Friday, August 14, 2009

Wall Street's Newest Casino Game

The casino operators on Wall Street have found a new way, called High Frequency Trading, to skim more of the cream off the top of US economic activity. It is part of the reason Goldman Sachs was able to have 46 "$100 million trading days" last quarter.

High frequency trading uses the speed of supercomputers to trade faster than a human trader ever could. Owners of supercomputers, such as Goldman Sachs, program them to take advantage of information milliseconds faster than other computers and whole seconds faster than human traders.

This a major recent development. High Frequency Trading now accounts for about 70 PERCENT of ALL the trading volume in the US stock market. This is another reason I personally do not believe the recent rally in stock prices.

High Frequency Trading computers are able to beat other computers because they are actually located AT the exchanges. These computers take advantage of the finite speed of light and switching systems to FRONT-RUN the market. This is supposed to be ILLEGAL. They also gain information on orders and market movements sooner than the market as a whole.

This becomes a bit technical but there are several ways that High Frequency Traders make out like bandits:

1) Some of the traders take advantage of volume rebates of about 0.25 cents per share offered by the exchanges to brokers who post orders and provide liquidity. When the traders spot a large order, they fill part of it, then re-offer the shares at the same price, collecting the exchange fees along the way.

2) Some of the programmed trading systems take advantage of the institutional computers that chop up large orders into many small orders. They make the institutional trader, such as pension funds, bid up the price of shares by fooling its computer, by placing small buy orders which they then withdraw.

3) These programs also automatically "ping" stocks to identify large orders by issuing an order and then very quickly withdrawing it. Once this information is obtained, they buy the shares themselves and sell them on to the institutional buyers (suckers) at a higher price.

4) Program traders can buy large numbers of stocks at the same time to fool institutional computers and triggering very large buy orders. By doing this, program traders like Goldman Sachs can trigger sharply higher market moves.

The bottom line for us ordinary market participants is that insiders are using supercomputers to game the system, extracting billions of dollars from the rest of the market.

In effect, they are trading on insider knowledge about market order flow. Yet, government regulators look away and let them get away with it.

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