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Speed-addicted traders dominate today's stock market

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

Some analysts say automated trading is good for the market.

By virtue of the millions of orders they place each day, high-frequency firms make it easier for investors to complete trades quickly at fair prices. When a small investor buys or sells shares, there's often a high-speed trader on the other end.

Critics contend that high-speed traders have unfair advantages over other investors that could potentially destabilize the market.

Federal regulators have proposed rules to crack down on some practices.

The Securities and Exchange Commission is seeking to ban so-called flash trading, which critics say allows high-speed outfits to get an early glimpse of orders from other investors before they're accessible to the entire market. That yields enormous clues about the short-term direction of certain stocks, enabling traders to position themselves before the tidal wave of other orders hits.

High-frequency traders acknowledge their edge in deciphering trading patterns. But they say it's because they've built a better mousetrap, not because the system is gamed in their favor.

"If some people are better at analyzing data than other people," Narang of Tradeworx said, "I don't think anybody has a problem with that."

The SEC also wants to ban "naked access," in which brokerage firms allow the high-speed crowd to send orders directly to the market without first passing through the broker's traditional pre-trade checks and balances.

The review process ensures, for example, that a trader doesn't put through an inadvertent sell order that capsizes the market. The check takes only a split second, but naked access proponents say that's enough for them to miss a trade.

Some regulators aren't sympathetic.

"Unfiltered access is similar to giving your car keys to a friend who doesn't have a license and letting him drive unaccompanied," SEC Chairwoman Mary Schapiro said in proposing the rule.

Defenders say a variety of other checks already are in place to preempt a disastrous trade.

"Naked access is not harming the market," said Jeff Bell, an executive at Los Angeles brokerage Wedbush Morgan Securities Inc., a naked access provider. "Our firms and our clients are among the most sophisticated technologists and traders, and have built a process that is absolutely solid."

Naked access services account for roughly 9% of Webush's overall revenue, Bell said. Most of Wedbush's naked-access clients are other brokerage firms that already have performed their own checks, he said.

That's little comfort to Benn Steil, who follows financial issues at the Council on Foreign Relations.

"Naked access is problematic," Steil said. "All you need is one time for something to go wrong."

A more pressing problem, some experts said, is the underlying structure of the market.

An unintended byproduct of the SEC's move to encourage electronic trading has been a weakening of the NYSE specialists and Nasdaq market makers that traditionally maintained orderly trading. They were required to step in and buy during heavy sell-offs, thus limiting the magnitude of free falls.

Their role has diminished as their profits have shrunk, experts said. That's because high-speed traders fill many of the orders once handled by traditional firms. But unlike specialists and market makers, high-frequency players can choose not to trade during turbulent moments, such as when the Dow plummeted May 6. Experts say that may be a big reason stocks fell so hard so fast that day: There was no one to step in and buy.

"Over $1 trillion of market value evaporates in less than 15 minutes and people say, 'Who is to blame?' " Themis Trading's Saluzzi said. "No one is to blame. This is the market that we have. This is the byproduct of a market structure that has gone horribly wrong."

The SEC and other regulators are mulling over various changes in the aftermath of the market plunge. But few believe they'll crimp high-frequency trading.

"It's not bad or evil," Wedbush Morgan's Bell said. "It's technology innovation. You can't slow it down."

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