World Federation of Exchanges | Cambridge, MA | Nov, 2009

High Frequency Trading

What Is It & Should I Be Worried?

Presented by

Larry Tabb (Founder & CEO)

Agenda

What is high frequency trading

Who does it

Why has high frequency become an issue

How does this impact exchanges?

What is high frequency trading?

Wide definition Firms leveraging high speed market data and analytics to

look for temporal supply and demand trading opportunities. These firms typically are self capitalized and hold positions for very short periods of time (typically less than minutes)

Includes Equity market making Index arb Options market making ETF arb Stat arb/pairs trading

Narrow and more typically used definition Equity market making

Who does it?

Typically Equity market makers Proprietary trading shops And a few high frequency hedge funds Many located in Chicago

This is typically done by self-capitalized firms This is market-driven and not PM driven Significant investment in technology

infrastructure Not your standard investment strategy

Who trades?

US Equity Share Volume by Market Participant

IB Prop, 16%

Retail, 3%

Independent HFT, 29%

HFT Broker/ Market Makers,

28%

Long Only, 13%

HFT Hedge Funds, 4%

Hedge Funds, 7%

High Frequency Trading accounts for 61% of Share Volume

Source: TABB Group Estimate

US Equity Share Volume by Market Participant

High Frequency Trading accounts for 61% of Share Volume

Source: TABB Group Estimate

3% 7% 13% 16%

4% 28 % 29%

Investors

Liquidity Providers

RetailHedge Funds

Investment Bank PropLong Only

HFT Hedge FundsHFT Broker/ Market MakersIndependent HFT

Investors Liquidity Providers

The majority of trading is done by professional traders / liquidity providers

Goal of HFT - first to spot an opportunity & first to take advantage of it Co-location

Depending upon the firm, the HFT may need multiple locations May also want access to dark pools

Sponsored access

Flash trading

Market data Direct feed Messaging Low latency time series Back testing tools

High speed analytics CEP (mostly home grown) to locate trends Execution technology to trade

Why has HFT become an issue?

The floor is empty – most trading is done by machines

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

Jan-97Jan-98Jan-99Jan-00Jan-01Jan-02Jan-03Jan-04 Jan-05Jan-06Jan-07Jan-08Jan-09

Avg

. S

ha

res

(m),

Avg

. T

rad

es(

k)

0

200

400

600

800

1,000

1,200

1,400

1,600

Avg

. S

ha

res

/ T

rad

e

Avg Shares Per Day (mm) Avg Trades Per Day Shares / Trade

Source: TABB Group and Exchange Data

Electronic Trading Has Caused Steep Decline in Average Trade Size

US Equity Share volume and trades

Shares by Execution Venue (volume weighted)

37%

12%

14%

22%

15%

44%

11%

9%

24%

11%

38%

11%

9%

31%

12%

Sales Desk

Program Desk

Direct ToExchange

Algorithms

CrossingNetwork

2007 2008 2009

1%

-5%

-22%

18%

-10%

2 Year CAGR’07-’09

Algos have broken up flow into much smaller executions

Source: TABB Group – Institutional Equity Trading in America ’09/’10 – Preliminary

Capital usage is down because of credit crisis and advanced trading technology

Directionality of Capital Usage

6%

31%

63%

Up

Same

Down

68%% Firms

67%

84%

100%

SmallMediumLarge

Percent of Firms Paying More For Capital

Percent of Firms Using Capital

Source: TABB Group – Institutional Equity Trading 2008

Sales trader flow is declining – back to on-trend levels

33%38%

44%

37%

47%

59%

69%

2010e200920082007200620052004

Percentage of Order Flow Firms Sent to Sales Trader

3 Year CAGR-19%

’07-’08+19%

2 Year CAGR-13%

Source: TABB Group – Institutional Equity Trading in America ’09/’10 – Preliminary

Should exchanges be worried?

In last 23months, exchanges have lost 20% market share to dark pools and ECNs

89%

87%88

%

86%

85%

85%

82%83

%

73%76

%77%

76%77

%

73%74

%

72%

72%

71%

70%

67%69

%69

%69

%

67%

66%

66%

62%

59%

58%

57%

53%

53%

53%

4% 5%3%

5% 6% 7% 8% 9%

15%

14%

14%

14%

13%14

%13

%15%

15%16

%18%19

%19

%19

%18

%21%22

%22

%24%25

%27%

27%30

%29

%28

%

2% 2% 3% 2% 2% 2% 3% 2%4% 3% 3% 3% 4% 5% 5% 4% 4% 4% 4% 4% 4% 5%

3% 3% 3% 3% 4%6% 5% 6% 6% 7% 8%

5%6%6%6%6%6%7%6%8%8%7%8%7%8%8%9%9%9%8%

10%8%7%

9%9%11%10%10%10%10%10%11%11%11%

0%

20%

40%

60%

80%

100%

Jan-0

7

Mar

-07

May

-07

Jul-0

7

Sep-0

7

Nov-07

Jan-0

8

Mar

-08

May

-08

Jul-0

8

Sep-0

8

Nov-08

Jan-0

9

Mar

-09

May

-09

Jul-0

9

Sep-0

9

NYSE, NASDAQ, & Arca

BATS / DirectEdge

Crossing /Dark Pools

RegionalExchanges

Source: TABB Group LiquidityMatrixTM

Matched US Equity Flow as a Percentage of Total US Equity Matched Flow

Market share of liquidity pools are beginning to converge around 13%

US Equity Market Share (includes Internalized)Consolidated NYSE/NASDAQ Listed Equities

Jul 2008 – Sept 2009

4% 4% 4% 4%3% 3% 3% 3% 3%

5% 5% 5% 5%6% 7%

30%29% 29%

30% 30%

27% 27%26%

23%

21%20% 20% 20%

19%19%

16%

14% 14%15%

16%15% 15% 15% 14% 14% 14% 13% 13%

14%

18.10%18.00%

19.90%20.10%19.90%

18.00%17.90%18.30%17.20%

16.40%16.00%15.10%14.60%14.00%

13.00%

10% 10% 11%11%

10%11%

11% 11%10% 10% 11% 11%

10%9%

5%6% 5% 5%

6%6% 7% 7%

9%10%

10% 10%

12%13%

12%

7%

9%

7% 7%9% 8%

9% 9% 9% 9% 9% 8%10% 9% 9%10% 9% 9%

8% 9%

11% 11% 12%

14%

16%17%

17%

15%16% 16%

15%

10%

-5.00%

5.00%

15.00%

25.00%

35.00%

Jul-08

Aug-0

8

Sep-

08

Oct

-08

Nov

-08

Dec

-08

Jan-

09

Feb-

09

Mar

-09

Apr-0

9

May

-09

Jun-0

9

Jul-09

Aug-0

9

Sep-

09

Regionals Nasdaq NYSE Arca BATS DirectEdge Dark Pools Internalized

Source: TABB Group LiquidityMatrixTM Exchanges, BATS

Is it worth it? Benefits

Greater automation Low fees – exchange competition Tighter spreads High certainty of execution

Challenges Finding the needle in the haystack Massive quantities of

Data, IT,& Bandwidth Greater obfuscation

All of this tilts market toward larger brokers Will benefits remain when only mega-brokers can play?

However Sponsored Access is changing this Market is becoming more open and accessible (for the

technologically advanced)

World Federation of Exchanges | Cambridge, MA | Nov, 2009

High Frequency Trading

What Is It & Should I Be Worried?

Presented by

Larry Tabb (Founder & CEO)