By Suzanne Cosgrove

Algorithmic, or high frequency, trading has come under fire by some regulatory bodies, including the European Commission, for its role in speeding up the pace of the financial markets -- but it appears the practice is here to stay.

High-frequency trading is a “business strategy,” or part of one, said Peter Nabicht, chief technology officer of Allston Trading, speaking at a September panel discussion of high-frequency trading sponsored by the Futures Industry Association at Chicago’s Union League Club.

“High-frequency trading has been make possible by some of the low-latency work that has been going on in the markets, and relies on that,” Nabicht explained, “but it’s not one single strategy.”

Broadly speaking, firms who specialize in “algo” trades use market data and ultra high-speed computer analytics to look for trading opportunities in various financial instruments, then take positions for very short periods of time, often for less than a minute.

Algorithmic trading is standard fare in stock markets, and is expanding in futures and options. But it is a newer – and growing -- phenomenon in other sectors. In a September report, consultancy Aite Group found most large foreign exchange banks are building up their algorithmic capabilities, “including new-strategy development.”

“It’s doing the types of things you would do in the pit -- buying something that you think is relatively cheap and selling something that is relatively expensive … just as you would in the pit,” said Donald Wilson, CEO of DRW Trading Group, also a member of the FIA panel. “I don’t really see it as a new thing. It’s a new way of doing an old thing.”

Regulators beg to differ. They worry that the lightening-quick speed of the trades can heighten volatility and contribute to price swings like the “flash crash” that rattled stocks on May 6, 2010, when the Dow Jones Industrial Average fell by nearly 1,000 points before rebounding.

These concerns about wild markets remain on the front burner as agencies strive to implement the financial reforms required by the Dodd-Frank Act.

In written testimony delivered on Nov. 3 to a Senate Permanent Subcommittee on Investigations, Commodity Futures Trading Commission Chairman Gary Gensler noted that the majority of trading volume in key futures markets – more than 80 percent in many contracts – is day trading or trading in calendar spreads.

In addition, “as electronic trading has grown, we have seen a significant rise in high-frequency trading, and the CFTC is working to ensure our regulations are a match for modern challenges,” Gensler said.

At the same time, European leaders are approaching the subject from another vantage point. The Wall Street Journal reported that German and French leaders at the Group of 20 summit pushed for a tax on trades of stocks, bonds and derivatives, a suggestion that also might rein in trading. However, President Obama rebuffed that proposal.

And while William Brodsky, CEO of the Chicago Board Options Exchange, stressed in a recent interview with Financial Times that high-frequency trading makes markets more liquid and should not be slowed down, the practice still has critics within the industry.

“The function of the market is to provide information” to investors, said Michael Gayed, chief investment strategist at New York-based Pension Partners LLC, in an interview.

“Those messages (on valuation) get distorted” when shares are seen as instruments, not as stocks in a company, Gayed said. That results in market participants misinterpreting the information that comes from price and becoming more cautious, he added.

Algorithmic traders say their function is very different from that of long-term investors.

“When your holding period of a stock is a millisecond, it has almost no impact … on somebody that’s holding a position for more than a day,” said Nabicht, speaking at the FIA panel. “Getting into and out of one stock in a millisecond, or two, or five does not impact somebody who is picking a stock for long-term gains over a six-month period.”