Predatory High Frequency Trading: A CALL TO ACTION SERIES-Part 2

Predatory High Frequency Trading: A CALL TO ACTION SERIES-Part 2

This post is the third installment of an ongoing series. Please read my prior blog posts under “Predatory High Frequency Trading: A Call to Action Series” for more complete information. Now that we know what High Frequency Trading (HFT) is, let’s look at the circumstances that led up to the current state of affairs where over half of the trading volume (total number of trades per day) executed through our exchanges are now effected by HFT. How Could This Happen? Like many other unintended consequences predatory high frequency trading (HFT) was made possible by regulatory action meant to protect investors. Electronic trading was originally implemented in the late 80’s to ensure that investor orders would be executed in a timely manner even if human market makers were unavailable or hiding (i.e. Black Monday when traders just stopped answering phones so investors couldn’t continue to sell securities). Since then electronic trading in general has been considered a very valuable technological advancement allowing faster and more accurate trade execution and lower trade costs, but it isn’t without issues. As electronic trading replaced the human element on all exchange floors, it became harder to control pricing fairness between investor and trader. There are 13 major exchanges in the United States including the well-known New York Stock Exchange, plus many small off shoot exchanges, so altogether there are around 50. As a result a security, say GE stock, may be offered for sale on many exchanges at the same time at many different prices. Over the years it became increasingly difficult to tell if one was getting a good price for a security or not. Regulation NMS was the SEC’s attempt to create a consolidated marketplace with fair pricing, more accurate quotations,...
Predatory High Frequency Trading: A CALL TO ACTION SERIES-Part 1

Predatory High Frequency Trading: A CALL TO ACTION SERIES-Part 1

This post is the second installment of an ongoing series. Please read my prior blog post “Predatory High Frequency Trading: A Call to Action Series – Introduction.”     What Is Predatory High Frequency Trading? As I mentioned in the introduction to this series, not all High Frequency Trading (HFT) is created equally. Some HFT actually serves to create more and faster access to investor capital, what we call liquidity. HFT was developed by people in innovative firms familiar with the way trade information is disseminated electronically between the various stocks exchanges and the exchanges’ antiquated, patch-worked computer systems. These firms have better, sleeker technology and higher paid computer programmers that give them quicker access to stock pricing information than most exchanges have. This along with more direct physical server location to each exchange, creates speed the exchanges can’t compete with. This speed and co-location allows them to see stock prices before anyone else, including the Securities Information Processing (SIP) system which was designed and implemented by regulators in 2007 to coordinate security pricing from all exchanges to produce an average or “best” price for a security. As you can imagine, advanced pricing information made this innovation ripe for exploitation. Enter predatory HFT. With a lot of help from expertly designed algorithms, some high frequency traders decided to manipulate bid and offer prices by small percentages or fractions of a percentage then pocket the difference or “spread” between the original prices of the stock and their newly engineered price. The profit derived from each spread transaction may only be a fraction of a penny so most traders don’t notice it. However, large institutional traders that trade thousands of shares of each security at one time noticed. For them, the price instability they were suddenly seeing...
Predatory High Frequency Trading: A CALL TO ACTION SERIES-Introduction

Predatory High Frequency Trading: A CALL TO ACTION SERIES-Introduction

That Was Then… My office is located in a historic building in the nation’s oldest city, which also happens to be my home town. Today the ground floor serves as an events venue of old world sophistication and grandeur. From the huge marble columns that line the room on both sides, to the hand crafted scroll work on the walls, there is no doubt it was designed to impress. In all the opulence, however, one object at the back of the room seems out of place. It’s a huge round vault door. The building was originally built in 1928, to house First National Bank. While the bank’s name changed many times over the years, the vault door remained a constant. I was so thankful that the venue’s owners decided to retrofit the vault into a hip bar area instead of doing away with this enduring piece of my personal history. As a child, I loved visiting the bank just to stare in awe at door. It’s massive at about 8 feet in diameter and 2 feet thick. During the day the door stood open exposing the intricate inner workings of complex metal gears and locking mechanisms. It looked absolutely impenetrable! I assumed that the money we deposited into the bank would always be safe behind that door. But that was then… This is Now… Now I know that security can be an illusion. Like everyone else the Great Recession rocked my world by exposing the fragility and greed of some of our most trusted financial institutions. It was even more disturbing to realize that my chosen profession seemed to be intertwined with the very financial institutions involved in causing the crisis. I had to be strong for...