The press continues to try to shine a light on high-frequency trading.
This morning, The Wall Street Journal reports on one tactic called “naked” access, which it says allows traders to trade anonymously through brokerage firms’ accounts. Yesterday, Matthew Goldstein of Reuters examined how high-frequency trading gone awry can hurt the little guy.
The SEC is already trying to ban a form of high-frequency trading called a flash order that lets some firms see orders for split-second before the rest of the market. The Journal reports it’s also scrutinizing naked access, which the paper explains here:
Sponsored access is akin to members of an exclusive club charging others to use their pass. The members in this case are registered brokerage firms that are approved and pay to trade on exchanges. High-frequency firms or other traders such as hedge funds cut deals with these regulated brokerage firms that let them use their computer access codes — known as a “market participant ID” — to trade directly on exchange computers that match buy and sell orders.
Stock exchanges are usually left in the dark about the identity of the trading firms, and only see trade orders in the name of the sponsoring broker. Still, exchanges and brokerages have supported the practice, which brings in huge trading volumes and fees.
But the SEC says naked access could threaten the stability of the markets.
Defenders of sponsored access note that so far there has been scant evidence that the arrangements pose risk to markets… They also say high-speed traders are sophisticated enough to avoid problems.
Heard that kind of thing before.
Goldstein, meanwhile, looks at a small-time investor who got burned by a stock tumbling in a crash he says was likely exacerbated by high-frequency trading:
On April 28, (Brian) Watson was caught in a freak trading storm as shares of Dendreon plummeted 69 percent in 70 seconds. The Seattle biotech’s stock plunged to $7.50 from $24, as the company got ready to provide investors with an update on its experimental prostate cancer treatment drug.
In little over a minute, the equivalent of an entire day’s worth of trading activity in Dendreon’s shares took place before the Nasdaq stock market halted the stock.
By then the damage was done. The lightening fast selling triggered a so-called stop-loss standing order Watson had with his broker to sell Dendreon shares if the stock fell into the low $20s. But the stock fell so fast that the broker didn’t actually sell Watson’s 1,500 shares until the price had hit $15.
Watson forfeited $18,000 in unrealized gains and absorbed a $1,500 loss.
Dendreon is not some penny stock, either. It’s a $3.3 billion company. The question remains: If it can happen to that company, who can’t it happen to? And could it happen to the market as a whole?
To add insult to injury, the stock regained its loss and more by the next day. Too late for Mr. Watson.
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 rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.