Stock Traders Find Speed Pays, in

Milliseconds
Today's Business: Charles Duhigg on Trading Strategies
July 2, 2!!", New York Times
#t is called high$%re&uency trading ' and it is suddenly one o% the (ost talked$
a)out and (ysterious %orces in the (arkets*
Po+er%ul co(puters, so(e housed right ne,t to the (achines that dri-e
(arketplaces like the .e+ /ork Stock 0,change, ena)le high$%re&uency
traders to trans(it (illions o% orders at lightning speed and, their detractors
contend, reap )illions at e-eryone else1s e,pense*
These syste(s are so %ast they can outs(art or outrun other in-estors,
hu(ans and co(puters alike* 2nd a%ter gro+ing in the shado+s %or years, they
are generating lots o% talk*
.early e-eryone on 3all Street is +ondering ho+ hedge %unds and large )anks
like 4old(an Sachs are (aking so (uch (oney so soon a%ter the %inancial
syste( nearly collapsed* 5igh$%re&uency trading is one ans+er*
2nd +hen a %or(er 4old(an Sachs progra((er +as accused this (onth o%
stealing secret co(puter codes ' so%t+are that a %ederal prosecutor said could
6(anipulate (arkets in un%air +ays7 ' it only added to the (ystery* 4old(an
ackno+ledges that it pro%its %ro( high$%re&uency trading, )ut disputes that it
has an un%air ad-antage*
/et high$%re&uency specialists clearly ha-e an edge o-er typical traders, let
alone ordinary in-estors* The Securities and 0,change Co((ission says it is
e,a(ining certain aspects o% the strategy*
6This is +here all the (oney is getting (ade,7 said 3illia( 5* Donaldson,
%or(er chair(an and chie% e,ecuti-e o% the .e+ /ork Stock 0,change and
today an ad-iser to a )ig hedge %und* 6#% an indi-idual in-estor doesn1t ha-e
the (eans to keep up, they1re at a huge disad-antage*7
For (ost o% 3all Street1s history, stock trading +as %airly straight%or+ard:
)uyers and sellers gathered on e,change %loors and dickered until they struck
a deal* Then, in 8""9, the Securities and 0,change Co((ission authori:ed
electronic e,changes to co(pete +ith (arketplaces like the .e+ /ork Stock
0,change* The intent +as to open (arkets to anyone +ith a desktop co(puter
and a %resh idea*
But as ne+ (arketplaces ha-e e(erged, PCs ha-e )een una)le to co(pete
+ith 3all Street1s co(puters* Po+er%ul algorith(s ' 6algos,7 in industry
parlance ' e,ecute (illions o% orders a second and scan do:ens o% pu)lic and
pri-ate (arketplaces si(ultaneously* They can spot trends )e%ore other
in-estors can )link, changing orders and strategies +ithin (illiseconds*
5igh$%re&uency traders o%ten con%ound other in-estors )y issuing and then
canceling orders al(ost si(ultaneously* ;oopholes in (arket rules gi-e high$
speed in-estors an early glance at ho+ others are trading* 2nd their co(puters
can essentially )ully slo+er in-estors into gi-ing up pro%its ' and then
disappear )e%ore anyone e-en kno+s they +ere there*
5igh$%re&uency traders also )ene%it %ro( co(petition a(ong the -arious
e,changes, +hich pay s(all %ees that are o%ten collected )y the )iggest and
(ost acti-e traders ' typically a &uarter o% a cent per share to +hoe-er arri-es
%irst* Those s(all pay(ents, spread o-er (illions o% shares, help high$speed
in-estors pro%it si(ply )y trading enor(ous nu()ers o% shares, e-en i% they
)uy or sell at a (odest loss*
6#t1s )eco(e a technological ar(s race, and +hat separates +inners and losers
is ho+ %ast they can (o-e,7 said Joseph M* Mecane o% ./S0 0urone,t, +hich
operates the .e+ /ork Stock 0,change* 6Markets need li&uidity, and high$
%re&uency traders pro-ide opportunities %or other in-estors to )uy and sell*7
The rise o% high$%re&uency trading helps e,plain +hy acti-ity on the nation1s
stock e,changes has e,ploded* 2-erage daily -olu(e has soared )y 8<=
percent since 2!!>, according to data %ro( ./S0* 2lthough precise %igures
are elusi-e, stock e,changes say that a hand%ul o% high$%re&uency traders no+
account %or a (ore than hal% o% all trades* To understand this high$speed
+orld, consider +hat happened +hen slo+$(o-ing traders +ent up against
high$%re&uency ro)ots earlier this (onth, and ended up handing spoils to
lightning$%ast co(puters*
#t +as July 8>, and #ntel, the co(puter chip giant, had reporting ro)ust
earnings the night )e%ore* So(e in-estors, s(elling opportunity, set out to )uy
shares in the se(iconductor co(pany Broadco(* ?Their acti-ities +ere
descri)ed )y an in-estor at a (a@or 3all Street %ir( +ho spoke on the
condition o% anony(ity to protect his @o)*A The slo+er traders %aced a
&uandary: #% they sought to )uy a large nu()er o% shares at once, they +ould
tip their hand and risk dri-ing up Broadco(1s price* So, as is o%ten the case on
3all Street, they di-ided their orders into do:ens o% s(all )atches, hoping to
co-er their tracks* Bne second a%ter the (arket opened, shares o% Broadco(
started changing hands at C2<*2!*
The slo+er traders )egan issuing )uy orders* But rather than )eing sho+n to
all potential sellers at the sa(e ti(e, so(e o% those orders +ere (ost likely
routed to a collection o% high$%re&uency traders %or @ust ! (illiseconds '
!*! seconds ' in +hat are kno+n as %lash orders* 3hile (arkets are
supposed to ensure transparency )y sho+ing orders to e-eryone
si(ultaneously, a loophole in regulations allo+s (arketplaces like .asda& to
sho+ traders so(e orders ahead o% e-eryone else in e,change %or a %ee*
#n less than hal% a second, high$%re&uency traders gained a -alua)le insight:
the hunger %or Broadco( +as gro+ing* Their co(puters )egan )uying up
Broadco( shares and then reselling the( to the slo+er in-estors at higher
prices* The o-erall price o% Broadco( )egan to rise*
Soon, thousands o% orders )egan %looding the (arkets as high$%re&uency
so%t+are +ent into high gear* 2uto(atic progra(s )egan issuing and
canceling tiny orders +ithin (illiseconds to deter(ine ho+ (uch the slo+er
traders +ere +illing to pay* The high$%re&uency co(puters &uickly deter(ined
that so(e in-estors1 upper li(it +as C2<*=!* The price shot to C2<*", and
high$%re&uency progra(s )egan o%%ering to sell hundreds o% thousands o%
shares*
The result is that the slo+er$(o-ing in-estors paid C8*= (illion %or a)out
><,!!! shares, or CD,9!! (ore than i% they had )een a)le to (o-e as &uickly
as the high$%re&uency traders*
Multiply such trades across thousands o% stocks a day, and the pro%its are
su)stantial* 5igh$%re&uency traders generated a)out C28 )illion in pro%its last
year, the Ta)) 4roup, a research %ir(, esti(ates*
6/ou +ant to encourage inno-ation, and you +ant to re+ard co(panies that
ha-e in-ested in technology and ideas that (ake the (arkets (ore e%%icient,7
said 2ndre+ M* Brooks, head o% Enited States e&uity trading at T* Fo+e Price,
a (utual %und and in-est(ent co(pany that o%ten co(petes +ith and uses
high$%re&uency techni&ues* 6But +e1re (o-ing to+ard a t+o$tiered
(arketplace o% the high$%re&uency ar)itrage guys, and e-eryone else* People
+ant to kno+ they ha-e a legiti(ate shot at getting a %air deal* Bther+ise, the
(arkets lose their integrity*7