High Frequency Trading

 

stock-humor-buy I was explaining High Frequency Trading to my mother the other day over the phone.  In an oversimplification, what are, in effect, supercomputers that run extremely sophisticated algorithms are able to game the system in an undetectable way to generate millions of dollars of profits in fractions of a second.  They do it without any human interaction, and by and large, without their knowledge.  This is all legal mind you.  While I applaud ingenuity in almost all instances, there are rules for a reason.  The stock market was supposed to be a place where the average person was able to play on a level playing field with the big-time players.  We know this hasn’t been the case in some time (if ever, actually), but this takes matters to the extreme.  Here is how it works:

High Frequency Trading Programs account for 70% of market volume

High Frequency Trading Programs (HFTP) collect a ¼ of a penny rebate for every transaction they make. They’re not interested in making a gains from a trade, just collecting the rebate.

Let’s say an institutional investor has put in an order to buy 15,000 shares of XYZ company between $10.00 and $10.07. The institution’s buy program is designed to make this order without pushing up the stock price, so it buys the shares in chunks of 100 or so (often it also advertises to the index how many shares are left in the order).

First it buys 100 shares at $10.00. That order clears, so the program buys another 200 shares at $10.01. That clears, so the program buys another 500 shares at $10.03. At this point an HFTP will have recognized that an institutional investor is putting in a large staggered order.

The HFTP then begins front-running the institutional investor. So the HFTP puts in an order for 100 shares at $10.04. The broker who was selling shares to the institutional investor would obviously rather sell at a higher price (even if it’s just a penny). So the broker sells his shares to the HFTP at $10.04. The HFTP then turns around and sells its shares to the institutional investor for $10.04 (which was the institution’s next price anyway).

In this way, the trading program makes ½ a penny (one ¼ for buying from the broker and another ¼ for selling to the institution) AND makes the institutional trader pay a penny more on the shares.

And this kind of nonsense now comprises 70% OF ALL MARKET TRANSACTIONS. Put another way, the market is now no longer moving based on REAL orders, it’s moving based on a bunch of HFTPs gaming each other and REAL orders to earn fractions of a penny.

The Stock Market is Rigged! Surprise!

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~ by jvaudio on August 25, 2009.

One Response to “High Frequency Trading”

  1. […] Who knows whether the above is true or not. What can be said is that A) the theory of market manipulation has some support in Pigou who said that markets quite often boomed and busted due to psychological biases that caused people to overinvest in useless things or excess capacity, such a world could surely also be manipulated in the manner mentioned above, and B) It can’t be out of the realm of possibility in a world where 70% of market volume is comprised of High Frequency Trades. […]

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