How to beat high-frequency traders

Just when Australian regulators thought that the heated debate about the risks of high-speed trading in Australia had died down, up comes Michael Lewis’s new book, Flash Boys.

But unlike in the US, where Lewis says traders are using high-speed computer systems and mathematical algorithms to prey on everyday investors, the Australian marketplace is claimed to be a lot different.

The Australian Securities and Investments Commission released a lengthy report last year, which examined the impact of high-frequency trading and found that the vast majority of concerns were being “overstated.” It has since put out new rules and guidelines that aim to stamp out market manipulation, including so-called front-running of selected client orders in dark pools – that is, away from trading on public stock exchanges.

Still, some investors remain wary of the risks of high-frequency trading and say the practice provides little benefit to the market and enables brokers to charge for liquidity that they do not provide.

Trade execution firm BestEx’s founder and director, Phil Weinberg, has compiled six practical tips for dealing with HFT in Australia, aimed at helping investment managers trading domestic and/or international equities.

■ 1. Ensure that you have a basic understanding of the types and strategies of HFT, the way different brokers rout orders, the brokers that facilitate HFT in their dark pools and the impact of trading with HFT on your performance.

■ 2. Execute exclusively through “smart” brokers and use tools that specialise in searching for liquidity without signalling your intentions to the market. HFT will prey on the most vulnerable managers and brokers.

■ 3. Avoid submitting round lot orders that signal to HFT the presence of a human operator. The size of each order placed into the market should be randomised.

■ 4. Avoid giving volume-weighted average price (VWAP) or participation rate instructions (that is, “percent of volume” or “over the day”). These types of orders follow a predictable trading schedule and are easily picked off by HFT. Instead, determine the optimal execution that fits the prevalent market conditions.

■ 5. Consider other ways to pay brokers for research if their execution methods are harming your performance.

■ 6. Choose trading venues that incorporate smart matching engines that benefit you more than the venue operator or other participants.

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