The Times Takes on High-Frequency Trading

The New York Times puts the high-frequency trading issue front and center on the nation’s agenda this morning with an excellent story above the fold on page one.

We’ve been calling for the press to hit this topic for weeks, ever since Reuters broke the news that an ex-Goldman Sachs employee had been arrested for allegedly stealing huge amounts of its proprietary automatic trading software code. So I’m particularly glad to see this piece.

Especially since reporter Charles Duhigg has the goods here. It’s not only an explainer on what high-frequency trading is, he’s got some reporting on a real-world example of the manipulation that it entails.

“Manipulate” is exactly what’s going on here and the Times is good not to shy away from using such a loaded word in its lede:

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.

That’s followed by some background:

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.

And that’s sure what it looks like from this story. Audit readers will recall we’ve repeatedly harped on the prosecutor’s statement in the Goldman code-theft case:

The bank has raised the possibility that there is a danger that somebody who knew how to use this program could use it to manipulate markets in unfair ways.

Which raised the obvious question of why Goldman couldn’t use it unfairly, too (by the way, Goldman is an Audit funder). The Times is good to quote from the prosecutor’s statement and also gets an apparent scoop that the SEC is “examining certain aspects of the strategy.”

What’s clear from this piece is that high-frequency trading is just another way that Wall Street craps on the little guy, as former SEC chief says:

“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.”

And not just because HFT is faster, it’s because it offers unfair advantages:

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.

This is presented as fact that doesn’t even need attribution in The New York Times, and I don’t doubt a lick of it.

But there’s more: The stock exchanges actually subsidize the high-frequency traders’ unfair advantage, as the Times reports.

The Times story has been excellent up to now, but what’s next is what moves it up a notch or two. I was really surprised Duhigg was able to get this, and it’s worth quoting at length:

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.

If this doesn’t cry out for a nice strong dose of regulation, I don’t know what does.

Applaud the Times for this excellent piece of reporting, and for giving it the play it deserves. Applaud Reuters and the blog Zero Hedge for hammering on this.

Let’s hope Congress and the administration pay attention. To ensure that, we’re going to need much more reporting on this area.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.