By Stephen Anson
Equipped with some of the most powerful super-computers in the world, high-frequency traders anticipate millisecond changes in the market, allowing them to score immediate gains and affect the market index. These trading practices have been used for years, and though there are many federal rules criminalizing insider trading and securities fraud, no one has used these rules to go after high-frequency traders until recently. Whether or not these trades are illegal remains an open question. In the interim, growing public discontent will likely lead to more lawsuits and perhaps eventual securities reform.
Public interest in high-frequency trading has grown lately, spurred in part by Michael Lewis’s new book “Flash Boys.” In his book, Lewis described the market as being “rigged” by “high-frequency traders armed with fiber-optic lines and computer servers located next to, or even inside, the exchanges.” This advanced technology gives high-frequency traders an advantage over other traders. The technology provides faster access to information about the flow of the market, and the traders then use advanced algorithms to purchase as many of the “in demand” securities as possible. Their computer programs will then, nearly instantaneously, sell those same securities back out in the market, often for a nice little margin. High-frequency traders can still turn a profit, even if they are buying large volumes of stock and selling them for the same price, because they receive a liquidity rebate for each transaction from the relevant exchange. The exchanges, such as the New York Stock Exchange (“NYSE”), pay these liquidity rebates, which typically amount to a fraction of a penny per share, because it increases the overall liquidity in that marketplace.