It shows one half-second of trading in just one stock, boring old Johnson & Johnson, on May 2. The video slows down the trades so that the milliseconds -- thousandths of a second -- tick slowly by, and so that human eyes can comprehend what's happening.I fully understand that all of this is legal and I will readily concede that the process might "enhance liquidity in the market" (I know that when I place an order online at Schwab, it is completed as fast as I can click the "check order status" button). But... this still scares the shit out of me.
What you see is trading gone haywire, hopelessly beyond the control of any regulators that might want to make sure all of these trades are legitimate. This flood of trading confuses even other machines, creating mismatches in orders that high-speed traders can exploit, millisecond by millisecond.
"These guys are not stealing dollars, they're stealing pennies," says Nanex founder Eric Hunsader, who presented the video at a recent Wired conference. "It's like paper cuts instead of first-degree murder."..
Inside of the one half-second of trading represented by the video, more than 1,200 orders and 215 actual trades occur, Hunsader says. (The colored boxes in the video represent exchanges, and the dots that go flying represent individual orders.)
Regulators are desperately trying to keep up. The European Union last year approved a new rule mandating that all trades must exist for at least a half-second, in order to try to minimize the kind of quote-stuffing that frightens and confuses markets. It turns out that half-second is an eternity.It is a financial Armageddon just waiting to happen. Why doesn't anyone have the cojones to limit this activity?
Addendum: A well-informed reader wrote to me privately re the content of this post, asking to remain anonymous, and offering the following counterpoints, which I thought were valid enough to bring above the fold to the content of the post -
That HuffPo article is kind of silly, what it shows and what it concludes don't follow at all. What the video seems to show is the pretty straightforward implementation of a regulation called RegNMS. If you send an order to one exchange but there's a better price at another one it's required that the exchanges get you that better price. Obviously that means the exchanges are going to have to talk to each other whenever an order comes in that might have a better price somewhere else. All you're seeing is those "hey can you beat this price" messages going out to all the other exchanges. Skip to 2:50 and you can see one or two happen all alone, the crazy visual is just a lot of that happening all at once.I will be the first to agree that the Huffington Post tends to be sensationalist in hyping mundane material to increase clicks, and while the comments above temper my angst a bit, I remain uncomfortable with the overall concept of HFT. Re the latter, the reader who wrote to me also provided a link to A High Frequency Trader's Apology, which discusses the concept in some detail.
(Nanex has an older but more detailed page about some of this at http://www.nanex.net/Research/IsNBBOIgnored.html that seems to be addressing a slightly different issue about which I know nothing)Notably there's no indication that anything in the video has anything at all to do with HFT. This is the exchanges and only the exchanges trying to clear trades as fast as they can while complying with the rules they operate under. The cacophony seems to be because there are a lot of orders and computers can execute the straightforward (and, again, legally mandated) arithmetic astonishingly quickly. All the underlying orders could very well be boring mutual funds trading with each other without it looking very different.
Which is not to say that there's no nefarious stuff going on in the markets just that this video doesn't show anything like that. I'm happy to be corrected if I've misinterpreted it of course; I'm not an expert in market microstructure.
As an aside, one reason your Schwab trades execute immediately may be that they never even make it to the public market. They're either matched inside Schwab by another customer doing the reverse trade or sent to a 'dark' venue that pays Schwab for doing so:This is called 'payment for order flow'. Note that this still falls under RegNMS so Schwab (or the venue where your trade eventually ends up) must do the 'notify all exchanges' dance from the video. You can see a nice breakdown of where actual trading volume happens in the US at Bats' website: http://www.batstrading.com/market_summary/. The NASD and TRF volumes are things like Schwab filling the trade internally without ever reaching an exchange but also trades that happen on 'dark pools', like the ones that Schwab sends to. Note I'm not calling out Schwab in particular here, this is common practice.