The Industry Needs to Come Together on Policing Itself When it Comes to HFT

Depending on who you talk to, high-frequency trading is either taking over the entire market, it's stagnant, or the death knell is sounding. Since we write about high-frequency trading, I say let the good times roll...or plummet but then immediately rebound.

On Monday, I read an article in The New York Times citing a Tabb Group estimate that stated that high-frequency trading "only" accounts for 51 percent of average daily shares traded in the US. This is down from 61 percent in 2009.

Then on Tuesday I read an article in The Australian, which is owned by News Corp and touts itself as being a part of The Wall Street Journal, saying that "high-frequency trading machines" account for 70 percent of total trades.

Recently, I moderated a webcast that focused on high-frequency trading and how firms can best build an HFT environment. Toward the end of the discussion I posed this question to the listening audience: To help curb the practice of HFT, what would be the most effective measure? The No. 1 response was "None, HFT is a natural evolution; let the markets decide," which received 34 percent of the vote.

It's not all that surprising that that would be the top answer, as I would have to imagine that most of the listeners were more interested in the art of high-frequency trading rather than the controversy surrounding it. The next most popular answer was implementing so-called "speed breaks" (26 percent), followed by exchange-led punitive messaging rules (19 percent) and a transaction tax (17 percent).

Here's the thing, HFT is going to exist ─ and exist prominently ─ henceforth until the regulators make it impossible for them to exist, which I don't see happening unless there is a catastrophic event. While the May 6, 2010 Flash Crash and the Knight debacle were scary as hell, the markets rebounded quickly each time.

And it also makes sense that HFT has dipped a bit since its zenith in 2009, when it made up 61 percent of trades, according to Tabb, up 40 percent from 2005. Quite frankly, many firms tried to run with the big dogs and found that the cost was great. As Mehmet Yanilmaz, partner at prop-trading shop Myra Trading, noted during the webcast, "The cost of infrastructure is the greatest challenge."

Add to that the difficulties inherent in managing risk, all while trading volumes are down as a whole, in general, and it's logical that some firms to have chosen to shy away from the strategy.

Some protections, which should be detailed by the Securities and Exchange Commission, are necessary in managing the systemic risk that high-frequency trading potentially poses, such as mandatory testing of algorithms and harsher punishment for firms that abuse HFT practices or whose tech glitches jolt the industry. But trying to curb something that is a natural evolution of technology is not the way to go about it.

But the industry itself should be at the forefront in policing itself. Perhaps initiatives such as AT 9000, which is a quality management system for algorithmic trading that is trying to develop quality standards for automated trading, is the way forward.

The one thing that has become quite clear, though, is that the industry needs to join hands and step forward on this, or else an over-reactive regulatory body or worse, Congress, will be forced to step in.