The SEC's "Oh Crap" Moment on High Frequency Trading...
Goldman Sachs, nut vice. Nut vice, Goldman Sachs. Now you two play nice, you hear me?
The S.E.C. chairwoman, Mary L. Schapiro, said on Tuesday that she would push to eliminate a controversial high-frequency trading technique known as “flash orders,” which allow traders to peek at other investors’ orders before they are sent to the wider marketplace.
“We want to know if people are utilizing technology for illicit purposes such as gaming the markets and getting advance knowledge of trades,” said Senator Charles E. Schumer, Democrat of New York, who had threatened to introduce legislation banning flash orders. “Chairman Schapiro is going to attempt to separate innovations, which are good, from taking advantage of people, which must be prohibited.”
An explosion of computerized trading has helped drive volume on the New York Stock Exchange alone up by 164 percent since 2005. Stock exchanges say that more than half of all trades are now executed by just a handful of high-frequency traders, who use rapid-fire computers to essentially force slower investors to give up profits, then disappear before anyone knows what happened.
The S.E.C. is also expected to propose new rules for semiprivate marketplaces known as “dark pools,” which are available only to select investors, as well as other trading techniques, according to people with knowledge of the agency’s thinking. The S.E.C. is still discussing what form those rules might take, and is expected to adopt them this fall or later.
In a flash order transaction, buy or sell orders are shown to a collection of high-frequency traders for just 30 milliseconds before they are routed to everyone else. They are widely considered to give the few investors with access to the technology an unfair advantage, even by some of the marketplaces that offer the flash orders for a fee.
But sentiment on other trading innovations is mixed. Dark pools, for instance, are useful to institutional investors like mutual funds because they offer the ability to anonymously buy or sell shares in private marketplaces without revealing the price until all trades are completed. Large investors often prefer such transactions when they wish to trade big blocks of shares, out of fear that announcing their intentions will set off a run in prices.
But some dark pools are open only to select investors. And they often give participants quick peeks at orders before they are filled, offering valuable insight on how prices are likely to shift once the transaction is announced.
“There is the danger that significant private markets may develop that exclude public investors,” Ms. Schapiro said in a speech in June. Such marketplaces could offer select participants valuable information “to which the public does not have fair access," and potentially make it difficult for the public to get accurate prices, she continued.
Of course, Market Ticker has some thoughts on this here and here worth checking out.
I preferred this particular assessment of KD's myself:
The amount of "slippage" due to these programs sounds small - a few cents per order. It is. But such "skimming" is exactly like paying graft to a politician or "protection money" to the Mafia - while the amount per transaction may be small the fact of the matter is that it is not supposed to happen, it does not promote efficient markets, it does not add to market liquidity, the "power" behind moves is dramatically increased by this sort of behavior and market manipulation is supposed to be both a civil and criminal violation of the law.
But the question that must be asked here is whether or not these activities are sanctioned by the regulators themselves. After all, isn't there something in the PPT code that insists its ultimate purpose is to "normalize" markets? Without a fundamental understanding of how markets work (hint: they made up $700 billion to save notional losses which still have not been recognized in most cases, essentially conjuring up free money), one doesn't need to be a market genius to see that TPTB could in theory be promoting the same behavior they are now (at last) condemning.
This is called the "oh shit" moment and I believe we can say that the SEC is finally having one.