Written by William R. Rusk, GEI Associate
In anticipation of Michael Lewis’ new book, Flash Boys: A Wall Street Revolt (available April 1, 2014), GEI fuels your appetite for High Frequency Trading with this brief analysis. If you have any interaction with security markets, including most retirement accounts, then you have most likely been affected by HFT.
Computerized Markets
The benefits of computerized markets are pretty clear to just about anyone who is paying attention. Whether it is the vast amount of data that may be mined, or the convenience of trading and tracking securities virtually from anywhere, typically we share the belief that computerized trading has made our markets and therefore our economy more efficient. However, most people are not aware that for a fee, an institution may receive knowledge of large orders being placed a few fractions of a second before the general public is able to see the order. It is just a few fractions of a second, no big deal right? Wrong.
Enter the Data Oracles
In the blink of an eye a HFT, or firm with high frequency trading capabilities is able to not only determine the maximum price the buyer is willing to pay, but also effectively raise the price of the good to that max price. The HFT firms have the ability to raise the price of a good without adding any value, and a valid change in supply and demand is not occurring. Yet some experts still argue that HFT is making the markets more efficient and regulatory agencies are not exactly hot on the HFT trail.
Alright, so how are high frequency trading firms, which are mostly international banks, able to accomplish this technical and seemingly illegal feat of finance? Making the investment into super computers and complex algorithms is already assumed. Next the firm would participate in a “flash trade”, which is the name for paying an exchange for a sneak peak at a large order. What happens next is a bit complex but luckily it was eloquently explained by Karl Denninger in his article, “HFT: The High Frequency Trading Scam” written for Seeking Alpha back in July 2009.
