The near disappearance of stock market volatility is putting high-frequency traders in a panic, persuading them to pursue new markets.
With each passing week, the VIX, the main measure of S&P 500 volatility, falls to another low. That spelled trouble for high-frequency traders (HFTs) because their businesses are built on profiting from rapidly moving stocks.
The numbers tell the story. Revenues at Getco, a top-tier HFT, fell from $714-million in the first months of 2011, to $399-million in the same period last year. The firm's profits fell 82 per cent.
The reasoning is relatively simple: despite the belief that HFTs are the root cause of erratic markets, they don't initiate volatility or volumes – they just amplify them. In order for HFTs to be wildly profitable, there must already be uncertainty in the market.
And with the S&P 500 above the 1,500 mark, investors are starting to feel much more confident.
Facing this dilemma, HFTs are looking at other avenues, such as foreign exchange and futures trading. This chart from the Financial Times says it all. HFT market share in U.S. equities is falling, but jumped from about 25 per cent in FX in 2008 to an estimated 40 per cent today.
As the FT points out, Getco noted in its recently filed regulatory merger filing that it expects there to be big growth in fixed-income markets for HFTs, and there's the possibility of opening up the swaps market. But even the allure of new assets comes with warnings signs. Getco also noted that average volatility across all of the products it trades – equities, currencies, fixed-income – was at a five-year low in the first nine months of 2012. Sure the VIX fell, but so did volatility for the 10-year Treasury note future, dropping 28 per cent from 2011 levels.
Plus, if too many HFTs pile into a market like fixed-income, it will be hard for many of them to make money and consolidation could be the next wave.
As for Canadian volumes, despite the HFT slowdown, trading levels are slowly returning to their historical averages, according to CIBC World Markets. Traders were in a tizzy for much of 2012 because volumes fell off a cliff, but some perspective is necessary. Volumes shot through the roof in the summer of 2011 – again, uncertainty – and then crashed early last year. Lately they've been recovering to more normal, and calm-inducing, levels.
(Tim Kiladze is a Globe and Mail Capital Markets Reporter.)
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Tim Kiladze