by ARGeezer
Mon Jul 27th, 2009 at 05:06:54 AM EST
At the beginning of last week it seemed that the Main Stream Media was determined to ignore the ongoing scandal of how the financial markets were being run. But The New York Times is starting to run articles on the High Frequency Trading Scandal and other aspect of gross manipulation of the markets and looting of the economy by Wall Street and, especially, by Goldman Sachs.
The NYT ran an article by Charles Duhigg earlier in the week, Stock Traders Find Speed Pays, in Milliseconds, (see below for link and quote) and followed up on Saturday with a guest editorial by Tobin Harshaw in the Weekend Opinionator entitled Is Wall Street Picking Our Pockets?
"It is the hot new thing on Wall Street," according to The Times's Charles Duhigg, "a way for a handful of traders to master the stock market, peek at investors' orders and, critics say, even subtly manipulate share prices. It is called high-frequency trading -- and it is suddenly one of the most talked-about and mysterious forces in the markets."
Well,...it's nice to have a clear villain back in our sights. But is it fair to say the wizards of Wall Street (Goldman Sachs, this means you) are picking our pockets, or are they really the smartest guys in the room after all?
The rest of Harshaw's article is a mine of references and links and a general survey of blog and press coverage of this subject. But instead of quoting Harshaw quoting Duhigg, we will go to the source, as that is where Harshaw starts.
promoted by whataboutbob
Stock Traders Find Speed Pays, in Milliseconds CHARLES DUHIGG, NYT July 23, 2009
For most of Wall Street's history, stock trading was fairly straightforward: buyers and sellers gathered on exchange floors and dickered until they struck a deal. Then, in 1998, the Securities and Exchange Commission authorized electronic exchanges to compete with marketplaces like the New York Stock Exchange. The intent was to open markets to anyone with a desktop computer and a fresh idea.
But as new marketplaces have emerged, PCs have been unable to compete with Wall Street's computers. Powerful algorithms -- "algos," in industry parlance -- execute millions of orders a second and scan dozens of public and private marketplaces simultaneously. They can spot trends before other investors can blink, changing orders and strategies within milliseconds.
High-frequency traders often confound other investors by issuing and then canceling orders almost simultaneously. Loopholes in market rules give high-speed investors an early glance at how others are trading. And their computers can essentially bully slower investors into giving up profits -- and then disappear before anyone even knows they were there.
High-frequency traders also benefit from competition among the various exchanges, which pay small fees that are often collected by the biggest and most active traders -- typically a quarter of a cent per share to whoever arrives first. Those small payments, spread over millions of shares, help high-speed investors profit simply by trading enormous numbers of shares, even if they buy or sell at a modest loss.
-Skip-
"This is where all the money is getting made," said William H. Donaldson, former chairman and chief executive of the New York Stock Exchange and today an adviser to a big hedge fund. "If an individual investor doesn't have the means to keep up, they're at a huge disadvantage."
Electronic trading was presented as an opportunity for anyone with a personal computer to benefit. But not just "anyone" can co-locate their hardware on the exchange floor, nor is just "anyone" able to afford powerful hardware and, especially, the sophisticated software and algorithms that run on them. Nor can just "anyone", for a fee to the exchange, get to see the data stream from the exchange's trading system monitor a fraction of a second before everyone else.
"It's become a technological arms race, and what separates winners and losers is how fast they can move," said Joseph M. Mecane of NYSE Euronext, which operates the New York Stock Exchange. "Markets need liquidity, and high-frequency traders provide opportunities for other investors to buy and sell."
Of course Mr. Mecane would not be so gauche as to suggest limitations on this "technological arms race"--after all his firm makes its money by hosting the biggest of these races and allows the big boys to locate the hardware for their proprietary HFT desk on the exchange floor. Tyler Durden, however, has pointed out that High Frequency Trading is a very inefficient and problematic way to provide liquidity and that it exposes the market to major risks. On a typical day over half of the volume on major exchanges is provided by proprietary High Frequency Trading systems, not by human traders. But dealing with the risks this may pose, apparently, is the role of the government and the taxpayer.
Duhigg then describes what happened to the human traders on Wall Street when pitted against the HFT computers. It involves a recent incident where Intel had reported good earnings the previous evening and traders saw an opportunity to profit from 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.
The result is that the slower-moving investors paid $1.4 million for about 56,000 shares, or $7,800 more than if they had been able to move as quickly as the high-frequency traders.
It would seem that the new "for profit" NYSE finds it profitable to rent a few big boys enough of an advantage to suck up a significant portion of the profits of all of the other NYSE traders, not to mention the retail customers world wide. But now that they are "for profit" they need to make a profit.
"You want to encourage innovation, and you want to reward companies that have invested in technology and ideas that make the markets more efficient," said Andrew M. Brooks, head of United States equity trading at T. Rowe Price, a mutual fund and investment company that often competes with and uses high-frequency techniques. "But we're moving toward a two-tiered marketplace of the high-frequency arbitrage guys, and everyone else. People want to know they have a legitimate shot at getting a fair deal. Otherwise, the markets lose their integrity."
Perhaps something will come of all this exposure:
>Schumer Asks SEC to Ban Flash Orders Used by High-Speed Traders
July 24 (Bloomberg) -- Senator Charles Schumer asked the U.S. Securities and Exchange Commission to ban "flash orders," saying the transactions give high-speed traders an unfair advantage over other investors.
Nasdaq OMX Group Inc., Bats Exchange Inc. and Direct Edge Holdings Inc. hold these orders for milliseconds, giving their customers the opportunity to gauge demand before traders on other exchanges get the chance to bid, Schumer said in a letter to SEC Chairman Mary Schapiro. Brian Fallon, a spokesman at Schumer's office, confirmed the authenticity of the letter.
"Flash orders allow certain members of these exchanges to obtain access to order flow information before that information is made available to the public," Schumer wrote. That allows "those members to use rapid trading programs to trade ahead of those orders and profit from advanced knowledge of buying and selling activity," he added.
The senator said that if the SEC doesn't prohibit flash orders, he will introduce legislation that would.
We'll see.
