High Speed Trading At Exchanges

Finally Congress is looking at high speed trading and what it is doing to the marketplace. Like most things, this is a messy issue. It’s not necessarily electronic trading that is causing the problems. Mostly the roots of the problems are in the way the markets are regulated by the SEC, and in the way the exchanges administer them.

Congressman and Senators don’t have intimate understanding of these markets. They also have relationships with banks, trading firms, exchanges and individuals so don’t look for any altruistic market based rules or regulations to come out of their committee hearings. But it’s good that there is a public vetting.

Just in the past week we have learned of new order types not available to regular consumers of the market. We have learned favored participants get data feeds that other market players don’t get. This is patently unfair and gives one part of the market an edge they can arbitrage against the rest of the market.

One of the reasons Fama’s Efficient Market Hypothesis works is the assumption that no one has more information than the rest of the marketplace. It’s why we have insider trading laws. But today, some have more information than the rest of the market and they are making outsized returns because of it.

Once I met a guy that uncannily could predict exactly where the Crack spread in energy markets would go. It was truly amazing. He would say, “I think it’s going to move up.”. Gosh darn it, it moved up. He was never wrong. Ever. It turns out, he had inside information on the supply/demand of the energy market and he was not allowed to trade. I never traded on his information because I wasn’t a crude trader and I have a cynical tendency to discount anything I hear from people that aren’t in the market.

What we have today in the marketplace is a tiered playing field. Insiders get first dibs. In the old days of guys on trading floors, there most certainly was an edge. That’s why you leased or bought a membership to an exchange-to get the edge.

When I was in a pit, I knew I only had to be faster than the other people in my pit. It’s also why there were huge fights over pit position. Sometimes when I was faster it didn’t matter, since another guy was standing closer to the order filler. Lots of times, order fillers would whisper in their pals ear. Those guys always made a lot of money-more than the average trader in the pit. Getting a wink and a nod always helps.