When milliseconds count

The latest flash point in Wall Street rocket science is something called “high frequency” trading. The trick to this is using high-speed computers to exploit asymmetrical information. As the New York Times explains:

When buy or sell orders are submitted to marketplaces like Nasdaq, they are sometimes flashed to a collection of high-frequency traders for just 30 milliseconds — 0.03 seconds — before they are routed to everyone else. In that half-second, fast-moving computer software can gain valuable insights regarding growing or declining demand in certain stocks, and can trade ahead of other market participants, pushing prices up or down.

Already Senator Chuck Schumer has called for an SEC ban while the financial services industry defended the practice. In his Washington Post column today, Steven Pearlstein (The Dust Hasn’t Settled on Wall Street, but History’s Already Repeating Itself) laments the practice:

But as far as I can tell, buying and selling huge volumes of securities in a matter of seconds is just another high-tech form of speculation that is only remotely connected to the fundamental purpose of financial markets, which is to raise and allocate capital efficiently for businesses that need it. Liquidity is certainly good for markets, but we recently learned from painful experience that it is also possible to have too much of it. And though sophisticated computer systems can be powerful tools in plotting trading strategies and managing risk, we also know that these systems have blind spots and can backfire when too many people try to pursue the same strategy at the same time.

I have a more fundamental question. I’m not a securities lawyer, but I thought the idea of one set of people having access to public information before others was forbidden. As Pearlstein notes:

Already, the Securities and Exchange Commission is preparing to clamp down on exchanges that, in return for special fees or guaranteed trading volume, provide certain hedge funds with access to some trading orders that come into its computers a fraction of a second before they are “posted” for everyone else. That’s just enough time for the hedge funds’ computers to detect patterns in the order flow and use that insight to trade ahead of other market participants.

It may be only milliseconds of access to the trading information before others have access to that information. But, in this case milliseconds can make a very big difference.

Welcome to the Information Age.

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