From The New York Times
It is the hot new thing on Wall Street , a way for a handful of traders to master the stock market, peek at investors’ orders and, critics say, even subtly manipulate share prices.
It is called high-frequency trading — and it is suddenly one of the most talked-about and mysterious forces in the markets.
Powerful computers, some housed right next to the machines that drive marketplaces such as the New York Stock Exchange, enable highfrequency traders to transmit millions of orders at lightning speed and, their detractors contend, reap billions at everyone else’s expense.
These systems are so fast they can outsmart or outrun other investors, humans and computers alike. And after growing in the shadows for years, they are generating lots of talk.
Nearly everyone on Wall Street is wondering how hedge funds and large banks such as Goldman Sachs are making so much money so soon after the financial system nearly collapsed. High-frequency trading is one answer.
And when a former Goldman Sachs programmer was accused this month of stealing secret computer codes — software that a federal prosecutor said could “manipulate markets in unfair ways” — it only added to the mystery. Goldman acknowledges that it profits from high-frequency trading, but disputes that it has an unfair advantage.
Yet high-frequency specialists clearly have an edge over typical traders, let alone ordinary investors. The U.S. Securities and Exchange Commission says it is examining certain aspects of the strategy.
“This is where all the money is getting made,” said William Donaldson, former chairman and chief executive of the New York Stock Exchange and today an advisor to a big hedge fund. “If an individual investor doesn’t have the means to keep up, they’re at a huge disadvantage.”
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 SEC authorized electronic exchanges to compete with marketplaces such as 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 per 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.
“It’s become a technological arms race, and what separates winners and losers is how fast they can move,” said Joseph Mecane of NYSE Euronext, which operates the New York Stock Exchange. “Markets need liquidity, and high-frequency traders provide opportunities for other investors to buy and sell.”
The rise of high-frequency trading helps explain why activity on the United States’ stock exchanges has exploded. Average daily volume has soared by 164% since 2005, according to data from NYSE. Although precise figures are elusive, stock exchanges say that a handful of high-frequency traders now account for a more than half of all trades.
High-frequency traders generated about US$21-billion in profits last year, the Tabb Group, a research firm, estimates.
“You want to encourage innovation, and you want to reward companies that have invested in technology and ideas that make the markets more efficient,” said Andrew Brooks, head of United States equity trading at T. Rowe Price, a mutual-fund and investment company that often competes with and uses high-frequency techniques.
“But we’re moving toward a two-tiered marketplace of the high-frequency arbitrage guys, and everyone else. People want to know they have a legitimate shot at getting a fair deal,” Mr. Brooks said.
“Otherwise, the markets lose their integrity.”
