Remember that fake-fad of the early part of this century (at least in the U.S.), "flash mobs?"
Well, Wall Street has been practicing something called "flash trading," a computer-aided form of stock trading that recently got noticed thanks to a high-profile and somewhat damaging story in the New York Times, which you can read by clicking here.
There are two elements to this: high-frequency trading and flash trading.
Every big Wall Street firm does high-frequency trading. Super-fast computers use sophisticated algorithms to trade millions of shares of stock in a matter of seconds all day long, to make big profits out of small moves in huge volumes of stock.
Think about it like this: If a share of Stock X moves from $25 to $25.01 and back again to $25 in one second of normal trading, that's only one penny of profit realized during that one second of that stock's life. No human being can or will make money off that.
But a computer program can, if, for instance, it is programmed to buy 300,000 shares of Stock X at $25 and sell it at $25.01, even if that happens over only one second. Then do it again, and again and again, throughout the entire day. You can see how the arbitrage math adds up. Further, high-speed trading puts liquidity in the markets, which is a good thing.
What we're talking about here is special kind of high-frequency trading, called flash trading, and the reason it's on the hot seat is because it may be unfair to all traders.
In flash trading, some members of some exchanges -- including Nasdaq, Direct Edge and BATS -- get a look at buy and sell information a millisecond before it becomes available to the public.
Normally, this wouldn't make any difference. But when you have computers capable of making millions of computations in the span of a millisecond, it could mean millions of dollars.
Anyone can see how this is tacitly unfair: You have to have access to a super-computer to be a flash-trader. If you don't, you're at a disadvantage.
"In a pre-supercomputer era, specialist traders or market makers could get an early peek at prices, but they were also compelled to trade in a way that would benefit the markets as a whole—sometimes even taking a loss that they'd have to make up in the future. [High-frequency traders] have no such strictures, and that's what worries some people," writes Martha C. Wright in Slate's Big Money today.
Which is why SEC chairman Mary Schapiro said today that she has "asked the staff for an approach that can be quickly implemented to eliminate the inequity that results from flash orders."
Truth is, flash orders are a speck on the trading landscape. They made up only 2.4 percent of all U.S. shares traded in June.
But the money and technology sure matter to the big traders. A former Goldman Sachs computer programmer who left with some code he shouldn't have was recently arrested. The take on this is that the code was used for high-frequency trading.
Goldman's second-quarter earnings, reported earlier this month, zoomed up 33 percent compared to the same period last year. The firm attributed the profits -- amid a recession -- to increased trading revenue.
Further, and probably more importantly, this is an image issue: The SEC failed to catch Bernie Madoff. Schapiro wants to look like the new sheriff in town. Wall Street traders are seen as a bunch of guys who will find their way around any rule or regulation. Shutting down flash trading may not ding the markets that much, but it will be seen as a blow for the little guy.
-- Frank Ahrens
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