Why It's Important: High-frequency trading firms -- mainly proprietary trading firms and hedge funds -- are responsible for as much as two-thirds of U.S. equities daily trading volume and are the major source of liquidity for retail and institutional investors, according to many experts. Critics contend that HFT firms that colocate their black-box trading strategies at or near exchange data centers have unfair access to execution venues and can front-run slower traders. Concerns over flash orders and unfettered sponsored access, or "naked access," have prompted the SEC to review the pros and cons of these strategies, but any rule changes could dramatically impact this major source of liquidity.

Where the Industry Is Now: Low-latency trading strategies and automated trading systems have exploded and become widely adopted by electronic market makers and statistical arbitrage players that eke out small profits by capturing the spread across multiple execution venues. According to Larry Ryan, Hewlett Packard's chief technology officer for worldwide financial services, automated high-frequency trading is responsible for 50 percent to 70 percent of equities trading volume on any given day.

To speed up automated trading, HFT firms typically colocate the servers that house these strategies in a data center at or near the major equity venues (Nasdaq, NYSE, BATS, Direct Edge); firms that trade across multiple execution venues may pick a neutral data center in the middle. "Everyone is trying to take latency out of their systems -- the trading venues, the ECNs, the exchanges are trying to trade faster because the broker-dealers are directing order flow based on [the venue's] the response time," explains Ryan.

Focus in 2010: Regulatory oversight will be the focus as Sen. Ted Kaufman (D-Del.) has called for a broad market review of market structure by the SEC. The regulator already has proposed a ban on flash orders and is examining high-frequency trading as well as formulating proposals on how to regulate sponsored access, colocation and dark pools. Risk management gateways on the exchange side or plug-in risk controls on the broker infrastructure will come into play as ways to rein in naked access. Meanwhile, HFT shops will focus on expanding their strategies to markets in Europe and Asia and moving into other asset classes, namely U.S. options, futures and foreign exchange.

Industry Leaders: The big HFT players are electronic market makers, including Getco, Tradebot, Citadel, QuantLab and hedge fund mangers such as D.E. Shaw, SAC Global Advisors and Renaissance Technologies. Proprietary trading desks of Goldman Sachs, Morgan Stanley and Deutsche Bank also engage in HFT. Lime Brokerage is a key provider of colocation services and market data to hundreds of low-latency trading firm. Clearing broker Wedbush Morgan is a major provider of sponsored access to HFT shops and reportedly clears trades for Getco.

Technology Providers: HFT depends on advanced trading technology, high-performance computing systems, colocation and low-latency networks. "HFT firms need low-latency market data, usually direct feeds, connectivity to the execution venues, smart order routing technology and a FIX engine," comments Sang Lee, managing partner at Aite Group. Some of the top providers of these technologies include FTEN, Quanthouse and Lime Brokerage, which offer infrastructure to HFT firms including market data and connectivity to execution venues, according to Lee. Colocation/proximity service providers include British Telecom and Savvis, along with 7Ticks, Equinix, and Switch and Data. "Clients want to be close to the trading engines and new exchange connectivity that we're bringing on," says Varghese Thomas, VP, financial markets at Savvis in Weehawken, N.J.

Alpha-generation platforms such as Alphacet are designed to help quants develop strategies more quickly than before, while Marketcetera launched an open source software platform for building automated trading systems. Complex event processing (CEP) engines are still in demand as HFT firms code their rules in memory to search for patterns in real-time streaming data.

Firms also need low-latency messaging middleware, tick databases and feed handlers. "That's how you get the data around and how applications speak to each other," explains Tabb Group senior analyst Kevin McPartland. He names 29West and Tervela as top innovators in this area.

Price Tag: HFT technology is expensive, but analysts say the barriers to entry have fallen. McPartland estimates that entry costs are a few hundred thousand dollars. But as HFT firms scale out to multiple product types, geographies and larger order flows, the costs will escalate to multiples of that.