What is “High-Frequency Trading”, and How Does It Distort the Markets?

Joseph Saluzzi – partner and co-head of equity trading for Themis TradingThemis – gives a succinct and stunning explanation of high-frequency trading.

This is a topic that professional stock traders know a lot about, but the public knows nothing about.

Saluzzi explains that 70% of the volume in the stock markets are from computer program trading.

The program traders make money from making trades, regardless of whether stocks go up or down.

Specifically, the program traders collect an average of a quarter of a penny per share every time they buy. Even if they sell it at same price a fraction of a second later, they make another quarter of a penny when they sell. Over billions of trades, this adds up to real money.

The program traders claim that they are providing liquidity for the markets. But they aren’t. They’re simply providing volume (remember, 70% of the volume in the stock markets are from computer program trading). This distorts basic information about the markets, and confuses real investors’ view of what is going on.

But when things are truly bad in the markets, the high-frequency traders will probably pull out of the market until things come down. So when it counts, they will pull out of the market, withdrawing liquidity.

The New York Stock Exchange, Nasdaq and other big stock exchanges rent space on special servers for the program traders, so they make money from this.

Saluzzi says that one way to curb this manipulation and distortion of the markets is to force program traders to wait 1 second between buying and selling a stock. In their make-believe world, a second is an eternity . . . so forcing a 1-second delay would reduce the attraction and profitability of program trading.

Watch the 8-minute interview.

Goldman Sachs is by far the largest program trader in the market, twice as large as the next biggest.

Remember, Saluzzi is talking about a legal trading activity – an activity which is known and accepted among traders and regulators. He is not even talking about other types of programs which can manipulate the market in even more dramatic ways.

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