Enabling Platforms For Fast Markets (As you’re probably aware, GETCO – one of the world’s largest high frequency trading (HFT) prop shops, is buying Knight Capital. This came about after Knight nearly collapsed when a technical glitch on Aug. 1, 2012, caused the firm to lose $440 million. While the acquisition is clearly opportunistic, since Knight was so crippled after its August losses, the move also signals GETCO’s lack of confidence in the long-term profitability of the HFT model, particularly in equities.
Sharply Declining Profits in HFT
GETCO and Knight are two of the largest market makers on the New York Stock Exchange. Apparently, however, GETCO’s decision to purchase Knight is based partly on sharply declining profits in high-frequency trading, which is driving a decision to diversify away from pure prop trading. Knight is a market maker with substantial retail flow. They get huge equities flow from retail brokerages such as Fidelity, E*Trade and TD Ameritrade. According to Traders Magazine, Knight makes markets in some 19,000 U.S. equities, handling 3 billion shares a day.
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9 Comments to "GETCO-Knight Deal Signals End to HFT Profitability":
Anonymous
22 February 2013
Hft are know to use market making strategies, why do you think this is a sign of diminishing returns?
ericphilo
25 February 2013
Why wouldn't GETCO use Knight's order flow as another HFT algo input? The brokers have been doing this to position their book since time immemorial.
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lberke
25 February 2013
In my opinion, this is a great combination of capabilities. Knight established a strong reputation in the institutional markets as a successful marketmaker. That reputation as a valued dealer goes back a long ways. Knight also, under Tom Joyce, transformed itself into an electronic trading firm. It built pricing algorithms, internalization engines & access to retail order flow. Getco, having profited from what will no doubt be considered the "hay day" of HFT, is indeed diversifying its business and will be successful in doing so. Knight's clients are very familiar with algorithmic pricing models and electronically generated liquidity. And Getco brings some of the smartest technologists and model builders in the marketplace to the table. Liquidity will beget liquidity and when investors regain their strong appetite for US equities (France, Italy and the FTT will help quite a bit in that regard), a combined Getco / Knight will be well positioned to facilitate.
Comments (129)
avinash17
25 February 2013
Will institutions/retail brokers have perceived trust issues with sending flow to a HFT-First shop who is now playing around with non-HFT flow? Will the fact that these flows are now in the same room cause a fox in hen house view?
Comments (3)
lberke
25 February 2013
avinash17, I believe that as a NYSE Euronext DMM, Getco has been "playing around" with non-HFT in quite a big room for quite some time. Now that doesn't mean that, as you say, institutions won't be concerned about the fox in the henhouse. However, if the "fox" is a market-maker, electronic or otherwise, whether it be at an exchange or in a dark pool or on a block trading desk or at a market-making broker/dealer like Knight, that fox has been a counterparty to the hens' trades for time immemorial. As they say, competition and risk-taking and differing views on price is what makes the world go round.
Comments (129)
avinash17
25 February 2013
@Iberke I definitely see your point. There is also perception that the broker is out to find the best price for the buyside and market-making allows for risk taking to help the buyside meet their goals in favor of fees (at-times at least). Secondly, even though Getco has been on the floor they will now gain control of the additional and somewhat significant wholesale flow once they gain access to NITE's book. They will have to fight "How will I know you wont skim-off-the-top-of everything I send you and behind closed doors?" question and it might further impact the value of their declining HFT biz.
Comments (3)
Anonymous
26 February 2013
It simply illustrates how compelling it becomes to preempt retail flows to secure profitability.
lberke
26 February 2013
avinash17, indeed, there has always been somewhat of a delicate balance inherent in the natural conflict of interest between the market maker and the institutional / retail investor. And yes, Getco / NITE will represent a significant percentage of flow and price discovery. I think the thing that drives this combination is a recognition on the party of Getco AND Knight that until volatility returns to equities, options and ETFs, the only reasonable strategy is to leverage order flow on behalf of customers. When volatility comes back, HFT profits will return, albeit not to the levels they once were. In that environment, institutional / retail investors will be just that much more challenged to transact without incurring increased transactions costs. And oh, at that time, they will look for the market makers to step in....
Comments (129)
candyce
26 February 2013
Great to see that my article stimulated such interesting conversation! Here's another tidbit to add to the discussion. Traders Magazine reported GETCO and Knight's results for 2011 and 9 months of 2012 here.
GETCO: NET INCOME: $24.6 million, first nine months 2012, down from $134.8 million in 2011
Knight: NET LOSS: $353.5 million, first nine months 2012, versus profit of $75.0 million in 2012
We all know why Knight showed such a huge loss. But GETCO's net income compared to 2011 is very telling and makes it clear why they're choosing to diversify. Personally, I think this merger makes great sense for both organizations.
Comments (27)