Best of the Week
Most Popular
1.Spain Ignores Scotland Lesson as Catalan Independence Referendum Could Spark Civil War - Nadeem_Walayat
2.Used Car Buying From UK Dealer Top Tips, CarMotion.co.uk Real Customer Experience - N_Walayat
3.Spanish New Civil War Begins as Madrid Regime Storm Troopers Quell Catalan Independence Rebellion - Nadeem_Walayat
4.Virgin Media Broadband Down, Catastrophic UK Wide Failure! - Nadeem_Walayat
5.Are the US Markets setting up for an Early October Surprise? - Chris_Vermeulen
6.The Pension Storm Is Coming To Europe—It May Be The End Of Europe As We Know It -John_Mauldin
7.Stock Market Crash 2018; Will it Prove to be Another Buying Opportunity - Sol_Palha
8.The Profoundly Personal Impact Of The National Debt On Our Retirements - Dan_Amerman
9.Stock Market as Good as it Gets; Like 2000 With a Twist -Gary_Tanashian
10.1987 Stock Market Crash 30th Anniversary Greatest Investing Lesson Learned - Nadeem_Walayat
Last 7 days
Debt-Driven Consumer Economy Breaking Down - 23rd Oct 17
Next Wall Street Stock Market Crash Looms? Lessons On Anniversary Of 1987 Crash - 23rd Oct 17
This Super Metal Is Set To Soar By 300% - 23rd Oct 17
More New Record Highs As S&P 500 Gets Closer To 2,600 Mark - 23rd Oct 17
Another Minor Stock Market Top? - 23rd Oct 17
Bitcoin Hits $6,000, $100 Billion Market Cap As Helicopter Ben and Jamie Demon Warn The End Is Near! - 22nd Oct 17
Time for Caution in Gold Miners - 22nd Oct 17
“Great Rotation” Ahead; Will it Be Inflationary or Deflationary? - 21st Oct 17
The Trigger for Volatility, Rates and the Next Crisis - 21st Oct 17
Perks to Consider an Agent for Auto Insurance - 21st Oct 17
Emerging Megatrends Hurting Consumers - 21st Oct 17
A Catalyst of the Stock Market Bubble Bust - 21st Oct 17
Silver Stocks Comatose - 21st Oct 17
Stock Investors Ignore What May Be The Biggest Policy Error In History - 20th Oct 17
Gold Up 74% Since Last Stock Market Peak 10 Years Ago - 20th Oct 17
Labour Sheffield City Council Employs Army of Spy's to Track Down Tree Campaigners / Felling's Watchers - 20th Oct 17
Stock Market Calm Before The Storm - 20th Oct 17
GOLD Price Creates Bullish Higher Low - 20th Oct 17
Here’s the US’s Biggest Vulnerability in NAFTA Negotiations - 20th Oct 17
The Greatest Investing Lesson Learned from the 1987 Stock Market Crash - 20th Oct 17
Stock Market Time to Go All-in. Short, That Is - 19th Oct 17
How Gold Bullion Protects From Conflict And War - 19th Oct 17
Stock Market Super Cycle Wave C May Have Started - 19th Oct 17
Negative Expectations, Will the Stock Market Correct? - 19th Oct 17
Knowing the Factors Affect your Car Insurance Premium - 19th Oct 17
Getting Your Feet Wet In Crypto Currencies - 19th Oct 17
10 Years Ago Today a Stocks Bear Market Started - 19th Oct 17
1987 Stock Market Crash 30th Anniversary Greatest Investing Lesson Learned - 19th Oct 17
Virgin Media Broadband Down, Catastrophic UK Wide Failure! - 19th Oct 17
The Passive Investing Bubble May Trigger A Massive Exodus from Stocks - 18th Oct 17
Gold Is In A Dangerous Spot - 18th Oct 17
History Says Global Debt Levels Will Lead to Another Crisis - 18th Oct 17
Deflation Basics Series: The Quantity Theory of Money - 18th Oct 17
Attractive European Countries for Foreign Investors - 18th Oct 17
Financial Transcription Services – What investors should know about them - 18th Oct 17
Brexit UK Vulnerable As Gold Bar Exports Distort UK Trade Figures - 18th Oct 17
Surge in UK Race Hate Crimes, Micro-Racism, Sheffield, Millhouses Park, Black on Asian - 18th Oct 17
Comfortably Numb: Surviving the Assault on Silver - 17th Oct 17
Are Amey Street Tree Felling's Devaluing Sheffield House Prices? - 17th Oct 17
12 Real-Life Techniques That Will Make You a Better Trader Now - 17th Oct 17
Warren Buffett Predicting Dow One Million - Being Bold Or Overly Cautious? - 17th Oct 17
Globalization is Poverty - 17th Oct 17
Boomers Are Not Saving Enough for Retirement, Neither Is the Government - 16th Oct 17
Stock Market Trading Dow Theory - 16th Oct 17
Stocks Slightly Higher as They Set New Record Highs - 16th Oct 17
Why is Big Data is so Important for Casino Player Acquisition and Retention - 16th Oct 17
How Investors Can Play The Bitcoin Boom - 16th Oct 17
Who Will Be the Next Fed Chief - And Why It Matters  - 16th Oct 17
Stock Market Only Minor Top Ahead - 16th Oct 17
Precious Metals Sector is on Major Buy Signal - 16th Oct 17
Really Bad Ideas - The Fed Should Have And Defend An Inflation Target - 16th Oct 17
The Bullish Chartology for Gold - 15th Oct 17
Wikileaks Mocking US Government Over Bitcoin Shows Why There Is No Stopping Bitcoin - 15th Oct 17
How to Wipe Out Puerto Rico's Debt Without Hurting Bondholders - 15th Oct 17
Gold And Silver – Think Prices Are Manipulated? Look In The Mirror! - 15th Oct 17

Market Oracle FREE Newsletter

3 Videos + 8 Charts = Opportunities You Need to See - Free

High-Frequency Trading Has the Potential to Kill the Markets

Stock-Markets / Financial Markets 2012 Aug 17, 2012 - 10:46 AM GMT

By: money_morning

Stock-Markets

Best Financial Markets Analysis ArticleShah Gilani writes: It's no wonder the public is scared to invest in stocks. They believe the game is rigged.

It is, and I'm going to tell you who's behind it, what's really happening, when it started, where the sinkholes are, why they're there, how you can play in the short run, and how America can get back to investing in a successful long-term future.


The bad news is the problems infecting our capital markets are all systemic. The good news is that they can be eradicated one by one, if not all at once (which won't happen).

Today, we're going to look behind the curtain of high-frequency trading.

It's a nasty bug in the system and has long-term consequences, including the potential to kill the markets.

First of all, high-frequency trading isn't just what you think it is. It is much more than you know, and is in fact part of the fabric of the markets.

High-frequency trading (HFT) is known to be a game that specialized firms and trading desks play. Here's what most people think they know about high-frequency trading.

The HFT crowd uses super-fast computers to execute trades across different exchanges. There are 15 exchanges in the U.S. and more than forty "dark pools" (private trading venues that serve as de-facto exchanges) where shares can be traded.

Part of the problem is that there are so many trading venues trading the same stocks, but that's another story.

Here's what the high-frequency trading game is really about.

The HFT game is about sometimes setting-up and almost always "picking-off" trades that represent tiny discrepancies in prices across all those different trading venues.

Sometimes HFT trades are arbitrage plays where a position is bought somewhere and sold simultaneously somewhere else because price discrepancies across different exchanges make such opportunities possible.

Sometimes HFT plays are manufactured by "pinging" (sending out fake orders to try and move prices), which triggers other orders to be sent, which in turn are picked-off, or to be more politically correct, traded upon.

It's Actually High-Speed Trading
The truth is that almost all trading today is high-speed trading. So to call it all what it really is, we're going to label the problem we're highlighting today "high-speed trading," of which actual high-frequency trading is a huge part.

Who is involved in high-speed trading? Everyone.

The bottom line of trading, or investing for that matter, is that they are both driven by prices. Bids and offers - what people will pay to buy shares and what they are offering to sell them for - are important. People want to get the best price whether they're buying or selling, whether they're trading or investing.

Bids and offers are posted on exchanges (they are not posted in dark pools, hence the name). The object of speedy execution is to reach the place where the shares you want to buy or sell are posted at the prices you want. The first one there gets the shares. That's the simple explanation, without going into how many shares are being bid for or offered at any given price.

So speed is important. That's why everyone is in on the speed train, traders, investors, and exchanges, too.

What the game has wrought, however, is a mountain of unintended consequences. (Although "unintended" can be easily argued, usually by folks like me. But that's another story.)

What's going on is that competition for trades (transactions by themselves are money-makers because people pay to get their trades executed; they pay brokers, trading platform operators, and exchanges) forces intermediaries (brokers and brokerages) and some exchange venues to actually pay for "order flow."

The idea of paying for order flow is that if you have a lot of orders on your exchange to buy and sell any given stock, chances are the spread (the difference between the bid and ask) will be narrower and liquidity (the ability to trade more shares at better prices) will be deeper.

But none of that much matters if you can't get to those opportunities fast enough. So, we're back to speed being a major component.

How fast is fast, by the way? According to Celnet in the past ten years or so, the time it takes to execute a trade on the NYSE has dropped from 3.2 seconds to 48 milliseconds. And that's on a slow day.

Trades can and are routinely executed in fractions of a millisecond, partly depending on how close someone's servers are to the servers that house the exchanges bids and offers.

Feeding the Speed Machine
As I said, the problem (which, don't worry I'll get to, and you will cringe), is systemic. As far as who's involved - which is almost everyone - the exchanges are the biggest purveyors of speed. They feed the speed machine because they get paid to.

For example, in 2010 the NYSE-Euronext opened a $600 million, 400,000 square feet (that's seven football fields) server location in Mahwah, New Jersey, just across the river from the exchange's trading floor.

Why so big? Because they rent space right next to their servers for brokerages and firms and traders that want speedy access to the servers to reduce "latency" (the time it takes to get an order from one spot to another), making super-fast trade executions even faster.

It's systemic because other exchanges do the same for high speed junkies. They get paid to rent space next to their servers; they get paid for each transaction they make. It's about money.

When this all started is quite telling. Starting in 1998, electronic venues were allowed to compete with established exchanges for transaction business, and speed was one of the factors offered as a reason for more competition.

What's interesting is that if you parallel the advent of faster and faster trading, it coincides with the markets essentially being flat over the same time horizon.

Why this is happening is obvious. There's money to be made in pushing speed.

Systemically, the speed game has spawned multiple Wall Street money-making opportunities. Whether it's the exchanges co-hosting trading servers on their premises, or HFT players who now account for between 50% and 70% of trading volume on any given day, or the proliferation of traders and trading desks everywhere, speed equals greed.

So what's the problem with speed and greed? Systems break down when they can't handle it.

Remember the "Flash Crash" in May 2010? How about high-speed exchange BATS blowing up its own IPO on its own exchange because of a technology speed bump?

Or the Facebook Inc. (NasdaqGS: FB) IPO fiasco that imploded because the Nasdaq couldn't handle all the speed orders fast enough? Or that Knight Capital almost said goodnight to its future when its new high-speed software, meant to compete with the NYSE's new kind-of paying for order flow game, blew up in its face?

Oh, and what does Knight do? It buys order flow from the likes of Fidelity, E-Trade, TD-Ameritrade, and a whole lot more outfits.

Speed Kills
What's undermining investor confidence in stocks is that it's all about speed and what Wall Street gets from having the advantage, and what games Wall Street erected to make money from the speed circuit that drives trading.

It's about trading, not investing. It's all about punching out what incremental gains you can in the short term, not about going the distance with safe investments in the long term.

If there are more speed traps, and there will be, markets will collapse one day. When the HFT guys doing more than half the trading on every day the markets are open disappear (as they did during the Flash Crash), and the liquidity they swear they provide dries up like an Iowa cornfield, we'll see how quickly desperate sell orders are executed.

Oh, never mind. Speed won't be a problem if that happens. The SEC, in their infinite wisdom, will shut the markets down with circuit-breakers and cooling-off periods.

Instead of addressing the speed problem, they're going to use a Band-Aid on what will amount to a heart-attack victim.

It happened before and the public knows it will happen again. That's the tragedy. That's why there is no confidence in our markets.

The only way to play these days is to join the short-term trading crowd and not get burned holding onto volatile stocks that, no matter how good-looking, can be turned upside down in a New York minute by the velocity of truth.

And the truth is... speed kills.

If we ever want to fix the markets and make them safe again, we're going to have to slow down the speeding train that's taking us all over the proverbial cliff.

Source :http://moneymorning.com/2012/08/17/the-truth-behind-the-tragedy-of-high-frequency-trading/

Money Morning/The Money Map Report

©2012 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2017 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife