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Speed-addicted traders dominate today's stock market

May 16, 2010|By Walter Hamilton, Los Angeles Times

The cramped computer room in an office building overlooking the Harbor Freeway can't match the color and tradition of the New York Stock Exchange.

No traders, opening bell or operatic din. Just floor-to-ceiling racks of Dell and Hewlett-Packard computers spitting out a monotonous drone. The only people passing through are janitors and the occasional programmer or electrician.

But while the NYSE remains the cynosure of the global markets, much of the world's stock trading emanates from drab computer rooms such as this one in downtown Los Angeles, or in outposts such as Kansas City, Mo., or Jersey City, N.J.

These are the epicenters of high-frequency trading, a breed of lightning-fast computerized trading that dominates today's stock market, but which critics say carries risks for investors and for the market itself.

Regulators have yet to pinpoint the cause of Wall Street's white-knuckle plunge May 6, when the Dow Jones industrial average sank 700 points in less than five minutes. High-frequency trading isn't believed to have sparked the sell-off but may have contributed to it.

To critics, that's evidence of the threat they say is posed by high-speed trading.

Detractors argue that high-frequency firms gain an edge through predatory trading tactics that harm other investors. Worse, they say, split-second trading has the potential to destabilize the market at turbulent moments. Given the speed and huge sums involved, one errant trade could wreak havoc, critics say.

"They're destroying the market from which they're making so much money," said Joe Saluzzi of Themis Trading in Chatham, N.J. "They're like locusts. They come in, swarm the market, squeeze as much as they can, and when they're done they'll just move on to a new market."

The high-speed industry dismisses such criticism. They say they've made trading cheaper and more efficient for all investors, and claim they're being made scapegoats for the perceived transgressions of others on Wall Street.

"Everybody wants to blame high-frequency trading for any sort of malice that's occurring on Wall Street," said Manoj Narang, chief executive of Tradeworx Inc., a Red Bank, N.J., investment firm that does high-frequency trading. "It's a ridiculous blame game."

The rise of high-frequency trading is the culmination of more than three decades of automation on Wall Street, which has seen a host of upstart electronic trading networks chip away steadily at the hidebound NYSE, with its stately Corinthian columns, famed bell ringing and bellowing human traders.

Beginning in the early 1970s with the creation of Nasdaq, an all-electronic marketplace composed of big brokerage firms, these networks were able to execute trades faster and more cheaply than the NYSE.

The Big Board responded by installing its own technology; floor traders were issued hand-held devices that replaced the wild gesticulating of earlier generations. It also bought a big electronic competitor.

But ever more sophisticated software, coupled with new government rules to cut investor trading costs and speed up the market, spawned a fresh generation of high-speed traders and new all-electronic stock exchanges catering to them.

Though just a few years old, two new exchanges, Direct Edge in Jersey City and BATS Global Markets in Kansas City, each have seized about 10% of U.S. trading volume. The NYSE's share of trading in its own listed stocks, by comparison, has slumped to 34% from 76% four years ago, according to Equity Research Desk in Greenwich, Conn.

In a bow to its faster brethren, the NYSE is building a high-speed trading hub in suburban New Jersey. It also recently signed a high-speed trading firm to operate on its tradition-steeped floor.

Firms that engage in high-speed trading, such as Tradebot Systems and Getco, account for an estimated 60% to 70% of U.S. trading volume, and their market share is on the rise.

"They're the man behind the curtain of the market," said Jamie Selway, managing director at New York brokerage firm White Cap Trading.

The high-frequency game is all about speed. The goal is to be the first to buy or sell at the most advantageous moments. Shares are swapped in millionths of a second, and being even a microsecond late can be the difference between snagging a trade and losing it to the next guy.

High-frequency traders' often-tiny gains on those trades added up to $7 billion last year, Tabb Group, a research firm, estimates.

Traders toast their successes at bimonthly happy hours in New York bars. They'll converge next month at Johnny Utah's, a cavernous watering hole near Rockefeller Center that features a 300-pound mechanical bull.

Hedge funds and brokerage firms pour millions of dollars into developing trading software, and guard it zealously. Goldman Sachs Group turned to the FBI last year when it suspected a former employee of stealing sensitive computer code. FBI agents arrested the man after he got off an airplane in New Jersey. Other firms have sued departing employees.

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