High-Frequency Trading

[WallyWeaver]

For those of us who have been paying attention to the wild fluctuations in gold/ silver prices (GLD, AGQ, etc.) over the past year and a half, this may give you some insight as to what we're up against. Don't worry, though, gold was $248/ oz. about 10 years ago....

WW.

High-Frequency Trading

Updated: Dec. 4, 2012

Over the past few years, high-speed or high-frequency trading — known as H.F.T. — was the biggest new thing to hit Wall Street trading, and in the minds of many, the most disruptive. On any given day, this lightning-quick, computer-driven form of trading accounts for half of all of the business transacted on the nation’s stock markets.

Critics say H.F.T. has contributed to the hair-raising flash crashes and computer hiccups that seem to roil the markets with alarming frequency.

H.F.T. first became a significant part of the Wall Street scene in the 1980s, when it was blamed for exacerbating the market plunges in October 1987. Since then, the computers involved have grown vastly more powerful and the algorithms that guide their trading vastly more sophisticated.

For years, H.F.T. firms have operated in the shadows, often far from Wall Street, trading stocks at warp speed and reaping billions while criticism rose that they were damaging markets and hurting ordinary investors. More recently, they have been stepping into the light to buff their image with regulators, the public and other investors.

At the same time, figures suggest that the practice may be cooling down a bit. Profits from high-speed trading in American stocks were on track to be, at most, $1.25 billion in 2012, down 35 percent from 2011 and 74 percent lower than the peak of about $4.9 billion in 2009, according to estimates from the brokerage firm Rosenblatt Securities. And the percentage of stock trades handled by firms that specialize in H.F.T. fell to about 51 percent in 2012 from 60 percent in 2009.

Drops in overall trading volume have made it harder to make profits for traders who quickly buy and sell shares offered by slower investors. In addition, traditional investors like mutual funds have adopted the high-speed industry’s automated strategies while the technological costs of shaving further milliseconds off trade times has become a bigger drain on many companies.

Meanwhile, the firms are trying to stave off the regulators who are proposing to curb their activities. To make their case, the firms have formed their first industry trade group, hired former Securities and Exchange Commission staff members and spent nearly $2 million in the last few years on Washington lobbying and contributions to lawmakers. Some even want to be called “automated trading professionals” rather than high-frequency traders.

High-Speed Trades Hurt Investors, U.S. Study Says

In early December 2012, a top government economist, Andrei Kirilenko, concluded in a new study that the high-speed trading firms that have come to dominate the nation’s financial markets are taking significant profits from traditional investors.

Mr. Kirilenko, the chief economist at the Commodity Futures Trading Commission, reported that high-frequency traders make an average profit of as much as $5.05 each time they go up against small traders buying and selling one of the most widely used financial contracts.

The agency has not endorsed Mr. Kirilenko’s findings, which are still being reviewed by peers, and they are already encountering some resistance from academics. But Bart Chilton, one of five C.F.T.C. commissioners, said on Dec. 3 that “what the study shows is that high-frequency traders are really the new middleman in exchange trading, and they’re taking some of the cream off the top.”

The study came as the Financial Stability Oversight Council, an organization of the nation’s top financial regulators, is showing increasing concern that the accelerating automation and speed of the financial markets may represent a threat both to other investors and to the stability of the financial system.

The oversight council, which includes Treasury Secretary Timothy F. Geithner and Ben S. Bernanke, the Federal Reserve chairman, took up the issue at a meeting in November that was closed to the public. The council said in its annual report this summer that recent developments “could lead to unintended errors cascading through the financial system.” The C.F.T.C. is a member of the oversight council.

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Mr. Kirilenko’s study focused on one corner of the financial markets that the C.F.T.C. oversees, contracts that are settled based on the future value of the Standard & Poor’s 500-stock index. He and his co-authors, professors at Princeton and the University of Washington, chose the contract because it is one of the most heavily traded financial assets in any market and is popular with a broad array of investors.

Using previously private data, Mr. Kirilenko’s team found that from August 2010 to August 2012, high-frequency trading firms were able to reliably capture profits by buying and selling futures contracts from several types of traditional investors.

The researchers found that more aggressive traders accounted for the largest share of trading volume and made the biggest profits. The most aggressive scored an average profit of $1.92 for every futures contract they traded with big institutional investors, and made an average $3.49 with a smaller, retail investor. Passive traders, on the other hand, saw a small loss on each contract traded with institutional investors, but they made a bigger profit against retail investors, of $5.05 a contract.

Background

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 S.E.C. 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 a 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.

Link: http://topics.nytime...ding/index.html