High-frequency trading (HFT) has become a multi-billion dollar business in the last few years, and it is still growing. Until a couple of years ago, only the big investment banks like Credit Suisse and Goldman Sachs were able to afford the infrastructure required to operate consistently profitable high frequency trading operations. But that situation is changing. More and more proprietary trading firms are now getting into the market.

There are various reasons for this. First, the costs for putting together a high frequency trading infrastructure have come down considerably as exchanges, software firms and service providers have opened up their offerings to a wider market. Stock exchanges in particular are capitalizing on the demand for “co-location”, which is where the trading firms actually house the computer servers running their black box trading systems inside the exchanges’ data centers. They do this in order to reduce latency (the amount of time it takes to send an order from their system to the exchange’s matching engine). After all, when being a few microseconds ahead of your competitor results in the difference between a profitable and a losing trade, the distance between your system and the exchange’s matters.

Secondly, private equity firms, seeing the profit opportunities that high frequency trading can bring, are luring away some of the top talent from the major investment banks to set up quantitative hedge funds that specialize in computerized trading at high speeds.

Whether all of this is sustainable is another question. Regulators are now looking closely at the world of high frequency trading and latency arbitrage (where traders are able to take advantage of getting prices earlier than other market participants) to see if any predatory or manipulative practices are going on.

The whole landscape of the stock markets and equity trading is changing, not just in the US but elsewhere in the world too. Only time will tell whether the changes are for better or worse.

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