High Frequency Trading: Is it a Fair Game?

(http://www.tradedecider.com/user/blogs/TD%20Blog/2009/09/30)

By Corinne Speckert, TradeDecider.com

written on September 30, 2009 04:34, last update 6 months ago

What happened to the days of battling out prices, face to face, on the exchange floor? Well, those days may be scarce, but the people aren't missing, they've just been replaced by the new hires: high-frequency trading computers.

These new computers are booted with powerful algorithms, which transmit millions of buy and sell orders at once, leaving those without them in the dust. In addition, high-frequency trading computers have the ability to intercept competitor's orders — enabling their users to manipulate share prices.

Although proponents of high-frequency trading argue that it makes transactions cheaper for everyone because it provides a constant flow of securities, it has recently been at the center of controversy, as critics claim it creates an unfair playing field — with retail investors receiving the shorter end of the stick.

One edge high-frequency traders have is the ability to scan dozens of public and private marketplaces simultaneously — enabling them to change orders and strategies within milliseconds. One apparent way these fast-acting machines finagle funds out of average investors is by issuing and then subsequently canceling orders, in effect, driving up prices and then selling them back to traders at inflated levels.

High-frequency traders also profit off exchanges, which acquire small fees of around one-quarter-a-cent per share and go to the largest and most active traders. Multiply those fees by millions of shares and it's easy to imagine how a quarter-cent can become a huge gain and ultimately, give these traders an advantage.

High-frequency trading was authorized by the Securities and Exchange Commission in 1998 in attempts to open the market and compete with the New York Stock Exchange. Despite good intentions, it soon became apparent that there was a concentration of profits among a few dominating high-frequency traders — leading to the regulation of flash orders by the SEC.

Flash orders are beneficial to high-frequency traders because they provide an inside glimpse of market actions, but with the SEC now considering a ban on these sneak-peak helpers, we'll soon find out how beneficial they in fact are.

The financial hedge-fund giant, Goldman Sachs, said that high-frequency trading accounted for less than one percent on its total revenue in the first half of 2009. Despite the small percent, that still totals up to around $232 million — hot off the high-frequency trading floor — and that doesn't account for the company's high-frequency trading of options and commodities, which are estimated to account for more than 15 percent of daily trading volume, according to the wire service, Reuters.

Goldman Sachs isn't the only firm cashing-in. Among some of the financial giants profiting off this fast-track method is the hedge fund, Citadel, which is the high-frequency volume leader, controlling around 25 percent of daily trading activity, Reuter's states.

Beyond that, high frequency trading brought in about $21 billion in profits last year, according to the research firm, Tabb Group. So, if it's generating all this money, what's the problem? The problem, according to the New York Times, is that only a handful of traders are making that money and it's at the expense of small investors.

Note: Because of my lack of experience in financial writing, Phillip Pham, the CEO of TradeDecider, Inc., did not credit my name for these writings. Should anyone have questions regarding the authorship of these writings, please contact Phillip Pham at (408) 693-9358 or through e-mail at dtprophet@yahoo.com and philip4av@gmail.com