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The suspicious thing about financial conspiracy theories is that they are all alike. A “sophisticated” or “shadowy” investor makes pots of money in ways nobody quite understands. The indignant theorist casts aspersions on their methods, inserts a non sequitur regarding its effects and explains how this is frightfully unfair for the “little guy”. Cue political outrage. The latest involveshigh frequency trading (HFT) and so-called flash orders.
HFT is high-volume trading used by banks’ proprietary traders and a new breed of electronic trading outfits. It relies on synthesising information faster than others using powerful computers, often co-located within exchanges. Flash orders are sent to certain traders in a market fractionally before being routed more widely. Its speed of execution can save traders money, if only a sliver of a basis point.
The effects of HFT, which perhaps accounts for 70 per cent of US trading volumes, are ill-understood. There are concerns that its users, as well as providing liquidity, probe the market to extract early information, meaning others lose out. Flash orders may increase that informational advantage.
But it is worth distinguishing between the illegal and the irritating. Frontrunning – or trading ahead of customer orders – is the former. Successfully employing the biggest nerds and the best millisecond-saving technology is not. Markets have always been skewed against retail money, whether information sloshes around an open-outcry pit or a high-tech algorithm. Now, however, cheaper technology, plus the disaggregation of traditional exchanges, means HFT is exploding.
Moves by the Securities and Exchange Commission to review flash orders are welcome, as would be a proper look at HFT. There is a potential investor protection issue. More important, regulators should lead in understanding market changes and how traders make their dough. That does not imply a secret plot. It is just part of their day job.
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