Saturday, July 25, 2009

Stock Trading On The Internet Is 100% Failure

Are you one of the hundred of thousand trading stocks on the internet? Well, there are a few people, right at the top of the food chain, who know exactly what you all are doing...and flashing this valuable information to the selected few. These few can than use that information so you will earn some money sometimes...but no too much. Just enough to brag the results of your trading knowledge and capabilities to your friends and just enough to keep you interested in their the game. Result: a few hundred of billions of Dollars of commissions. No, no, not for you....for them, silly. Conclusion: you are being set up for failure while trading via the internet on the stock exchange. This is because they want your money....and they want lots of it.

Update: Flash trading for the selected few (certainly not you) (Zero Hedge)
Update 1: Senator wants SEC to ban "flashing" (Reuters)
Update 3: High Frequency trading is Insider trading (Huffington Post)
Update 4: Sen. Edward Kaufman: A level Playing Field For Investors (Real Clear Markets)

Market manipulation and insider trading with the exchange's OK


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 like the New York Stock Exchange, enable high-frequency 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 like 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 Securities and Exchange Commission says it is examining certain aspects of the strategy.

"This is where all the money is getting made," said William H. Donaldson, former chairman and chief executive of the New York Stock Exchange and today an adviser 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 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 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 M. 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 nation's stock exchanges has exploded. Average daily volume has soared by 164 percent 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. To understand this high-speed world, consider what happened when slow-moving traders went up against high-frequency robots earlier this month, and ended up handing spoils to lightning-fast computers.

It was July 15, and Intel, the computer chip giant, had reporting robust earnings the night before. Some investors, smelling opportunity, set out to buy shares in the semiconductor company Broadcom. (Their activities were described by an investor at a major Wall Street firm who spoke on the condition of anonymity to protect his job.) The slower traders faced a quandary: If they sought to buy a large number of shares at once, they would tip their hand and risk driving up Broadcom's price. So, as is often the case on Wall Street, they divided their orders into dozens of small batches, hoping to cover their tracks. One second after the market opened, shares of Broadcom started changing hands at $26.20.

The slower traders began issuing buy orders. But rather than being shown to all potential sellers at the same time, some of those orders were most likely routed to a collection of high-frequency traders for just 30 milliseconds -- 0.03 seconds -- in what are known as flash orders. While markets are supposed to ensure transparency by showing orders to everyone simultaneously, a loophole in regulations allows marketplaces like Nasdaq to show traders some orders ahead of everyone else in exchange for a fee.

In less than half a second, high-frequency traders gained a valuable insight: The hunger for Broadcom was growing. Their computers began buying up Broadcom shares and then reselling them to the slower investors at higher prices. The overall price of Broadcom began to rise.

Soon thousands of orders began flooding the markets as high-frequency software went into high gear. Automatic programs began issuing and canceling tiny orders within milliseconds to determine how much the slower traders were willing to pay. The high-frequency computers quickly determined that some investors' upper limit was $26.40. The price shot to $26.39, and high-frequency programs began offering to sell hundreds of thousands of shares.

The result is that the slower-moving investors paid $1.4 million for about 56,000 shares, or $7,800 more than if they had been able to move as quickly as the high-frequency traders.

Multiply such trades across thousands of stocks a day, and the profits are substantial. High-frequency traders generated about $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 M. 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. Otherwise the markets lose their integrity."


  1. Surely the issue here is that everyone needs access to high performance execution, not that there is anything inherently wrong with it. To try to rule out this approach would be like insisting everyone stick to using the horse and cart because the car is faster.

    Low latency execution services, available as managed services to everyone, and with orders undisclosed until the point the execution algorithms are triggered, provides the answer, but it needs a genuinely peer-to-peer execution infrastructure, instead of the currently olipolistic model being promulgated by certain exchanges (especially NYSE-Euronext).

    The current tiered approach, with orders accumulated into sell-side firms, then run through their systematic internalisers, and then their own dark pools, before being finally placed out into external execution venues, doesn't serve the investor well, but the issue isn't the low-latency guys, its the structure of the market. Low latency is just a toolkit, and risk is minimised with fast infrastructure, so I think any needed reform initiatives should be focussed elsewhere.

  2. The issue is "trust".
    If small investors turn around because they feel they are dealing in a crooked system, the complete stock exchange could come to a standstill. Apparently there are no markets anymore, only interventions.