Meet the new Turks of equities trading -- an elite group which keeps a low-profile, high-frequency traders are rapidly transforming our financial markets.

He doesn't want to reveal his name nor the company for which he works trading millions of shares each day. He is young, blond and works out of a non-descript office somewhere in middle America.

Meet one of the new Turks of equities trading. This mystery man is one of an elite group in the securities industry known as a high-frequency trader who is rapidly transforming our financial markets.

High-frequency traders use lightning-fast, super-powered computer algorithms to earn tiny profits - multiplied millions of times - from inefficiencies across markets.

One year ago, most of Canada's brokerage firms wanted little to do with them. They have been called predatory and rogues. "My guess is they thought we wouldn't be able to do enough volume to justify the pricing we were asking for," says the trader in his Midwestern twang.

Now many of the naysayers have changed their tune and are asking for his business.

A recent CIBC World Markets report on high-frequency trading noted that the market for trading equities "has changed more in the last year than it has possibly in the last decade." The bank estimates that high-frequency trading now accounts for 20% to 30% of the volume on Canadian exchanges. Their impact has led to debate and, as the financial industry copes with new cries for greater transparency, many expect there will be some kind of regulatory review of their practices.

For all the transformation these new traders have brought to Canada, few on Bay Street understand how they operate. Fewer still have met one. These players are so protective of their trading strategies that they've hived themselves off from the major financial districts, and don't frequent the regular conferences, country clubs and watering holes. They are able to work under the radar because they trade their own capital, keep a low head count, and are based in cities like Chicago, Kansas City and Mount Pleasant, South Carolina, according to Irene Aldridge, author of the new book High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems.

No one knows exactly how many high-frequency traders or their firms have moved into the Canadian market. There are a number of banks and hedge funds employing these strategies around the world, but the names of four big proprietary trading shops keep cropping up on the topic: Citadel Investment Group, TradeBot Systems, Getco and Automatic Trading Desk.

The strategy is to push out orders in a scatter-gun approach using sophisticated, super-fast routers. These traders do not subscribe to buy-and-hold strategies - they profit from short-term moves in the stock. They might buy a Canadian stock and quickly resell it in the American markets or exploit price differences across various exchanges.

Profitability lies in their technological horsepower: They can flip 20- to 30-million shares a day, at least five times more than an active human trader.

Their presence has rattled Bay Street.

"They are omnipresent; they are involved in every name, all the time," says Alison Crosthwait, head of research for Toronto electronic brokerage firm ITG Canada.

Thomas Kalafatis, executive director, cash equities at CIBC, says part of the concern is "fear of change."

"Ultimately, it's not unlike any other industry that goes through massive technology innovation," Mr. Kalafatis adds. The CIBC report on high-frequency trading, which Mr. Kalafatis co-authored, makes the point that the new traders have created "a lot more noise: faster moving quotes, more bids and offers, more volume and in some cases, frustration."

But it's just not fear of technology that has Bay Street concerned. High-frequency trading has increased the cost of trading. Ms. Crosthwait estimates that ITG's trading fees have gone up 25% over the past year. "And we are not alone," she adds.

Since the arrival of high-frequency traders, trading volumes and liquidity have dramatically increased. On the positive side, this has made it easier for investors to get their order filled. Increased liquidity also reduces the spread between the bid-and-ask price. That has decreased 7.7% over the last year, according to ITG.

The reduced spread has its pros and cons. Companies listed on the exchanges like it because it has meant a decrease in stock price volatility. But it also means brokers/dealers engaged in arbitrage strategies of trading stand to make less money from a single trade. Also, those who make profits on market imbalances may see a hit on their profits as the high-frequency traders sniff out their strategies and beat them to the punch.

Broker/dealers are also seeing their fees to the exchanges rise, which eats into their profit margins.

Until recently, the Canadian market held little appeal for these traders. Two changes ushered them in: The launch of new alternative trading systems (ATS) such Chi-X Canada and Alpha Trading Systems and MatchNow, and the introduction of the incentive rebate program by the TMX Group Inc. The TMX's Electronic Liquidity Provider program, launched a year ago, works like this: Passive brokers who bring available stock to the market are paid a fee by the exchange, while those who take liquidity out of the market - buy the stock - must pay the exchange a fee for that transaction. A subset of technology traders have emerged who attempt to make profits from the rebate program by parking themselves on the exchanges "sitting passively everywhere," says Ms. Crosthwait at ITG. Because they are frontrunners, other broker/dealers are forced to respond to their quotes. That means the high-frequency traders are often pocketing the rebate and the traditional broker is paying out.

"For these guys everything is speed, and they are getting access to quotations before the general public. ... So, in essence, they are re-engineering the quotes by jumping between you and the seller," says Joe Saluzzi co-founder Themis Trading, a small firm in Chatham, New Jersey. Mr. Saluzzi has been a vocal critic of the high-frequency traders he refers to as predators.

He says investors are also at their mercy. "Most investors don't even realize they are losing money, because their pockets are getting picked without them even knowing it. The price you paid may have been inflated during the day, because they are taking advantage of the order flow and you don't even know it. We have a market now filled with speculators and not investors."

Not everyone is unhappy with the arrival of the new players. CIBC's prime brokerage firm jumped from fourth place to first place for volume of trades on the Toronto Stock Exchange in less than one year, partly because they were one of the first brokerage houses here to clear the trades of technology traders.

The other big winners are the alternative exchanges, which have seen their market share grow dramatically. One year ago, the TSX had a market share of 99.5% by volume for the top 60 stocks traded in Canada. Last month, its market share dipped the lowest ever on a monthly basis, to 69% according to IRESS, a U.S.-based technology vendor which measures these things. The beneficiaries are the new ATS exchanges. The TSX's overall market share now hovers around 80% when all stocks are factored in, but even that is a significant drop, according to ITG Research.

The changes over the past six months have been "fairly quick and fairly massive," says Tal Cohen, chief executive of Chi-X Canada. Chi-X came out of 2008 trading about three to four million shares a day, and last week was averaging over 34 million shares a day, he added.

"What you are seeing here is a shift in how people are approaching the market," Mr. Cohen adds.

Although traditional brokers are migrating to the new exchanges and their offers of price improvement, size improvement or lower fees, Mr. Cohen says growth on the exchanges is also attributed to the high-frequency traders.

On the surface it would appear that the TSX has little to fear from its erosion in market share because overall trading volumes have increased. "Everyone's benefiting from the growth in volume," says Mr. Kalafatis of CIBC

But there could be challenges ahead. Much of the TSX's growth has come from its rebate program, which means the fees being collected from brokers are lower, resulting in lower revenues, says Ms. Crosthwait. "The TSX could be in trouble."

An analyst report issued by John Reucassel of BMO Capital Markets stated that the TMX's miss in earning for its third quarter "was almost entirely due to lower than expected trading revenue." Revenue in cash equities was down 28% in the quarter, but down 42% at the senior cash exchange. "This is faster erosion in revenue than we predicted," reported Mr. Reucassel.

Bay Street is still digesting it all.

"The first ones to come to the market are the guys who come in to capture the rebate, but the next wave of high-frequency traders are trading across asset classes and add depth to the market, which is good business for us," says Robert Fotheringham, senior vice-president, trading TMX Group. "We feel confident our revenues will grow."

On the whole, the fear of change is gradually being overtaken by the excitement of innovation. The Canadian exchanges are attracting more global players than ever before, all with vastly different strategies, which is creating more opportunities to trade, says Mr. Kalafatis.

Even the brokers who once shunned the high-frequency traders are having a change of heart. "Before [the traditional brokers] were saying ‘this is not a healthy thing for the market.' But now you are seeing all the larger banks embracing it," says Mr. Cohen of Chi-X. "This is the future, this is where we are going."

kmazurkewich@nationalpost.com