The Story About the ASX, HFT and Dark Pools

Submitted by Marco Palmero on 21 August, 2012 - 22:40

High Frequency Trading

With the advent of technology and competition, the Australian stockmarket has been seeing increased high frequency trading (HFT) and the increase of the use of dark pools.

Alan Kohler in an editorial article about HFT says its "It's robbery a fraction of a cent at a time." Kohler also related the jargon of Dark pools to a "crossing", which is when the buying and selling broker for a trade is the same.

Dark Pools Are Growing

Institutional trades completed via dark pools are growing. The Australian Securities Exchange (ASX) have revealed that trading volumes have been at their lowest in 7 years.

The ASX have pushed for more regulatory intervention to minimise the impact of HFT (and the related issue of opening up competition in clearing and settlement of trades) and dark pools on liquidity on the market. The ASX Chief Executive, Elmer Funke Kupper, has said that the introduction of competition for clearing and settlement would be a "mistake".

High Frequency Trading is OK, Just Tweak It

Reading further into Kohler's article, not all HFT is bad, he flags the "bad" type of HFT as front running and suggests that, the "ASX could go back to only displaying the best bid and offer and removing market depth from the screens, which would throw a spanner in the works of the algorithms."

What is Front-Running, in terms of HFT?

Front-running is when the high frequency trading algorithm would automatically buy or sell ahead of large orders coming in from their clients.

In terms of High Frequency Trading, the algorithms, as part of their black box programming, detect order flow from seeing market depth and put in buy or sell trades ahead of large orders coming in.

They are able to jump the queue because of low latency,the sheer speed and efficiency of the algo as well as the co-located servers give an advantage to these market participants. (Read this PDF if you want to find out more about their co-located servers at the Australian Liquidity Centre at Gore Hill)

Alan Kohler cleverly observes that: "Stock exchanges are innovating themselves to death. The business of matching genuine buyers and sellers of company securities in a transparent, regulated market is becoming a smaller and smaller part of what’s going on."

The question that does keep running in my head is: "What real Impact does HFT and Dark Pools Have on the Market?"

Further Reading: