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High-speed traders on inside track

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Saturday, April 12, 2014, 9:00 p.m.
 

Michael Lewis' new book, “Flash Boys: A Wall Street Revolt,” has caused a tremor among investors. A fictionalized account, it nevertheless highlights a long-suspected fear that Wall Street stock markets are rigged in favor of high-frequency or high-speed traders.

These traders apparently use detailed information and high-speed connections to make billions of dollars in incremental amounts so small and hidden that they can escape the eyes of regulators. High-frequency trading, and particularly the privileged data stream connections it enjoys, does appear to put normal investors at an unfair disadvantage.

The sophisticated computer algorithms and trading strategies are carried out by computer in milliseconds.

The argument over high-frequency trading does not center on speed or sophisticated software, which might be considered an acceptable competitive advantage. Rather, the criticism is focused on the clearly privileged data feeds offered by stock exchanges to proprietary clients — at a price. Questions arise as to whether this privileged information leads to “insider trading,” which has been illegal for more than 80 years.

According to Bloomberg Businessweek, New York Attorney General Eric Schneiderman described high-frequency trading as “insider trading 2.0.”

It offers opportunities for “front running” and “quote stuffing,” whereby 10,000 instantly canceled orders can create synthetic buying or selling pressure affecting other orders.

Stock exchanges disseminate the latest stock price information to the public through a consolidated data feed to the public securities information processor. Exchanges sell more detailed “proprietary data” directly to subscribers. By law, both data feeds must be entered simultaneously. But it is the onward transmission that creates a possible unfair advantage. The faster and more full information transmitted through proprietary systems appears to favor financial “fat cats.”

Such favors appear to be expensive and very profitable for the exchanges. Bloomberg reports that NASDAQ's proprietary revenues increased two-fold between 2006 and 2012 to $150 million. Meanwhile, its feed revenue to “conventional” investors fell by 21 percent.

High-frequency traders pay for timely price data of increased depth. More concerning, they pay even more for hyper-speed, onward data transmission by means of faster computer processing, fiber-optic cables and laser beams.

High-frequency trades are so fast that even the speed of light becomes a limitation. Both travel at essentially the same speed of 186,282 miles a second, or “only” 186 miles in a millisecond. Therefore, high-frequency traders locate their data collection points as close as possible to stock exchange data distribution points.

Sophisticated people would not go to these extreme lengths unless it was outrageously profitable — even unfairly profitable.

At a glance, it appears that these trading practices and the distribution of price data from exchanges are in need of serious examination by regulators so that the playing field is not as uneven as the computer simulated destruction of Heinz Field in the movie “The Dark Knight Rises.”

John Browne, a former member of Britain's Parliament, is a financial and economics columnist for Trib Total Media. Contact him at johnbrowne70@yahoo.com.

 

 
 


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