Speaking before a US House of Representatives panel, Securities and Exchange Commission Chair Mary Jo White addressed allegations about the high-frequency trading markets saying they “are not rigged.” Her statement was in response to allegations made in Michael Lewis’ book “Flash Boys: A Wall Street Revolt,” which questioned the role of this type of trading and whether investors end up at a disadvantage because of it.
High-speed trading is computer driven and impacts over half of the volume of the stock market. Firms that engage in high frequency trading subscribe to data feeds that are superfast and can see the trades before other investors can, allowing them to avail of the information first. Lewis contends that high-speed traders are doing a kind of front-running that lets firms quickly determine whether there is investor desire to purchase a stock. He says this lets buy the stock first and then sell it back to the investor at a slightly higher cost.
Since the book’s release, the US Attorney General, the Federal Bureau of Investigation, the SEC and prosecutors in New York have all said that they are looking into the practices of firms that engage in high-speed trading. The FBI wants to see whether high-speed firms are in violations of prohibitions tied to insider trading, while NY Attorney General Erich Schneiderman is probing links between high-speed firms and the exchanges to see whether the markets are “catering” to these traders.
SEC Trading and Markets division officials, however, have said that since computers began dominating trading, the average investors have experienced better results. Still, a number of SEC commissioners are worried that high speed trading and glitches in the market are causing investors to become squeamish.
Computers engaged in this type of trading can process hundreds of thousands of transactions daily. Each trade yields just a fraction of a penny of profit for every share-but that can still add up to a lot because so many trades happen. The computers transmit algobot programs to look for miniscule market spreads while monitoring what the competition is doing and trying to make the trades first. Tiny transaction fees are incurred during the process.
This can be frustrating for a human trader who can be pre-empted while trying to make a trade by an algobot that goes in to make the buy first. The algobot then offers the trader the same transaction but at a higher cost.
Some are questioning whether high-speed trading is really another form of front-running, which is against the law. In front-running, a company uses insider information to make the decision to buy a securities block. Unlike with insider information, which is proprietary and not available to the public, the information that prompts high-speed trading is accessible to all.
SEC chair to Congress: ‘The markets are not rigged’, Reuters, April 29, 2014
The many rewards, and the hidden risks, of high-frequency trading, Christian Science Monitor, April 27, 2014
Fallout From High-Frequency Trading Hits Brokerages, The Wall Street Journal, April 6, 2014
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