High-speed trading is coming under increased scrutiny as a close cousin to insider trading.
While insider trading cases typically involve Wall Street honchos receiving confidential tips, critics say high-frequency trading also gives insiders an unfair advantage because they work out deals with exchanges to receive proprietary data feeds at a faster pace than is available to the general public.
“This process allows brokers to front-run trades and receive better pricing,” said Andrew Stoltmann, a Chicago securities attorney. “Essentially the general public is getting beat to the punch by milliseconds and is receiving different quotes on stocks. They are buying stocks at a penny or two higher than traders and are selling at pennies lower, unbeknownst to them.”
In recent months, a storm of subpoenas has rained down on high-frequency trading firms as federal lawmakers and the securities industry consider whether the practice has harmed retail investors and destabilized markets.
A Senate panel last month was set up to question key players in the securities industry about the special arrangements that exist with exchanges to front-run trades from high-frequency trading firms. The Securities and Exchange Commission, the New York attorney general, the Federal Bureau of Investigation and the Justice Department also have launched investigations into high-frequency trading.
The practice involves the use of computers programmed to rapidly trade stocks, moving in and out of positions in fractions of seconds, aiming to capture just a fraction of a cent in profit on every trade. Regulators fear it could pose a danger to the financial system, pointing out the practice may have contributed to the so-called May 6, 2010, flash crash.
During an interview with the news show “60 Minutes” on the eve of the publication of his book “Flash Boys,” author Michael Lewis alleged the stock market is rigged by high-speed traders, stock exchanges and Wall Street firms. He said traders have installed high-priced fiber optic lines connected to the exchanges to move orders faster than they would on public lines.
“As these high-frequency traders take cuts here and there, those pennies quickly multiply as they churn through millions of investors,” Mr. Stoltmann said.
Scott E. D. Skyrm, author of “Rogue Traders,” said what high-speed traders are doing to gain a market edge is nothing new.
“Over the years, people have used communications to get their orders into the market faster than the competition,” said Mr. Skyrm of New Canaan, Conn. “It used to be telegraphs, ticker tape, telephones, computers — and now we have fiber optic networks where some computers are faster than others.”
He said the Rothschild banking family gained a tremendous advantage over other traders when carrier pigeons arrived in London advising them — before even the government knew — that the British had won the Battle of Waterloo and thus that stocks were severely underpriced. The Rothschilds made a fortune by acting before those who had to wait for information to arrive on horseback.
“Now there are some traders in the market who are using faster communications to beat other traders in the market,” Mr. Skyrm said. “There‘s nothing inherently wrong with that. It’s really not the speed manipulating things. The problem is exchanges offering special deals to trade on their exchanges.”
Pittsburgh financial adviser Robert Hapanowicz, president of Hapanowicz & Associates, Downtown, said the stock market should be a level playing field. For the vast majority of retail investors, the difference in trading costs for them and high-frequency traders is insignificant.
“For large firms trading billions of securities, it could be a lot of money. But not for retail investors,” Mr. Hapanowicz said. “The amount of money is small, but that doesn't make it right. It doesn't mean we should overlook it.
“I would suggest retail investors take a page from Warren Buffett’s investment philosophy, which is to buy and hold for the long haul. If they plan to buy and hold, trading costs will be insignificant.”
Tim Grant: email@example.com or 412-263-1591.