At a time of great suspicion of all things Wall Street, stories start to emerge of sneaky tricks that insiders supposedly play to manipulate the market at the expense of the retail investor, Mr. TD Ameritrade, who can never get a break. It is a paranoid’s dream.
In August, the Times uncorked an investigation on Page One that raised problems then kicking around the specialty press and blogs associated with “high-frequency trading,” rapid-fire computerized buying, selling, canceling and arbitraging, that the paper called one of the “most talked-about and mysterious forces in the market.” We thought the story took the mystery thing a bit too far by conflating “flash” trading, which allows insiders an insta-peek before the rest of the market, with its far (very far) more prevalent cousin, HFT.
Today, the Journal steps in with a look at a further refinement: not just HFT, but anonymous HFT, wherein we learn that brokerages rent out their HFT access to unknown (to the exchanges and regulators) parties plying murky strategies with their unknown solvency. Who benefits? Squid! We meet again.
Making matters worse, this is apparently called “naked” access, which raises the specter of naked short selling, a whole ‘nother can of worms. Can’t they think of another word?
(Update and oops. I see our man Chittum already weighed in on this with a misdated, since corrected, post. He includes a compelling example from Reuters on how regular HFT may have hurt a small investor. The anecdote makes all the difference; in such an esoteric area, It’s hard enough to separate reality from mere suspicion.)
Zerohedge brought up the topic in its naked incarnation among what it called its “hyperventilating, schizo-paranoid ramblings” last summer.
The Journal explains the phenomenon very well, includes a useful graphic, and supplies an interesting anecdote of when naked trading went bad:
SWS Group Inc., a Dallas financial-services firm that “clears,” or processes, trades for clients, suffered a $6.3 million pretax loss when a client’s trade went awry. The client traded past certain limits and was “ignoring our repeated attempts to contact,” SWS Chief Executive Donald Hultgren said on an August earnings call.
Not returning calls. Always a bad sign.
The Journal also reports that the SEC is on the case.
“We understand that some firms are offering so-called naked access without effective controls over financial regulatory risk,” said David Shillman, associate director of the Securities and Exchange Commission’s division of trading and markets, which is stepping up its scrutiny of the issue.
Well, all set then.
This is not exactly looking at the big picture, or case closed, for that matter, but do read the story. It’s always nice to learn more about the mechanics of the stock market. And you never know; they really may be out to get you.Dean Starkman Dean Starkman runs The Audit, CJR's business section, and is the author of The Watchdog That Didn't Bark: The Financial Crisis and the Disappearance of Investigative Journalism (Columbia University Press, January 2014). Follow Dean on Twitter: @deanstarkman.