charge to encourage more trades to be put through the market because the majority of JSE trades are at values that will result in the floor charge being applied. The JSE also encourages higher value to be traded in the market by offering a 20% discount on all trade transaction fees when brokerage firms reach a threshold of R15-billion total central order book value traded for the month."
According to Parsons, in 1996, the JSE saw 4000 trades a day. In 2009, that number was up to 80000 a day and, this year, the JSE sees around 15000 a day. A greater volume of trades has meant a drop in the unit cost per trade.
Parsons said retail investors would not be interested in the hourly or daily movements of the share price, nor would increased volatility significantly affect value. "The long-term share price appreciation would be the same, even if there is more short-term volatility in the market, because that price is subject to the fundamentals of the company. Company fundamentals are not affected by an increase in the speed of trading in a marketplace. Generally, since the influx of algorithmic trading activity, market liquidity has increased. The ordinary investor who buys shares for a long-term investment benefits from this type of trading activity, as it has resulted in the narrowing of bid/ask spreads in the marketplace, which results in a better deal, thanks to less costs included in the spread.
"They also benefit from the increased depth in the central order book, as there is more liquidity available for them to trade against. Because of increased trading activity on the exchange, the JSE has also decreased the floor charge over time, which ordinary investors would benefit from indirectly.
"Any uncertainty brings about volatility, and that will always be a feature of the markets. What has become important now is how fast world news is disseminated via the media. A few years ago, everyone seemed to be talking about the decline in importance of the trader. Now they have become more crucial because it's how fast they can react to news and events that determines how well they do. Traders are having to develop a whole new skills set," she added.
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