High Frequency Fraud?

banker xLast week I alerted you to the shenanigans in the exchanges caused by high frequency traders. They have the ability, thanks to technology to legally “front run” your order by selling you shares that they just bought at a discount milliseconds before your order hit the market. The technology they use is information sent over high-speed cables, which are exclusive to their use.

Now, just because they get the info first does not necessarily mean that you are going to get stiffed. The real damage caused by high-speed traders is their ability to pile into a stock when they see massive order flow coming into the market. They can then exaggerate the moves in the share price by beating the market to the punch causing what appears to be excess trading volume and volatility.

It’s also these same traders that use computer algorithms to trade stocks based on resistance and support levels. That in itself is not a problem. The problem arises from the “lemming effect”. Because these algorithms are similar and the technology used for trading is similar, these computer programs can “force” you to act irrationally by painting an inaccurate view of how a stock is reacting to news, good or bad or how it is reacting to technical patterns. They call it efficient information flow, but in reality they are getting the information ahead of you and that is only efficient for them.

At the end of the day, for regular traders, the high-speed traders really can’t impact your trading unless you find yourself in one of the volatile stocks they are also following. You can bypass their efforts in two ways. First, you can be diligent about only using limit orders when you buy or sell stock. Limit orders specify the price you are willing to sell at or buy a stock. If you get filled at your price, does it really matter to you what someone else bought or sold the shares for?

The second way is to use an exchange that operates at slower speed, directly matching buyer and sellers and one that offers more transparency. There is such an exchange out there. It’s called the IEX and it was developed by a group of traders who are interested in accuracy and transparency. It’s can’t be accessed by most online brokers, yet. But Interactive Brokers and Tradestation are offering direct routing of orders to the IEX. This means that if you have an account at either firm, you can specify or direct that your order go through the IEX and not the New York Stock Exchange or any other exchange.

The IEX offers a 350-microsecond delay between orders and executions, enough to foil the high-speed traders efforts at buying or selling ahead of you. If investors can see a price difference in their favor, it may send shockwaves in the market and its biggest player, the NYSE and it’s parent company the Intercontinental Exchange (ICE-NYSE). This can only happen once the IEX starts displaying prices like every other exchange. If the IEX shows better pricing, then the NYSE will have to make changes to the way it allows traders to buy and sell as well.

As a result of high frequency or high speed trading the market is less transparent and moves at speeds that benefit those with the inside track and technology over the regular stock buyer. While many see that as no big deal, the consequences of allowing any one firm to have an advantage in what should be an open marketplace damages the integrity of the entire system. And it’s a system in dire need of more integrity to begin with.

To your wealth,

Banker X.

P.S. from Midas Legacy Editor: Through his Washington contacts, Banker X exposes insider trading activity and sends appropriate specific BUY recommendations to subscribers to his C.H.I.R.P. service.

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