The Dark Side of High Frequency Trading

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The video is about Senator Ted of Delaware explaining high High Frequency Trading became a large bubble that dominate the market and even too big to be regulated.

High Frequency Trading has dramatically grown since its beginning in the late nineties. Today it became the ultimate force that control and manipulate the stock market. With their sophisticated computers, High Frequency Traders influence and anticipate slow traders moves and even behaviors. In july 2009, an example of this type of manipulation happened. The issue of the New York Time released on 07/24/2009 discussed this.  

“It was July 15, and Intel, the computer chip giant, had reporting robust earnings the night before. Some investors, smelling opportunity, set out to buy shares in the semiconductor company Broadcom. (Their activities were described by an investor at a major Wall Street firm who spoke on the condition of anonymity to protect his job.) The slower traders faced a quandary: If they sought to buy a large number of shares at once, they would tip their hand and risk driving up Broadcom’s price. So, as is often the case on Wall Street, they divided their orders into dozens of small batches, hoping to cover their tracks. One second after the market opened, shares of Broadcom started changing hands at $26.20.

The slower traders began issuing buy orders. But rather than being shown to all potential sellers at the same time, some of those orders were most likely routed to a collection of high-frequency traders for just 30 milliseconds — 0.03 seconds — in what are known as flash orders. While markets are supposed to ensure transparency by showing orders to everyone simultaneously, a loophole in regulations allows marketplaces like Nasdaq to show traders some orders ahead of everyone else in exchange for a fee.

In less than half a second, high-frequency traders gained a valuable insight: the hunger for Broadcom was growing. Their computers began buying up Broadcom shares and then reselling them to the slower investors at higher prices. The overall price of Broadcom began to rise.

Soon, thousands of orders began flooding the markets as high-frequency software went into high gear. Automatic programs began issuing and canceling tiny orders within milliseconds to determine how much the slower traders were willing to pay. The high-frequency computers quickly determined that some investors’ upper limit was $26.40. The price shot to $26.39, and high-frequency programs began offering to sell hundreds of thousands of shares.

The result is that the slower-moving investors paid $1.4 million for about 56,000 shares, or $7,800 more than if they had been able to move as quickly as the high-frequency traders.”

In addition to action and behavior manipulation of slower investors,  High Frequency Trading can create a crash on the stock market like the one happened on may 6, 2010, and more popular as “The Flash Crash”*, in which the Dow Jones Industrial Average plunged about 900 points (about 9%) and recovered those losses within minutes. This kind of situation can occur given that all the transactions made by the High Frequency Traders are done through machines and robots that use very complex algorithms. As opposed to a human being, a robot is only able to perform the tasks it has been programmed for. Also, robots, computers, and machines can “bug”, which can be dramatic for the market given the access of computers to liquidities, and the network that relates all of them to the stock exchange. "The interaction between automated execution programs and algorithmic trading strategies can quickly erode liquidity and result in disorderly markets," said The the U.S. Securities and Exchange Commission and the Commodity Futures Trading Commission report about the Flash Crash of May 6 2010 .