Once able to maintain a low profile while generating massive profits from trades taking place in fractions of seconds, the world of high frequency trading (HFT) and all its controversies were pushed into the spotlight in 2014 with the publication of Michael Lewis’s bestselling book, Flash Boys. Yet, while the controversies over HFT remain, some are wondering whether the firms that employ the strategy will be as fortunate, as several are now struggling to turn profits, according to a recent article by the Financial Times.

Among a number of HFT firms who have recently announced declines in trading profits, Teza Technologies announced near the beginning of last November that it was getting out of the HFT business. In a separate article, Misha Malyshev, the company’s chief executive officer, was quoted by the FT as saying, “Generally, it is harder to make money.” (To read more, see: The World of High Frequency Algorithmic Trading).

No Volatility, No Money

While not being able to make money is probably a good reason to get out of any business, such a statement is not very helpful in explaining why the business isn’t making money any more. Fortunately, despite the numerous privately held HFT firms, the financial statements of publicly quoted firms are available to provide clues in order to better understand why the industry is showing signs of weakness.

In looking at Virtu Financial Inc. (VIRT), the FT found that this leading HFT firm’s trading income was closely related to the level of the Chicago Board Options Exchange Volatility index, or VIX. A high VIX level meant high volatility, and that meant more money for Virtu, while lower volatility meant less.

Volatile market prices bounce up and down creating a greater likelihood that price disparities will occur. When such disparities occur, arbitrage opportunities arise, which is where algorithms that recognize the arbitrage opportunity and can execute a trade faster than a human trader have the upper hand.

What markets have experienced, however, in recent years is low volatility, which has contributed to the declining profits of those firms who have profited on being the fastest traders. Virtu blamed its declining net trading income on low volatility pointing out that the average intraday volatility of the S&P 500 hit a low last August not seen since 1970.

Competition and New Trading Rules

In the face of lower trading revenues due to low volatility, HFT firms have also been facing the costs of stiffer competition. With the competitive advantage going to the firms who can execute trades the fastest, an arms race to develop the best algorithms and construct the best telecom infrastructure, has driven up the costs of being successful.