Is HFT’s Zero Sum Game Reaching Its Endpoint?

As far as growth and profitability are concerned, high frequency trading is on the decline according to the Financial Times. Industry insiders are expecting a wave of consolidation as firms realize they are reaching a threshold of sustainability and can no long afford the massive overhead needed to maintain trading in milliseconds. Combine that with ever-declining equity volumes, and you have a formula that has seen HFT profits decline for the past five years.

“It’s been a tough market. High-frequency trading companies are struggling [to cope with] a lack of volatility and trading volume, competition and a cost structure that continues to go up,” says Larry Tabb, founder of the consultancy Tabb Group.

While the industry experiences a marked decline in revenues from U.S. equity trading, the shenanigans will continue as firms move into other asset classes and foreign markets. In the meantime, high frequency traders are likely to consolidate, however Tabb doesn’t expect the same consolidation among trading venues. While there are currently 13 exchanges and about 40 dark pools, he says closing those will negatively effect liquidity.

“What we’ve learned is that when you consolidate markets, you hurt liquidity. I’m not sure we’re going to see a whole lot of consolidation of trading venues and liquidity pools. You may just see fewer people on them.”

Curiously, Tabb’s comments come in the wake of a merger announcement between BATS and Direct Edge. Eric Hunsader, of market data specialist Nanex, has been vocal in his belief that consolidating exchanges will actually improve liquidity.

Want to significantly reduce stock market complexity and increase liquidity? Reduce the number of exchanges.

— Eric Scott Hunsader (@nanexllc) August 26, 2013

The charts below from Zerohedge and Dealbook show the decline in GETCO’s revenue and profit since 2008.

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