The hottest new thing on Wall Street is cooling down.
High-frequency trading firms – the lightning-quick, computerized companies that have risen in the last decade to dominate the nation’s stock market – are now struggling to hold onto their gains.
Profits from high-speed trading in U.S. stocks are on track to be, at most, $1.25 billion this year, down 35 percent from last year and 74 percent lower than the peak of about $4.9 billion in 2009, according to estimates from the brokerage firm Rosenblatt Securities. By comparison, Wells Fargo and JPMorgan Chase each earned more in the last quarter than the high-speed trading industry will earn this year.
While no official data is kept on employment at the high-speed firms, interviews with more than a dozen industry participants suggest that firms large and small have been cutting staff, and in some cases have shut down. The firms also are accounting for a declining percentage of a shrinking pool of stock trading, from 61 percent three years ago to 51 percent now, according to the Tabb Group, a data firm.
High-speed trading is far from disappearing from the market, but the struggles facing these firms have been greeted with enthusiasm by some traditional traders and investors who have viewed the firms as formidable adversaries, or worse, market manipulators that create sudden spikes and drops in share prices.
Regulators are still grappling with whether the rise of high-speed firms has been a net benefit or loss for investors, so it is hard to pinpoint what effect the decline of these firms will have on the markets. Many market experts have argued that the technical glitches that have recently hit the market have been a result of a broader trend of the market splintering into dozens of automated trading services and a lack of human oversight.
The challenges facing speed-focused firms are many, the biggest being the drop in trading volume on stock markets around the world in each of the last four years. This has made it harder to make profits for traders who quickly buy and sell shares offered by slower investors.
In addition, traditional investors such as mutual funds have adopted the high-speed industry’s automated strategies and moved some of their business away from the exchanges that are popular with high-speed traders. Meanwhile, the technological cost of shaving further milliseconds off trade times has become a bigger drain on many companies.
Among the firms scaling back is the Chicago Trading Co., which this year earned a spot on a government committee formed to explore the emerging phenomenon of high-speed trading. Since then, the company has been making cuts to its New York office, according to people with direct knowledge of the moves. The company’s chief executive, Eric Chern, said some employees had been moved to Chicago and 10 had left the firm.
He declined to comment directly on the changes, but he did say that “the market environment always plays a factor in all our decisions.”
Douglas Cifu is the president of Virtu Financial, a big player in the industry. “There was this mythology that you could get 90 computers, some Harvard Ph.D.’s and you would turn on your machines and make money,” he said. “It’s just not the case.”
Virtu has not cut back, but it has acquired smaller firms that were struggling to continue operating on their own. Last month, Virtu bought Nyenburgh, a company that specialized in the most popular type of high-speed trading, known as market making, of European stocks.
At the same time, regulators around the world have increased their scrutiny of high-speed traders, and the structure of the financial markets has continued to shift. Executives at the trading firms worry that new regulations could curtail business even more, but so far, regulators in the U.S. have taken few steps to rein in trading practices.
The diminishing presence of these traders in the markets has not hurt the overall performance of stock prices. Leading indexes have been on a steady climb for the last few years. For high-speed traders, rising prices are actually a part of the problem: Climbing stock markets tend to be calmer stock markets, providing fewer trading opportunities for high-speed firms. The contraction is also pushing the firms to move into trading of other financial assets, such as international stocks and currencies. High-speed firms accounted for about 12 percent of all currency trading in 2010; this year, it is set to go up to 28 percent, according to the consulting firm Celent.
But executives at several high-speed firms said that trading in currencies and other assets was not making up for the big declines in their traditional areas of U.S. stocks, futures and options.
Sun Trading in Chicago bought a firm that allowed it to begin the automated trading of bonds earlier this year. That did not make up for the 40 employees the company cut in 2011. The firm’s chief financial officer, Chris Malo, said his team was preparing for the possibility that the high-speed trading business would become only more challenging.
“People think it’s easy money, and it’s not,” Malo said.