This Is Outrageous

First I want to direct the attention of those in the US finance industry to a white paper written by Themis Trading, called Toxic Equity Trading Order Flow on Wall Street. Basically, they outline why volume and volatility have jumped so much since 2007 -- and it's not due to the credit crisis.

They estimate that 70% of the volume in today's markets is from high-frequency program trading. They outline how large brokers and funds can buy and sell a stock for the same price and still make $.005. Do that a million times a day and the money adds up. Or maybe do it 8 billion times. It requires powerful computers, the complicity of the exchanges (because the exchanges get paid a lot), and highly proximate computer connections. Literally, the need for speed is so important that to play this game you have to have your servers physically at the exchange. Across the river in New Jersey is too slow. Forget Texas or California. This is a game played out in microseconds.

The retail world doesn't get to play. This is only a game for big boys who can afford to pay for the arms needed to fight this war. But the rest of us pay for the game, as that half cent is like a tax on transactions, not to mention the increased daily volatility, which skews pricing.

Think it doesn't affect you? That tax is paid by mutual funds, your pension fund, and every large institution.

Frankly, this is outrageous. The more I read, the angrier I got. And it's going to get worse as computers get faster and software more intelligent. We need rules to level the playing field. Themis suggests a simple one: just make it a rule that all bids have to be good for at least one second. That would cure a lot of problems. One lousy second! In a world of microseconds, that is an eternity.

Goldman Sachs (GS) went after an employee who stole some of their latest and greatest software this past week. The US assistant attorney general that the software had the potential to manipulate the market. Imagine that. I'm shocked. There's gambling going on in the back room? Gee, Commissioner, I had no idea.

All this "algo" (algorithmic) trading also gives a very false impression of volume. If you're a fund and see 10 million shares a day traded, you might feel comfortable holding one million shares and exit your trade easily. But if 80% of the volume is false algo trading, that volume isn't really there. You may have a position that will be difficult to exit, and not even know it.