I finished reading Michael Lewis’ book Flashboys, and it really motivated me to think about ‘fairness’. What Lewis’ book reveals is the advantage High Frequency Traders who invest BILLIONS in technology have over average investors. By investing heavily in technology these firms have been able to exploit the nanoseconds between when a stock order is placed and how it is executed. These algorithms can detect a trade by placing millions of 1 share trades (the bait) in multiple exchanges until they can find a buyer (a fish). Exchanges are helping these High Frequency Traders because they pay the exchanges cash. Within a few nanoseconds these firms can buy what you’re looking for a few cents cheaper, then sell it back to you at a no-risk profit.
In the past when this was done by humans it was called ‘Front Running’ and it was illegal. The SEC has been asleep at the wheel and now they call it legal as a part of High Frequency Trading. It took the New York Attorney General to really open the awareness of this issue.
How pervasive have High Frequency Trading firms become? The NYSE is now owned by a HFT firm, so is E*Trade. The majority of TDAMERITRADE’s stock trading is handled by HFT firms. Wow.
What can the average investor do? There is hope…. As described in Flashboys, an alternative trading system called IEX has been engineered to be safe from HFT. You can ask your broker to use IEX. What I’ve done is use a broker, Interactive Brokers, which allows me to use IEX to fill my buy and sell orders. This is a complicated broker for use by people who are experienced buying and selling stock and are willing to learn how to operate a complicated (but powerful) user interface.
Fundamentally, this is a huge fail for the SEC and the politicians who monitor stock exchanges.