Why is this article important? We see ones like this almost daily, but this one stood out to me because of the message it conveys. The article states that Virtu Financial will offer to trade on behalf of a handful of institutional investment firms in the second quarter of this year. The company, one of the biggest market makers in the world, has already tested its service with T. Rowe Price Group Inc, with a positive reception. Now, if you’re not familiar with Virtu, all you need to know is that it is one of the most successful high frequency trading and market making firms in the world. How successful? 1 losing day in almost 6 years of trading.
How are they able to accomplish this? Algorithmic trading. They are a pioneer in a subset of algo trading known as high frequency trading, or HFT for short. HFT’s use sophisticated technology and algorithms to trade stocks and other assets at near-light speed. So the message of this article may be startling for those currently not working in the industry. Many have always viewed large banks and investment firms as competitors to proprietary trading firms, while this article clearly shows that this is no longer the case. Why are they working together? Clearly, investment firms such as T. Rowe Price can no longer compete with algo trading firms such as Virtu.
Unknown to most, the technological infrastructure of many banks, clearing firms, and investment institutions is archaic. I’m talking like technology from the early 90’s. No, I’m not joking. Now that may not seem like that big of a deal to some, but considering how rapid financial technology has changed just from the start of the Great Recession in 2009, it’s downright pathetic. It’s like showing up to a race with a Ford Model T when the competition has a Lamborghini Aventador. These firms are characterized by legacy systems, software used for decades that has done very little to keep up with the pace of technological innovation. This is a huge cause for concern, and they know it. Those firms that have failed to adapt are now struggling to cope with current market conditions, and they’ve looked to acquire or partner with innovative fintech (financial technology) firms that have changed the game in order to stay relevant in a changing world.
The rise of algorithmic trading has grown exponentially in recent years, and it’s obvious that some behemoth firms are struggling to adapt. Algo trading in the US and Europe constitutes about 75-80% and nearly 60% of the total trading volumes respectively. Even in emerging economies such as India, algo trading constitutes about 46% of the total volume on the National Stock Exchange (NSE) and over 30% on the Bombay Stock Exchange (BSE). The rest of the world is following suit. Now there’s a ton of controversy as to whether banks, hedge funds, and proprietary trading firms manipulate the markets with these systems. Of course some do, there’s corruption in every industry, but that’s not the point of this blog post. The point is that some large investment houses failed to take algorithmic trading seriously when it was in its infancy. Too few powerhouses of the investment world made the shift to algorithmic trading when they needed to, and this allowed HFT firms such as Virtu to fill that gap and provide value to their clients with their superior execution platforms.
By staying on the forefront of innovation, software companies, hedge funds, and trading groups like Virtu have created a well-positioned niche for themselves that allows them to make up for the shortcomings of their competition. That is what the markets have always been about, competition. Ignore all the technical jargon and controversy about HFT trading that the media pundits barrage you with every day, because the chatter is easy to understand. It all boils down to one common reminder: Adapt or be replaced.
