2 min read

Trading in the Fast Lane

If you haven’t heard of High Frequency Trading yet, you will soon. It is changing the way markets work, improving liquidity and price setting, while allowing those few with access to the requisite tools to take a lion share of the profits generated. For example:

It was July 15, and Intel, the computer chip giant, had reporting robust earnings the night before. Some investors, smelling opportunity, set out to buy shares in the semiconductor company Broadcom. (Their activities were described by an investor at a major Wall Street firm who spoke on the condition of anonymity to protect his job.) The slower traders faced a quandary: If they sought to buy a large number of shares at once, they would tip their hand and risk driving up Broadcom’s price. So, as is often the case on Wall Street, they divided their orders into dozens of small batches, hoping to cover their tracks. One second after the market opened, shares of Broadcom started changing hands at $26.20.

The slower traders began issuing buy orders. But rather than being shown to all potential sellers at the same time, some of those orders were most likely routed to a collection of high-frequency traders for just 30 milliseconds — 0.03 seconds — in what are known as flash orders. While markets are supposed to ensure transparency by showing orders to everyone simultaneously, a loophole in regulations allows marketplaces like Nasdaq to show traders some orders ahead of everyone else in exchange for a fee.

In less than half a second, high-frequency traders gained a valuable insight: the hunger for Broadcom was growing. Their computers began buying up Broadcom shares and then reselling them to the slower investors at higher prices. The overall price of Broadcom began to rise.

Soon, thousands of orders began flooding the markets as high-frequency software went into high gear. Automatic programs began issuing and canceling tiny orders within milliseconds to determine how much the slower traders were willing to pay. The high-frequency computers quickly determined that some investors’ upper limit was $26.40. The price shot to $26.39, and high-frequency programs began offering to sell hundreds of thousands of shares.

via Traders Profit With Computers Set at High Speed — NYTimes.com.

As a whole I have no prblem with this technology, traders provided an innovation that makes the market place better, and over time, everyone will trade faster, dividing the gains from faster trading to more hands while still providing the added liquidity and price setting benefits for all.

However, flash orders, the ones that let high frequency traders see what slower traders are doing just before they do it, should be shut down. It is one thing to palce smaller orders to learn when others are willing to trade, but to see something before eveyone else is an unfair advantage. Financial Advisor’s are not allowed to trade n front of their clients (front running), for the same reasons: seeing others orders gives you an advantage over them and allows you to profit at their expense.