Stock trading has evolved considerably since the original Buttonwood Agreement was first signed back in 1792 and 24 stockbrokers met outdoors on Wall Street under a buttonwood tree.
The advent of the Internet and electronic trading has really advanced trading execution and the flow of information. Back in September, I wrote an article about high frequency trading, referred to as “HFT.” Since the publication of Michael Lewis’s book, “Flash Boys,” HFT has become a popular news item.
Charles Schwab, the founder of the discount brokerage firm that bears his name, has called HFT “a growing cancer that needs to be addressed.” He has gone so far as to say that HFT should be illegal.
Author Michael Lewis claims that the stock markets are essentially rigged in favor of the high frequency traders.
In my September article, I wrote about how a company spent hundreds of millions of dollars to construct a faster data pipeline from Chicago to New Jersey.
By routing the pipeline in a straight line, they get the data to their computers about 3 milliseconds faster than the old one. A millisecond is one thousandth of a second. If they were willing to spend hundreds of millions on that pipeline, it tells us that HFT is profitable and that speed matters.
Now, there are plans to build a similar pipeline that will connect London and the New York exchanges at a cost of more than half a billion dollars. The reason they’re spending that kind of money to save a couple of milliseconds is simple: there’s guaranteed money to be made by getting your orders in ahead of the next trader.
Electronic trading has lowered costs for consumers substantially. The spreads between the bid price and the offer price are very narrow — just a penny for highly liquid issues — and commissions have dropped from around a hundred dollars to under ten dollars at online discount brokerages.
High-frequency trading and electronic trading are not synonymous. Electronic trading has benefited consumers immensely. HFT, while it does help provide some additional liquidity, really does not benefit anyone except the trading firms who develop the sophisticated computer algorithms and reap the profits.
On the other hand, HFT may be responsible for the mini flash crashes that have become more frequent in the markets.
I think we’ll see some type of regulatory changes in the future that will address HFT, like some form of a Pigovian tax (sin tax) and hopefully it won’t increase costs to consumers.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information on his money management service can be found at his blog at www.sellacalloption.com or by calling 775-657-8065. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.