An Interview with Will Mechem on High-Frequency Trading and Regulation for Speed Traders

Will Mechem, Speaker at High-Frequency Trading Leaders Forum 2011, "How Speed Traders Leverage Cutting-Edge Strategies in the Post-Flash Crash World"Only two weeks before the High-Frequency Trading Forum 2011, Ultra High-Frequency Trading talks to Will Mechem, Managing Director of Pan Alpha Trading. He shares his thoughts on the future of high-frequency trading and upcoming regulation for speed traders. Mr. Mechem will be one of the guest speakers at the High-Frequency Trading Forum 2011, in New York City, from May 23rd to the 25th.

Ultra High-Frequency Trading: How are you involved with high-frequency trading?

Will Mechem: Pan Alpha trades intra-day high frequency statistical arbitrage strategies over U.S. Equities and Futures.  Our holding period ranges from milliseconds to a few hours.

UHFT: Volumes and volatility might decrease in the short term, is there a future for high-frequency trading?

WM: We are convinced that alpha today and in the short and mid-term comes not from skimming fractions of pennies off millions of trades, which by definition requires high volume and decent volatility to generate alpha, but rather from sophisticated quantitative models that can capture and interpret micro changes in price movements and then execute within the high frequency, low latency space.

However, the reality is that regardless of the strategy or holding period, market participants are going to have to become more aware of the latency in their executions to avoid costly slippage.  Anti-gaming algos, execution algos, etc., need to be on a level playing field with market makers and the like to maximize profitability.  This will introduce more sophisticated traders and faster technology in to the space which will re-enforce the cycle of ever faster trading.

From a pure arbitrage point of view high frequency trading is here to stay. By definition there will always be HFT, what has happened is that the technology / methodology / competences needed to make money using HFT have been assimilated and fully leveraged in its full capacity for the big guys.  So there is very little HFT opportunity left for small players or new entrants.

But if you don’t play the pure arbitrage game, and you use some speculative models or a view of the market, knowing that the big players are playing the arbitrage game, and that there are a lot of inefficiencies that big players cannot trade (either by their size or regulations), there are a lot of potential opportunities out there!

UHFT: How do you think the regulatory oversight for the industry will evolve?

WM: Wish I knew. We would not be surprised to see limits put on the amount of cancels per executed trades similar to what the CME does in the futures space. While this could theoretically impact liquidity, the number of actual fills to orders might actually improve.

UHFT: What would you recommend regulators to do regarding last year’s flash crash?

WM: We think the current approach to managing extreme volatility with circuit breakers is the most effective way to limit catastrophic moves in the market without causing market makers and others to assume unreasonable risk through unfair regulations that would require maintaining quotes etc.   The fact that the market recovered as quickly as it did might imply a certain amount of resiliency already existed in the markets at the time.

We think regulators should generate incentives for high-frequency trading to exist. Flash crashes are always going to be possible because there are always going to be supply or demand that is going to “break” the current curve. The only way to accelerate the resiliency of the market is to have more HFT traders.  If the incentives are not there for HFT players, the probability of another flash crash is not changed but the resiliency of the market will be deeply affected.

UHFT: Other than developed markets, how would you rank emerging economies as growth areas for high-frequency trading?

WM: There are a lot of opportunities in emerging markets from a trading point of view.  However, usually the challenges are with the business models of the exchanges.  The rules and regulations of the various exchanges often can make it very difficult to be profitable without being a stock broker on the exchange.

In China, the exchanges are fairly new and the infrastructure is very sophisticated. Plus, the regulatory environment for foreign investors is improving rapidly.  By giving investors the ability to move funds in and out of China through Hong Kong, list foreign companies on Chinese exchanges, and underwrite equity and bond offerings in the Yuan, China is whole-heartedly striving to make itself in to a global financial center.

We are also seeing a fair amount of interest in high-frequency trading from hedge funds and brokerage houses in India. While there are still some technological / regulatory challenges such as messages per second limitations with the exchanges, etc., we think this is temporary.  Also, the overall infrastructure is friendly to foreign investors with favorable offshore tax treatment etc. and the few quantitative funds that are there today are running more traditional systematic strategies. This would seem to suggest a real opportunity for firms with the resources to commit to understanding the intricacies and subtleties of the microstructure and to developing more sophisticated quantitative / HFT strategies, to capture some early alpha before the space gets more crowded.

UHFT: Finally, what would the high-frequency trading community should expect at High-Frequency Trading Leaders Forum 2011?

WM: High-frequency trading remains a very exciting topic and clearly one that will continue to generate some controversy.  We would hope that the participants in the High-Frequency Trading Leaders Forum 2011 would provide some valuable insights that can only be provided by practitioners in the space.  Anyone considering trading today needs to understand what they are up against, regardless of how they decide to execute their trades.

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