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TRADING SYSTEMS

Peter Van Kleef

CEO of Lakeview Arbitrage

trading systems high frequency trading hedge fund strategy Peter Van KleefPeter Van Kleef, CEO of Lakeview Arbitrage, is currently leading a series of High-Frequency Trading Experts Workshops in London, New York, Dubai, and Hong Kong. Mr. Van Kleef managed significant hedge fund type investment portfolios and quantitative trading departments for, among others, Cooper Neff, Salomon Brothers, HypoVereinsbank and Credit Lyonnais. He has over 15 years of experience in the development and running of sophisticated automated trading operations. He is a frequent speaker on complex arbitrage strategies with a focus on volatility arbitrage and high frequency algorithmic trading. He is also a well-known consultant to the investment community with regards to trading, risk management, operational and strategic issues.
 

Peter talks to FX Trader Magazine about his experience as a trader and explains the main benefits and risks involved in High Frequency Trading.

FXTM

How did you get into High Frequency Trading? Can you tell us a little bit about your background and experience as a trader?

PVK

During my studies, I was doing a stint at Salomon Brothers in the equity derivatives team in Frankfurt, Germany. We were arbitraging the index future against its components in the old IBIS and DTB trading systems, which were some of the first platforms for electronic trading. I was also market making the DAX options. This was in the early 90s. After finishing my studies in the US, I started working for Cooper Neff, which at the time was one of the leading players in the early days of high frequency trading. After that I had stints at DRW and Transoptions. All these firms were early adopters of electronic high frequency trading and at that time leaders in their field. It was immediately apparent that by having superior technology you could gain a significant advantage over your competitors and that you could generate outsize profits without outsize risk. After that, I started working for some larger banks such as Credit Lyonnais and HVB and helped them build up their electronic trading capabilities with the knowledge gained at the early leaders in the field. So I pretty much got in at the starting point of electronic high frequency trading and never looked back.

The speed race you are seeing now is just a repetition of what happened in the late 80s/early 90s when markets first got electronic and I am sure it will end in a similar way. There seem to be cycles in the market.

FXTM

Can you explain what high frequency traders do and how they trade?

PVK

Generally traders in this segment try to analyze the markets faster than their competitors and also exploit opportunities faster than anyone else. There are basically two distinct segments. The first one is where people rely mostly on speed to get trades that, for example, correct mispricing across different markets. Those trades are nearly risk free for the fastest and therefore competition is fierce. The second segment relies more on a strategic advantage by looking at the same data differently or looking at other data such as news in combination with market data. Here speed is still very important but know-how and strategy are at least equally important. As both approaches require the analysis of hundreds if not thousands of securities and their order books in real time, plus potentially other types of information, this kind of trading can’t be done by humans. Computers do all the analysis and also execute the trades. The job of the trader is to come up with the strategies the computers are supposed to run and to help the IT staff to implement them. After that, traders are monitoring the trading and setting the parameters of the strategies. The trader therefore has to be more the responsible and careful type rather than the aggressive gun slinging type of the past. Some IT background also doesn’t hurt. The machine always only trades as good as the trader that designed the strategies and the IT person that implemented them.

FXTM

What are the benefits of HFT for the markets?

PVK

HFT certainly ensures that prices across venues stay in line. Any significant deviation is arbitraged in split seconds. This is of course very valuable, as it ensures that differential pricing gets eliminated fast and people receive fair prices across venues. The second big advantage is that it makes it easier to provide liquidity to the market. If one can adapt prices quicker to changing markets one is less likely to be taken advantage off by, for example, news coming out. Any market depends on liquidity. This is mostly provided by market makers. They are also the early leaders and adopters of HFT as it helps them do their job better. Finally it equalizes opportunity. Electronic trading levels the playing field as connections and relationships are far less important than in voice traded markets. The technology is more affordable than ever and small firms can beat large established ones.

FXTM

What are the key risks involved in HFT today? And what should be done to avoid them?

PVK

Key risks are basically poor design of the strategies and infrastructure. Routinely firms that skip on safety and don’t do things properly get carried out of the market. Experience has significant value and getting people involved that have the necessary skills and experience certainly is worthwhile. Making sure that there is no single point of failure and starting small and in a controlled environment is also important.

FXTM

Why is there such a controversy surrounding HFT in the markets today?

PVK

Because it’s always nice to have someone to blame to raise one’s profile, especially when most people don’t understand the subject matter. It’s very easy to point the finger when someone doesn’t have a large lobby group. It’s always been in fashion to blame people with superior knowledge and technology for the evils in the world. People are always afraid of things that are new and that they don’t understand. HFT has been around for around 20 years. So if it would be really that bad, it should have made the same headlines before.

FXTM

What does it take to get into the high-frequency trading space?

PVK

Not much, these days you can get a brokerage account that gives you an API you can connect to with a minimum deposit of around 2K USD and you can download an open source engine like Marketcetera for free to get you started. Of course there are serious limitations to what you can do with such a low cost setup but it can get you started on a platform that can grow with your skills and needs. Going forward, you will see university students and even people from high school starting in algo trading from home. Even if you want a state of the art setup, it doesn’t need to break the bank. HFT trading has become affordable for almost anyone.

FXTM

What are the most profitable used HFT strategies?

PVK

Anything where people look at data that the competition doesn’t look at and that look at data differently than other people. Furthermore simple strategies. The most complex ideas rarely fly.

FXTM

Is it true that the winner, in other words, the fastest, takes it all?

PVK

On pure speed competition yes, unless the fastest is on the toilet or on vacation. Then number 2 has a chance. But most leading HFT firms don’t make their money because they are the fastest. Their strategies are smarter than the ones of their competitors or slightly more aggressive when it counts.

FXTM

What is the most important factor to reach speed: software - meaning the coding of the algorithms-,
hardware, or proximity to the order flow?

PVK

If you want to be a serious contender for the fastest slot these days, you have to implement things in hardware and plug it directly into the exchange with response levels pre-calculated so that your system does only execute binary comparisons.

FXTM

HFT is an extremely profitable business. Does this come mainly from the fact that HFT computers can see both some of the order flow and institutional flash orders?

PVK

No, not really. If you trade via a fast computer you exclude any human from competition. So that’s already a lot of people. If you then look for small but almost certain edge and scale such strategy across many underlyings and markets you make a lot of money with little risk. That’s where the juice is. Analysis of market microstructure and behavioral finance are areas with a lot of opportunity. Flash orders are only a small piece of the puzzle.

FXTM

How is HFT doing in the Forex space?

PVK

Forex has the drawback of very few liquid pairs to trade. The liquid pairs are of course crowded by a lot of players. Forex is an interesting market through the fragmentation and different time zones. Understanding of market idiosyncrasies and market structure are important.

FXTM

Are there profitable HFT strategies or players in the Forex OTC market?

PVK

OTC and HFT are a bit of a contradiction. If a trade is real OTC, so negotiated over the phone rather than a trading system or platform you can’t really call it HFT.

FXTM

How do you achieve speed in an OTC market without a central exchange?

PVK

If your definition of OTC is that of different proprietary bank platform, of course there is edge as there is always one provider that is out on the others. Exploiting that is not a very well received strategy of course by the price providers. If you want to take maximum advantage, you need to connect to as many platforms and price providers as possible to create your own synthetic central marketplace.

FXTM

Will sophisticated retail traders be able to develop HTF forex strategies and models?

PVK

That’s already happening. In no other market do retail guys get 400 to 1 leverage. So that’s very attractive if you have limited capital, especially as currencies have been very volatile recently.

FXTM

For a trading system developer, what are the differences between building a high-frequency trading system and a lower-frequency trading system?

PVK

If things go wrong, they will most likely go wrong fast and in size. So safety is paramount. That’s not so much the case with lower frequency trading as a human could always intervene after the first one or two bad trades or even before the first one, depending on frequency. In HFT, that is often not possible.

FXTM

During the month of October you will be holding various workshops in London, New York, Dubai and Hong Kong. What is the objective of these workshops?

PVK

Mostly to educate people about the subject matter and dispel some of the myths surrounding the topic. Also a main objective is to give people the necessary information to build a state of the art algo operation from scratch and how to avoid the main pitfalls. To show people options with regards to strategies and systems.

FXTM

What will be the major benefits for those who will attend?

PVK

To get a thorough understanding of the subject and how to master the challenges when getting into the game. For people that are already active in the field, the courses should also give some food for thought on how to improve one’s setup.

FXTM

How do you see HFT evolving in the future? Do you believe that most hedge funds and money managers will incorporate HFT strategies into their own trading?

PVK

Not most. It actually depends on your definition of HFT. What is medium frequency trading now was ultra high frequency trading 15 years ago. Many institutional investors have a fairly long term horizon and it will take them a long time to understand that some high frequency techniques can benefit them greatly. At the moment many consider it a fad that will pass and therefore don’t engage in the topic. That’s a mistake but then again, the markets are usually a means for wealth transfer from many to few and not the other way round.

FXTM

Would you like to give any specific advice to anyone considering getting into HFT?

PVK

Spend enough time learning about the subject. Learning lessons the hard way by trial and error can be expensive.