The fragmentation of the stock market and high-speed computerized trading have transformed the market into a “playground of Google – esque algorithms, powerful banks and secretive, fast-money trading firms.” You don’t want your 401(k) playing here.
Gone are the days when human traders called the shots from the floor of the N.Y. Stock Exchange and investors more often bought stock after studying a company’s financial statements.
About 70% of stock trading in the U.S. and 35% in the U.K. is done via high-speed computerized trading known as “high-frequency trading.” (H.F.T.) Stock orders are placed and withdrawn in milliseconds based on computer-generated algorithms (aka “algos”). Trading firms engage in technological arms races to obtain the fastest computers capable of exploiting minute price differentials among stock exchanges and other trading platforms, including the private platforms known as “dark pools” where hedge funds and other big traders can operate largely out of public view.
The U.K. is opposing EU efforts to crack down on H.F.T. One of the EU’s proposed new rules “would require high-speed firms to honor the quotes they submit for at least 500 thousandths of a second, an eternity for firms that are used to submitting and withdrawing quotes in millionths of a second.”
Despite systemic risks and recurring market flash crashes, the U.S. is lagging far behind reform efforts in the EU, Canada, Germany, and Australia. The vast increase in the volumes of trades generated by H.F.T. benefits banks’ trading desks and other exchanges.
The 2010 “flash crash” in the U.S. was caused by a feedback loop among computers that sent the stock market into a 9% plunge. Numerous flash mini-crashes followed. This August, Knight Capital lost $400 million in a few hours because of computer glitches.
Two critics of H.F.T., Sal Arnuk and Joseph Saluzzi, are garnering widespread praise for their new book, Broken Markets: How High-Frequency Trading and Predatory Practices Are Destroying Confidence and Your Portfolio. The two would “require H.F.T. firms to honor the prices they offer for a stock for at least 50 milliseconds.” Sound reasonable?