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Surveillance at the Sharp End

By Charles Gregory, VP of Product Management, KX

What’s The Role Of Trade Surveillance For Algorithmic Trading?

In the search for Alpha, many of the financial world’s brightest minds diligently craft algorithms to support complex trading strategies, beating their neighbors to the most fleeting opportunities to make a cent or two, often doing so in a matter of milliseconds.

More traders making faster trades in a dynamic market have caused a seismic increase in transaction volumes and data complexity. Additionally, there’s persistent pressure for the quants to identify even the smallest spreads. The demand to find a competitive edge and outsmart their counterparts regretfully pushes some players to test the limits of what’s acceptable – and legal. You only need to look at the enforcement page of the US Security and Exchange Commission (SEC) to see how often the line gets crossed.

With high-frequency trading (HFT) dangling the carrot of enormous profitability, it’s tough not to get caught in the trap of chasing success, whatever the cost. There is a legal requirement to “demonstrate control,” but any directive open for interpretation will be treated differently depending on resources and priorities.

Why does HFT need robust surveillance?

Simply put – because the price of not doing it can, and will, be high!

Ideally, compliance teams need complete independence from high-flying trading desks. After all, in the European Union, we’re under the watchful eye of MAD2 (Market Abuse Directive II), which requires market participants to commit to a level of transparency. Similar frameworks exist globally, affecting firms and individuals participating in regulated markets. And it isn’t a stretch of the imagination to expect regulatory bodies to take a retrospective stance and scrutinize some currently unregulated digital markets.

Effective trade surveillance will positively impact your bottom line and reputation. Now and in the future.

Fundamentally, you’re looking for a way to identify market manipulation. However, the challenge is that HFT transacts in fractions of a second, and the trading algorithms are incredibly complex and fiercely protected.

A modern surveillance solution will monitor for market manipulation by:

  • Alerting in real-time – i.e., unusual success ratios signaling potential wrong-doing
  • Continuously undertaking complex event data processing to search for the
    fingerprints of manipulative practices, such as spoofing and layering.
  • Scaling to ingest vast amounts of transactional data for richer analytics from multiple
    exchanges and data sources.
  • Enriching streaming data with historical context.
  • Presenting actionable insight from your data and trading landscape for validation
    and investigation.
  • Going beyond trade data to extract risk signals from communications and other data

The right tools go beyond regulatory mandates and can actually reduce costs, for example, by minimizing the impact of false positives by aligning alerts to even the most advanced trading strategies. It will demonstrate credibility and control quality to your board, customers, and market; and reduce the regulatory and reputational impact of fraudulent activity while simultaneously setting a foundation for a more prosperous future within – for example – currently unregulated digital exchanges.

Without credible surveillance in place, there’s the obvious risk of regulatory punishments – fines, cease-and-desist, or imprisonment – now or in the future. With regulatory bodies having access to all the data and their surveillance solutions monitoring the markets constantly – doing nothing is simply not an option.

And if your solution doesn’t add historical context, can’t handle the data volumes or complexity, or operate at the speed required to spot everything, you’ll miss something. Your solution needs to investigate and surveil as deep as the regulators, and as fast as the regulators. In micro-seconds, you always need to be one step ahead, spotting anomalies and stopping threats.

What does the future hold?

As markets evolve and grow, with increased use of HFT and the rise of new digital markets – including cryptocurrency exchanges – the volumes and complexity of data will only increase. Additionally, smarter Algos and better tech will drive transactional frequency through the current glass ceiling, constantly constrained by more stringent regulations and more punitive regulators.

It’s widely acknowledged that it’s in everyone’s interest that digital exchanges are demonstrably safe enough to attract institutional investors.

The only way to demonstrate control to today’s regulatory bodies, optimize your trading
operation, and set the foundation for a digital trading future is with a real-time
surveillance and compliance solution like KX Surveillance.

About KX Surveillance

Born in the most demanding data environments, KX Surveillance has been dealing with these challenges for more than 15 years and is already operating in digital currency exchanges, and winning awards around the world. Learn more here.