Putting a Speed Limit on the Stock Market

How ordinary investors might stand a chance against high-frequency traders.

Comments: 62

  1. Interesting stuff. Basically an add for IEX wrapped in an "editorial".

  2. A small tax on each transaction will provide much needed revenue while discouraging these computer driven trades that serve no useful purpose.

  3. The useful purpose for these high speed traders is to make a killing for themselves and if they kill me off, what care do they have?

  4. Why wouldn't you want to take advantage of the orders placed by those whose trades serve no useful purpose? You have the advantage because they don't know what you're trying to do, but you know how they operate, and exactly what they will be trying to accomplish. Sounds like heaven, to me, but then I'm always up for a challenge.

  5. No, it won't.

  6. Right now the bid and ask prices of Microsoft stock are 33.14 and 33.15, so the cost of trading for an individual investor who holds for the long term is trivial. He does not need to compete with high-frequency traders and should not try. Ten years from now, the value of Microsoft stock will depend on how its current and future products have done in the marketplace, not on the machinations of high-frequency traders.

    The best reason for individuals not to invest in individual stocks is not the presence of high-frequency traders but the lack of diversification they get relative to mutual funds and exchange-traded funds. Sensationalistic media coverage of high-frequency trading needlessly scares people away from the stock market.

  7. The amounts may be trivial to you and me, but the billions that are made come from somewhere. It is the same scheme as siphoning off the amounts after the second decimal point from people's bank accounts. It may not bug you much, but it bugs the economy as a whole in a big way.

  8. I read this with interest but this article appears to lack a conclusion. I almost reads like an advertisement....

  9. let's see. i put in an order to buy 100,000 shares on the market and i'm surprised the market views this a "signal" to buy the offer. wow... that's a surprise!

  10. Can someone please explain (or point to an explanation of) the special orders that the exchanges have created - it seems like those are the real problem. I've seen brief references that almost make it sound like you get to place an order to buy that is executed only if another order comes in higher or there's an uptick. That's almost like a window into the future, if true.

  11. The exchanges trade at different speeds, as a function of the hardware used by all the parties involved. This science fiction writer says it best:

    The future is already here – it's just not evenly distributed.
    — William Gibson, quoted in The Economist, December 4, 2003

    The HF trader can react to an order before the order is executed by an exchange. It's not so much "a window into the future" as it is the agreement by the exchanges to allow an event that begins later in time, to complete before the precursor event completes.

    There is no (let's hope) deliberate conspiracy t to delay an order; which would be illegal, but exchanges have allowed some traders to "co-locate" their supercomputers in the same buildings and to connect to the same high speed fiber optic cables that link the exchanges.

    Processing an order is a multi-step transaction. This adds to the speed differential. Simple physics gives an HFT a built-in permanent advantage at each step.

    What IEX is proposing is to "serialize" all transactions in it's trading system such that no HFT has an intrinsic advantage (based on proximity or ability to spend on hardware). That is just one aspect of the edge that HFT's have.

    The HF supercomputers evaluate all possible outcomes of a trade before a trade is offered,and pick "the best one". This is the "algorithm" in algorithmic trading. The IEX cannot level this playing field.

  12. That is merely computerized trading. You specify a purchase or sell price on a particular stock, and if the price of that stock moves to that point, your sale, or purchase, occurs, without you as a human having to watch that price.

    On a sale, for example, I can set a limit order of $12 on SGBC (Some Great Big Company), and if the stock goes up to $14.35, my shares will all get sold at $12, possibly a little bit more, as the price swings through that range.

    If I had been sitting there watching the rise, I might have seen the derivative of the price move as indicating it would go higher than $12, and tried to get more, but with a limit order, I don't have to be watching. I just set what I think is a fair price, and the trade gets executed if that price is reached. i don't get to capture the higher value, but I do get the proceeds of the sale at a price that I had determined earlier to be what I considered to be fair.

    These limit orders allow the average investor to execute stock sales and purchases inside a brokerage account, without having to spend all day watching a stock price feed.

  13. I bought Green Mountain stocks last year and was happy with the growth potential. Suddenly, and I mean overnight, the stock crashed. No warning, as if every institute sold off the stock. It was a vertical drop. I felt helpless.

  14. I'm sorry to hear about your loss, but the old addage goes that an investor should not invest in an indiviual stock which he/she cannot afford to lose. By the way, I'm just a regular schmoe.

  15. The old adage in the market is that there's a difference between a good company and a good stock. There is a lot of academic research that says that high priced growth companies will long run underperform. Usually the underperformance happens very quickly.

  16. mumbley
    So, what does the stock price crash you describe have to do with the company's growth potential? Would you kindly enlighten us?

  17. I long ago realized I was better off in low-expense index funds and a few stocks I could hold long. I don't understand how high frequency trading issues affect me. (For example, if there's a flash crash, so long as no large firms go under, stocks go back up.) This isn't a criticism of this article; perhaps a suggestion for some future article.

  18. Okay, but it's also time to look at a more fundamental question--vast amounts of wealth are being "invested" in things that have no real value because there aren't enough true investments to go around. Owners of stock are sold on the fiction that they are owning a piece of a company, but of course the game is rigged so that they really aren't (common shareholders lose first and most in a bankruptcy situation don't get any say in big decisions, and receive no pledge from the issuer that they can sell them back at a base value later). Owners of gold and diamonds are buying things with little industrial or commercial value on the basis of myth and history. Until investors stop investing in the worthless paper which is common stock, does it matter how fast they lose money on it? We need to focus on reforming the legal structure of stock issuance to ensure value to the buyer rather than on the details of how current buyers are fleeced...

  19. "but of course the game is rigged "

    I agree but did you notice the article writer avoids directly addressing that issue? He skirts it by saying that "we need small investors to feel more confidence in the market" which really isnt saying anything substantive.

  20. Rich,
    If you want to "ensure value" learn how to read and understand corporate financial statements, comparing them to prior years, also comparing them to other companies. You don't need to be a CPA, or even a college graduate.

    As for common shareholders losing first, that is not the norm in an inflationary environment, during which bond holders always lose first, each and every day until the next deflationary event.

  21. Why're we looking from the perspective of just one market participant, with the vast majority of the information and cited quotes solely from him? Surely that introduces a bias and hardly abides by standards of journalism.

    "IEXs computers will be set up so that, no matter how far away traders' machines are, everyone will get market information at the same time." This obviously violates numerous physical laws and probably merits further investigation.

    If this article is really an ad for IEX, I doubt it belongs in the Times.

  22. Presumably IEX will ping traders' machines periodically and measure how long the round-trip takes, and then stagger the release of information according to the results of the ping? Seems reasonable and relatively straightforward, although who knows if it will matter.

  23. They can measure for route delivery times using standard IP networking methods, and skew information delivery accordingly. They could even use a delivery platform similar to Akamai to allocate traffic, with the remote servers time synchronized either by local GPS clocks or through PTP. It wouldn't violate physics, and it wouldn't be that hard.

  24. Old-timers remember when stocks were priced in eighths of a dollar. When the switch to digital was made, Wall Street could have agreed to price stocks in tenths of a dollar. Wonder how history would have turned out...?

  25. If stocks were priced in dimes, an individual investor would typically pay 5 cents a share in spread, even for large cap stocks. Since stocks are traded in pennies, the spread is one tenth of this. That is better for investors.

  26. billhub -
    Certain people would still be complaining about high speed traders and their supposed "advantages." Fact is, they don't know what anyone will do next, since they can not read minds.

  27. "Many other market experts agree that the image of high-frequency traders as market manipulators is way overblown."

    These experts must be either high-frequency traders, consultants to high-frequency traders, or haven't traded in the market for a decade.

  28. Especially considering that there were 2 recent-ish gaffes with high speed trading and if I recall correctly the markets were closed early in one of those instances to stop the bleeding.

  29. abo -
    How is a high-frequency trader as bad as the auto salesperson who has been authorized to let you have a ten percent discount, but is able to sell you on the idea that five percent is sufficient because they're also going to throw in floor mats or a full tank of gas?

  30. I don't see any real issue for individual investors. Most heavily traded stocks have thousands of bids and asks, with a one cent spread. If you are buying for your long-term investment, high-speed trading is of little consequence. The market is cruel, and stocks can drop in an instant, but it is not due to computer algorithms.

  31. J, "If you are buying for your long-term investment, high-speed trading is of little consequence. "

    That is a notable use of "if."

    "but it is not due to computer algorithms. "

    But poorly made and untested high speed algorithms DID affect the market. Google Knight Capital Group in 2012.

  32. Just because the spread at any one time is .01, doesn't mean manipulation can't cost you more than that - the spread/price can move. Plus, if you own a mutual fund, and they are buying big blocks, and trading many times a year, and HFT gets in front of each of them, that could cost you.

  33. It seems to me, there is a simple solution to this.
    No matter how long it takes for a trade to get to an exchanges computers, there should be a time stamp that sets precedence, preventing others from jumping in ahead of another trade.

    That the HS traders computers can detect a trade, and change the price after it had been entered, should be a criminal act.

    When my broker sends in my request to trade, the time that request is made is stamped on the message. All computers that are allowed to trade must be required to be synchronized to a time standard, and any that deviate should not be allowed to trade, or even be subject to sanctions.

  34. I agree with you. I think this is what IEX is proposing, but trades occur across multiple exchanges and IEX are raw meat for the rest of the investment community..."Nice yoga pants, do you come here often?"

  35. Your simple solution is not so simple. For that to be fair to everyone, clocks would need to be synchronized (probably) down to the nanosecond level, if not further. If you imagine a world with no computer-based trading, it would be a competition of who could click "buy" first and you need a resolution fine enough such that it's nearly impossible for someone to tie.

    The timestamping precedence is exactly how most exchanges work -- first come, first serve -- though it happens at the exchange, which is why co-location costs a lot and why brokers are in NYC.

    The example used in the article is more damning to Katsuyama than it is to HS traders. First off, they never "detected a trade;" they saw the order, just like everyone else . If you offer to buy 100K shares of anything at a specific price, short-term supply-and-demand implies that stock is grossly under-priced and the price will move accordingly (though to be fair, exchanges used to "flash" orders to the market prior to them hitting the book giving participants a look ahead but this practice has ended because it's terribly unfair, as sellers could see they were selling too cheap in the example above and cancel as much as they could). Smarter firms figured this out and started trickling out small orders throughout the day so they wouldn't move the markets with large orders.

  36. THere should be a tiny tax on each stock trade-- it shouldn't affect people who actually are investing in companies but it would be enough to skim away the incentive for rapid in/out trades.
    Another possibility is to have an even higher tax for very short term capital gains, again to discourage people from writing programs that hold stocks for, say, seconds.

  37. Time-stamp the tax
    Assets held for mere microseconds get the tax hammer hardest
    Assets held for say, an hour pay half of that tax
    Assets held for a day pay a quarter
    Assets held for a week pay a tenth
    Assets held for a month+ pay 5%
    Assets held for a year pay 1%
    Assets held for more than 5 years pay zero

  38. Using machines to play with money because they can is not within the purposes of the method of raising and valuing capital for private business in what we used to call a stock market. Why not a separate playground for machines that people want to use to buy and sell. Or attach significant costs (call it mandatory taxes) so the public will benefit) to trading a sizable amount of a security within a specific time of its original trade, or when the same entity makes a certainnumber of transactions within a specific amount of time. The people who allowed the marketplace to be so manioulated surely can figure out what the machnes really are doing and put enough of a cost to that to put a big brake on it.

  39. This isn't an advertorial for IEX as much an advertisement for market fairness. These comments seem to be rife with denizens of the 50 Cent Party for Wall Street Bankers who ought to be in jail.

  40. The bottom line is that high frequency trading does not add social value. The role of a financial market is the efficient allocation of capital. It is not a casino. Nor is it a negative sum game for everyone but the brokers and speculators. We are all too familiar with the systemic risk imposed by the financial sector. There are also other social costs associated with a bloated financial sector that has far exceeded its socially optimal scale. It consumes scarce talent and capital resources that would otherwise be available to productive sectors of the economy. It also feeds the growing disparity in income and wealth distribution that has a negative impact on our social capital and our global competitiveness.

  41. "The beauty of the stock market is that it’s an astonishingly easy place for buyers and sellers to connect with one another. If you want to sell almost any stock, you can find a buyer within seconds and know within a few cents how much the buyer will pay. "

    Convenience trumping usefulness and efficiency.

    Or changing goals? Is the stock market a place for investing or a place for trading? It started as the first and is moving to become only the other.

  42. If an exchange can prevent uninvited third parties from taking a cut of every transaction, capital will gravitate toward it.

  43. Increased volatility from short term trading has always been a problem, even before the digitally based high frequency trades (which just make the problem worse). Warren Buffett recognized the problem many years ago, suggesting a tax of about 99% on short term trades. Modifying that, it would be desirable to tax trade profits concluded in less than a week (buying and selling, or in the case of shorting, selling and buying to close out the short) at 90%, with the rate declining gradually to zero after a year. Long term capital gains, moreover, should be indexed to inflation, with both short and long term trades taxed as ordinary income.

    Variable tax rates, beginning very high on short term trades, would reduce volatility and give long term investors (the majority of individuals) a more nearly level playing field.

    Disclosure: I am an investment advisor and director of the oldest online investment advisory service.

  44. Yes, Mort, I agree. The problem with high frequency trading is the potential for algorithm-induced volatility. And, yes, that can hurt small investors.

  45. This is completely bogus. Based on the information presented in the first paragraph, Mr. Katsuyama was a rookie trader. Plain and simple, that was his only problem. (other than he may have been aggregating his clients' trades rather than seeking immediate executions)

    The number of actual shares that are willing to be bought and sold does not change because he displays an order, but the price might change because he has not limited his price. He allowed others to take advantage. Until he understands that his behavior was a factor, his future will not improve.

    The moment you show that you're willing to change your price and chase after an execution, you're dead meat. If you instead leave your price unchanged and allow the market to move as it wishes without your further participation, the high frequency traders will at some point get out of their trades and the price will return to where it was prior to your order placement. That may happen prior to the end of that very same day, and your order may well be executed at your price.

    To prove this, simply try to cancel your original order. If the price you were using was a tradable price, you will be told your order was executed. If they allow your cancellation, simply re-enter your order the next day at a price that is five cents more favorable to you. In effect, you would be exacting a penalty upon the other traders. You will find that more often than not, they will pay you the penalty. Now, that's how a market works.

  46. "The number of shares that are willing to be bought or sold does not change because he displays an order"
    Wrong. HS traders notoriously enter and withdraw bids/offers in order to test the market. Offers to trade at a "good" price can instantly be pulled and replaced by slightly worst ones. This is all part of the HST stock in trade.

  47. I am in the investment business and transact daily on many of the described exchanges. I have no problem with a system, algorithm, or computer that is faster. That is not what is happening. High frequency traders are gaining access to order flow and then jumping in front of executed orders. That is called front running. That is criminal and anyone who is engaged in that activity or is facilitating that activity should be prosecuted and sent to jail. A system where certain select participants can see and get in front of legitimate order flow is simply corrupt. Where is the SEC?

  48. Yes, it's functionally indistinguishable from front running. Unfortunately, front running is only a crime when it's done by a broker/dealer who owes a fiduciary duty to their client.

  49. In the not so distant past, dark pools were not legal. Now, anything goes! Keep a hand on your wallet.

  50. "The problem was that he was often too slow. Back then, in 2007, the stock market was in the middle of a significant shift." The author implies technology created these imperfections. Guess what? Insiders always enjoyed (and will enjoy) advantages. Read The Speed Traders for more on this point.

  51. Trades in nanoseconds for the big dogs, but the flip side of all of this is that Schwab, Ameritrade etc al take 3 business days - 3 full business ays - to clear one lousy trade. By taking 3 days to close, they destroy the average Joe's ability to move with markets. Instead, we are left like pigeons ...

    Call me cynical, but my bet is that the 3 day to close process exists because it serves the interest of brokerage houses that are busy being paid to loani my shares out to hedge funds that sell short.

    Wall Street is out of control, but the President and his advisors can't seem to figure that out ......

  52. They sweep your funds into overnight, interest-bearing accounts and reap the profits.

    SWIFT is the application used to handle transactions, and it works in milliseconds.

  53. I am astonished every time I get a transaction stub with the execution price taken to a financially insignicant four decimals. Who's kidding who? One vote for "eighths" (or tenths).

  54. SANTIAGO,DR.—A different kind of game today—after the economic crisis that sent turbulence to the world markets. Remember there was not timing allowing commodities purchasing upon reading a prospectus. Today even worst though shares price changes by the minutes. Brokerage firms not longer have to wait for the unexpected—fluctuation. Good thing the Securities and Exchange Commission (SEC) designed a new set of regulations upon the last crisis obstacles.

  55. I am a proprietary trader with over 20 years experience trading the markets and now is the most volatile and dangerously unprofitable period in my career. That is, when I'm not HFT trading. My HFT trading is like legalized theft. I can and often do make more in an hour than 99.9% of people make in a year. It's disgusting. But it's legal.
    However, when I trade my retail options account I get burned on almost every trade and consistently lose everything in my account despite making the right decisions and right predictions using the same technical and fundamental analysis I use professionally. I'm convinced my retail broker is not only front running my orders, but is actually taking the counterparty side trading against and delaying execution of my orders so as to profit against my procreated loss. They're nothing short of petty thieves. This too is disgusting. I just don't know who is worse. Or which side to play on. Both sides of the same evil coin. And therefore, so am I for profiting - and losing - playing what has become the ultimate zero sum game of winner-takes-all monopoly. I hate it. I'm quitting as soon as I make my tenth million.

  56. Blame whomever or whatever you want, many people around the world believe the fix is in.

  57. The ways we find to make a buck!

    As has been posted, if it is really a problem add a fee or tax that changes the margin for the high frequency traders, but not regular traders.

  58. Some solutions are too good to pass up. Many comments have suggested a tax on transactions. How simple! This was done in the earliest years of the 20th century by New York state; it was abandoned when the exchanges threatened to move to New Jersey.

    And so we need now an international agreement on taxing the movement of securities. The tax need not be large, and it must not be large.

    Such a tax has the possibility of generating large sums for governments around the world. Most governments would be grateful for this money infusion.

    Moreover, this tax is extremely progressive, in that the direct impact is on those prosperous enough to be trading securities.

  59. As a technical person who has worked in the trading area, and also as a scientist, I think there is a real possibility of instability by introducing an artificial delay. Especially if this trading venue is the only one that operates in that way.

    In my opinion, there are only 2 credible techniques that have been described for improving stability and fairness of the markets. The first is to require, across all exchanges not just one exchange, that offered prices must be held valid for a minimum amount of time such is 50 milliseconds. The second is a micro tax on every transaction. It sounds as though the Italian approach is a combination of these two which will be interesting to see how it works out.
    You will hear people arguing against this as removing liquidity from the marketplace. That is very likely true, but it is removing exactly the kind of liquidity that we want to discourage.

  60. No company's value varies on microsecond intervals.

    If we want to encourage investors to participate in the markets based on assessments of companies' values, rather than on the wholly separate exercise of making money on a particular transaction, we can do that.

    Inserting a delay in executing buy/sell orders (the delay being randomly variable between 0.1 second and 5 seconds) would eliminate the advantage of special fiber data cables and colocation optimization, and would help return the market to traders who assess an investment's value, rather than try to make a buck on hyperspeed hit and run tactics.

  61. Keeping up is becoming impossible. JP Morgan is spending $350 million on a private optic line from to New York to Chicago that will give it a 55 millisecond advantage over its competitors in executing trades.

    Regulation is impossible.