January 27, 2010
The co-CEO of the Toronto-based electronic trading firm Infinium Group isn’t exaggerating.
A second is now a very long time in financial
markets, thanks to computer algorithms. Traders can gather and interpret
market data, and buy or sell securities in response, in milliseconds
(thousandths of a second) or even microseconds (millionths of a second).
Measured by volume of shares, it is often the
largest single trader of major companies listed on the Toronto Stock
Exchange - more active, in other words, than any of the otherwise dominant
investment dealers owned by Canada’s Big Five banks.
Tchetvertnykh and co-CEO Alan Grujic, who
are both 42, founded the firm in 2002. Unlike old-style investment dealers,
Infinium is a pure proprietary trading outfit - it trades only its own
money, none for clients.
By some industry estimates, these hotshot
dealers - along with Goldman Sachs and some other established firms that
have also jumped into the high-frequency game - now account for about a
quarter of daily stock trading volume in Canada, and as much as 60% to 70%
south of the border.
In November, Paul Myners, financial services secretary to the U.K. Treasury Department, told an interviewer that,
How can management be accountable to investors who change every few seconds?
Thomas Caldwell, CEO of Caldwell Securities Ltd., a mid-sized Toronto dealer that has large investments in the NYSE Euro-next and other stock-exchange holding companies around the world, worries that,
High-frequency traders say that, far from bringing on the apocalypse, what they are doing is very safe and useful.
If they buy and sell almost instantaneously at virtually the same price, the risk of massive losses is tiny. Moreover, they argue that huge benefits accrue to average investors in particular.
More liquidity means anyone can get an order
filled almost immediately at the market price. (The “spread” is the formerly
wide gap between the high price traditional brokers would quote to clients
who wanted to buy a security, and the lower price they would offer to
investors who wanted to sell.)
The meeting place was the CAMI automotive factory in Ingersoll, Ontario. Grujic, who had graduated from the University of Toronto in 1990 with a bachelor’s degree in electrical engineering, was programming and monitoring robots on the plant’s assembly line.
However, he’d decided to go to the University of
British Columbia for an MBA, and was helping management look for his
successor. One candidate was Tchetvertnykh, who had graduated from the Kiev
Polytechnic Institute with a degree in cybernetics in 1990, and had come to
Canada from Ukraine to enroll in the MBA program at the University of
Western Ontario’s Richard Ivey School of Business.
Tchetvertnykh’s father was a physicist and his
mother an accountant. Grujic was born in Toronto, but his parents were from
the former Yugoslavia - his father an electrical engineer who founded his
own consulting firm, and his mother a PhD in psychology. But the duo also
realized that finance, not the professions, was the place to make big money
in North America.
In 2000, he jumped to Merrill Lynch, working
first in London, then moved back to Toronto in 2001 to establish a
Grujic and his colleagues also developed computer models for bond pricing. Most bond trading was still done over the phone in those days, but the models could instantly compare the price of, say, a five-year bond with the prices at several different points on the yield curve (from one to 30 years) and determine if the five-year bond was rich or cheap.
Hobnobbing was an education, too.
In 2000, TD moved Grujic to Tokyo, where he
traded even more complex options and derivatives, essentially creating new
The enfranchisement of Instinet, Island, Archipelago and Brut meant competition for the NYSE - fast, technologically advanced competition that allowed just about any sizable trader to place orders directly in the market, rather than route them through investment dealers that held seats on the NYSE.
There are now dozens of electronic marketplaces
in the United States alone, and only about 25% of all American stock trading
is routed through the NYSE.
Capturing the spread ($125 on even a small
retail order of 2,000 shares) had been a reliable source of profit for
traditional brokerage firms for decades, and for a mini-invasion of
individual day traders in the 1990s. But with decimalization, bid-ask
spreads shrank to less than a penny overnight.
Through all their early postings, the two men had stayed in touch, and talked a lot about launching their own business together someday. That someday came in 2001, when Merrill Lynch sold almost all of its operations in Canada to CIBC. Tchetvertnykh didn’t want to work for a bank, and Grujic was getting restless in Tokyo.
As well, both men had recently married, and they didn’t want to raise families in hectic international financial capitals.
The duo still weren’t sure exactly what the business would be, however.
At first they thought of opening a boutique brokerage firm, like Toronto-based GMP Capital, but,
Although the advent of wafer-thin spreads knocked traditional brokerages for a loop, and wiped out day traders, Tchetvertnykh and Grujic figured there were lucrative niches in the market for new proprietary trading firms.
So, in 2002, he and Grujic founded Infinium with $1 million of their own money.
Off-the-shelf computer hardware was readily
available. The hard part was writing the software from scratch - even for
two engineers with a decade of high-level experience in global markets.
In practice, that means that a high-frequency firm might continuously offer to buy or sell a stock. If, say, a traditional brokerage comes in and accepts that offer, it pays the fee. The fees and rebates are tiny - say, 0.003 cents a share for liquidity takers and a rebate of 0.002 cents per share to the liquidity provider (which means the exchange covers its costs).
But if you collect rebates on a few million
shares a day, they do add up. The same goes for capturing bid-ask spreads,
which have been whittled down to fractions of a cent on major stocks, but
still can be realized.
Infinium runs about a dozen broad strategies at any given time.
Before Infinium could get its systems running, Tchetvertnykh and Grujic had to spend months programming in risk controls, record-keeping functions and tests for compliance with regulations.
On any one trade, says Tchetvertnykh, there are
dozens of automatic checks within about 20 microseconds.
There are some patterns and anomalies that only
savvy traders who monitor the algorithms can spot. One Infinium trader in
Toronto who specializes in European stocks and currencies, watches 22
computer screens throughout her working day.
Infinium opened a U.S. subsidiary in 2005, and
Grujic moved to Marin County, north of Silicon Valley. Good call: Revenue
climbed to $13 million that year.
That’s still small: The full-service investment banking divisions of several Big Five Canadian banks each generate more than $1 billion a year in revenue.
And privately owned Getco LLC, one of the largest U.S. high-frequency trading firms, employs more than 200 traders, and earned an estimated profit of $400 million (U.S.) in 2008.
Grujic and Tchetvertnykh say Infinium’s next step is further geographic expansion.
The London office, which opened in 2008, gives them a beachhead in Europe, and they’re looking at other countries around the world. Yet they aren’t certain how big Infinium will get.
Grujic says that,
Tchetvertnykh says he’d at least consider going public.
He’d also consider selling out - he points out
that Citigroup paid $680 million (U.S.) for South Carolina-based Automated
Trading Desk LLC in 2007.
High-frequency traders argue that regulators
will first have to find problems, and so far, there don’t appear to be any.
In a study of high-frequency trading in Canada published in September, New
York-based Investment Technology Group Inc. made the same argument as the
Infinium principals that their kind benefit the market: Bid-ask spreads and
share-price volatility in Canadian stock markets is down over the past two
years, and order depth - which measures share availability - is up.
Much of the impact has been obvious:
The CIBC traders also say they believe that high-frequency traders,
But critics like Thomas Caldwell say that such overall numbers don’t tell the whole story. They question whether high-frequency traders are providing “real liquidity” to the market. In fact, argues Caldwell, high-frequency traders are also removing it.
How? Large institutional investors know that if
they start trying to push through a large block of shares at a certain price
- even if the block is broken into many small trades on several ATSs and
markets - they can trigger a flood of high-frequency orders that immediately
move market prices to the institution’s disadvantage. (This is the source of
the “frustration” mentioned in the paper by the CIBC traders.)
But the dark pools mean that “all the big orders
are now sitting somewhere else.”
Exhibit A: the investment bank Bear Stearns, which folded after its share price plummeted in March, 2008, even though then-SEC chairman Christopher Cox assured the markets that the firm was sound.
Gripes like Caldwell’s make Grujic chuckle a bit.