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Wall Street Has a Problem as High Frequency Trading Moves to Main Street

Posted by Larry Doyle on July 24, 2009 6:54 AM |

I am not here to rain on the parade, but I do think developments overnight have the potential to dramatically change the nature of our markets if not our economy. I am referring to issues surrounding high frequency program trading.

Until now, the debate over high frequency trading has largely been relegated to Wall Street periodicals, financial news outlets, and blogs, including Sense on Cents.

Well, this morning America awakens to see this high frequency debate course across the front page of The New York Times, Traders Profit With Computers Set at High Speed:

It is the hot new thing on Wall Street, 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.

Powerful computers, some housed right next to the machines that drive marketplaces like the New York Stock Exchange, enable high-frequency traders to transmit millions of orders at lightning speed and, their detractors contend, reap billions at everyone else’s expense.

These systems are so fast they can outsmart or outrun other investors, humans and computers alike. And after growing in the shadows for years, they are generating lots of talk.

Nearly everyone on Wall Street is wondering how hedge funds and large banks like Goldman Sachs are making so much money so soon after the financial system nearly collapsed. High-frequency trading is one answer.

This article is likely sweeping the globe at this very minute and, in my opinion, is particularly devastating in its tone and delivery . . . and justifiably so.

I can only imagine the commentary this evening at the local Rotary Club, Knights of Columbus, Lions Club, town carnivals, and church fairs. Probably something along these lines:

“Have you heard how Wall Street is screwing us?”

“I knew that game was never on the up and up.”

“What a bunch of thieves.”

Without entering into a debate over the merits or lack thereof of this high frequency program trading, I think Wall Street has a huge problem on its hands. Why? A question of fundamental fairness. With the publication and dissemination of this article, try to explain to the average Joe looking to buy 50 shares of IBM how he is being treated equitably.

As the New York Times reports:

“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.” (LD’s highlight)

What do you think? Please share your thoughts and opinions.


Related Commentary

Is Uncle Sam Manipulating the Markets?  July 1, 2009

Is Uncle Sam Manipulating the Markets?  Part II July 6, 2009

Is Uncle Sam Manipulating the Markets?  Part III July 8, 2009

Why High Frequency Program Trading Smells  July 14, 2009

High Frequency Trading: Point-Counterpoint July 17, 2009

  • gregory orr

    I would guess that investors who use market orders are mostly affected by this. I almost exclusively use limit orders, and let the market move me in and out of positions, so from my standpoint, Hi-Freak only adds liquidity to the market, and actually tightens up the bid-ask a bit…

    • asdf

      I’m sorry but your post indicates a completely lack of knowledge about high frequency program trading.

      A) HFPT WIDENS the bid-ask spread — this is how the algos pick up an extra few cents per trade.

      B) HFPT does indeed effect limit orders… the algos ‘ping’ using small blocks of 100 shares to discover your secret limit price, then sell to you AT THAT PRICE.

      This obviously makes it fraudulent, as they are discovering hidden information not available to ordinary market participants, and are exploiting it for financial gain.

      • Trader

        To ASDF: actually, your comment shows lack of understanding.
        A) Any group of added individuals/traders/programs to the market by definition dont increase spreads. How can adding a participant increase the existing NBBO? They can take the bid/ask, or they can post a limit order, but they have no power to widen the spread. By joining with other market participants, they, by definition, narrow spreads. Spreads today are as narrow as any time in history.
        B) normal investors do not use secret orders of any kind. Any normal brokerage account will display their clients limit orders in normal fashion – not with hidden reserve orders that might be pinged. Reserve orders or fractional orders are brought to market by institutions, and they are playing the game by hiding the true size of their orders. So, the fact they may get pinged/gamed doesnt really make me feel bad…the gamer gets gamed so to speak.

        Last, this is not fraudulent. There is a difference between being better/faster/smarter while playing within the regulations and cheating/lying/stealing/breaking the law.

        If anyone thinks co-location is bad – where do you draw the line? If you cant co-locate, then everyone who lives in NYC will still have an advantage to someone who lives in LA when trying to execute. Is that unfair? Kudlow (who I cant stand) actually made a great point this morning. He said that idiots in 1930 were blaming the telephone for creating market chaos. If you have a problem with fast trading, how do you slow it? If everyone is forced to slow down by 1 second, then you are still just as latent to your competitors as you are today.

        Now let me say also that flash orders and dark pools should be illegal and are operating in very grey at best areas. Dark pools operate in ways that disseminate a central marketplace which is counter to regulations. Flash orders operate within a loophole of reg nms…and even in that loophole are suspect at best. Close those holes, and you will have a more fair market….but you will still lose to speed no matter what you do the farther you live or operate from the exchanges so really what are you trying to do?

  • Larry Doyle

    Greg….great point. Thanks for adding that. Perhaps more investors should utilize limit orders to mitigate the negative impact of the hfpt. Thanks.

    Actually, in light of further color from asdf, perhaps even limit orders are subject to being gamed as well.

  • Actually..

    You guys who are still playing with fire in the stock market are, in my professional opinion, either not getting the message, or you have no clue what’s going on. The problem isn’t high frequency program trading by investors, it’s Plunge Protection Protocol manipulation by the FED and the U.S. government to make your dead horse you are feeding on, seem like a fresh meal. It’s a carcass, folks, truly it is, and one day you’ll find your teeth falling out of your greedy skulls for feasting on this rotting carcass’ very dead meat.

    I’d suggest getting all the way out of the market, lest you find yourself holding very empty bags. At some point, even the PPT artificial trading garbage they are using to create the illusion of a ‘life and viable’ market, will be unable to fool everyone.

    Next time you see road kill, don’t drool or salivate all over yourselves or wreck your car trying to get to it first, just drive on by and think; “man, I just know that will rot my damned portfolio..”

    time to kiss your corpse goodbye and walk briskly away from it, dear fools. It’s carrion. It’s been carrion on too long, people!

  • David

    Despite the high-frequency “community” justifying this high speed front-running as “market making” or simply replacing the specialists to provide liquidity — nice try. The reason we no longer need market makers/specialists/ and selfless high frequency traders is simply that in an instantaneous electronic platform buyers and sellers can make their own market — I think it’s called supply and demand if I remember econ. 101. To use loopholes in regulations to build a high speed arbitrage tool to skim millions, pennies at a time in milliseconds, is disingenuous and self-serving.
    I’m a very active trader who uses limit orders, but this nakedly predatory practice with market orders is another black eye for Wall Street professionals, always angling for an advantage. Now inside information comes in the form of milliseconds. Isn’t technology swell…

  • Petricone456

    I can definitely see why high-frequency trading (HFT) is becoming such a big issue but I can say it will be VERY difficult for the small mutual fund, let alone the small investor, to avoid the affects these strategies have on the prices of equity securities. Avoiding the affects will be extremely difficult and competing with these HFT shops on the investment front is almost out of the question. The real heart of the high frequency trading discussion should be centered on the exchanges themselves.

    First one needs to understand how an exchange makes money. The exchange makes money in a ‘maker-taker’ pricing schedule. This ‘maker-taker’ schedule commands firms to pay the exchange a fee to buy stock in return for a rebate any time the firm sells stock. The exchange simply pockets the spread between the fee and the rebate. While this spread is razor thin, the business of running an exchange is very profitable considering billions of shares change hands every day in the U.S. equity market.

    Here is the catch—exchanges offer volume discounts. The ‘maker-taker’ pricing schedule is tiered so that the more stock a firm trades the lower effective spread they pay to do so. HFT strategies game this tiered ‘maker-taker’ pricing structure at exchanges because it pays to do so. Check out this link to see how the exchange industry prices equity trading ( Notice that different exchanges pay higher rebates (known as the post rate) than others to draw greater volume and trading activity to their respective exchange. The difference in trading costs across multiple different exchanges is arbitraged by the HFT shops’ strategies and technology. Warren Buffett’s of the world need not apply! Welcome to the world’s most lucrative video game played by the world’s biggest geeks! (On a separate note, you will not see or hear that one year ago exchanges actually paid firms to trade ETFs by paying a higher post rate than take rate. Yes, exchanges actually paid brokerage firms to trade ETFs. Is it any wonder why trading in ETFs has exploded?)

    Again, the HFT trading world is extremely complex and driven by some seriously smart people. For an example of how complex the HFT trading world is you must understand the world of equity market structure. Take a look at this recent article from Trader’s Magazine to get a sense ( It talks about some pretty complex trading rules but you will see little mention of HFT strategies. What you will see, if you didn’t fall asleep reading the article, is that exchanges are setting up rules that create private markets that only HFT trading shops could take advantage of.

    Unless you are ready to tackle a room full of PhDs, the SEC and the exchanges themselves, I’d be prepared to continue your coexistence with high frequency trading shops. Exchanges became for profit companies not too long ago and provided opportunities for great investment returns for investors who bought in at the IPO price. Unfortunately, these for profit companies now have shareholders to report to—shareholders who want more volume and more profit. Unless exchanges return to being private companies they simply cannot and will not stop offering services that cater to high frequency trading strategies.

    To stay on top of issues relating to high frequency trading check out the ‘Wall Street & Technology’ website as I’ve found it to be a pretty informative website. Also Google search names like GETCO, WhiteCap Trading and Jamie Selway for additional information.

  • John Q.

    The problem for retail investors really isn’t so much with PPT, HFPT etc., as I see it. More realistically, it is the undeniable fact that HFPT does not trade individual stocks per se. Instead, it runs the indices(indexes) in a pre-sequenced movement, using varying baskets of stocks, each weighted differently for each “leg” of the sequence. These sequences are choreographed to instill good old FUD in the poor bloke trying to compete with a keyboard. But when all is said and done, the pattern is clearly visible. And, as they say, where there is a pattern, there is intent.

    I have spent countless hours studying the movements of indices and various stocks, and there is no doubt in my mind that overall market movement is not a function of individual stocks being traded on their own unique merits, as should be the case, but clear and unmistakable direction from an unknown party or parties. I base my (manual)trading on this understanding, and I do fairly well, despite also being sometimes assailed by FUD, owing to the pattern changes instituted every so often(for example, the pattern in the weeks prior to March 6 was different to that which prevailed for some 6 weeks after).

    This is my take on the markets as they are right now. The futures are worth exactly crap insofar as market direction goes. Some days, they don’t even indicate an approximation of where the market will open in the first 60 seconds. Next, a precise plan is in operation from the pre-market, subject only to extraordinary disruption by the day’s events. Even those events are incorporated into the day’s plan with the “black box” reading the news faster and sooner than human eyes, and assigning weightage to key words. Obviously, this is not an exact science, so sometimes there is some waffling. Finally, longer-term market direction is also under “guidance”, often flying in the face of the opinions of most people you talk to, analysts, investors, economists, etc.

    Who does control all of this, I do not know, but I am under no illusion that it is not under the control of some entity. Some people offer the opinion that HFPT is employed by “smarter” traders, despite the fact that the smartest individual trader, and even some trading houses, cannot afford the hundreds of millions of dollars it costs to develop and maintain such a system. What HFPT does, rather, is to deploy an unfathomable advantage into a machine that delivers profits at will to the entity, often at the expense of the bedeviled retail investor. This is the furthest thing from a level playing field for all investors.

  • Helvete

    Is the plunge protection team still around??

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