Turns out there might be something unsavory about computers running proprietary algorithms to trade stocks at light speed for fractional cents, often faster than it takes information (moving at the speed of light) to register that trades have even taken place. The Wall Street Journal and other outlets are now reporting that FBI and the Attorney General's office have been investigating the legality of high-frequency trading.
Insider trading is defined as the "buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security." High Frequency Trading is the process by which a computer program makes thousands of trades every second in order to extract profits in the fractions of cents from a single stock. Unless you are a computer, you can't really assess information at light speed. High frequency trading just might be illegal insider trading as it involves "information not readily available to the public unless you are a computer belonging to an investment bank."
The probe began last year but has benefitted from increased publicity surrounding the issue, the latest being both the news of the probes breaking yesterday and Sunday night's 60 Minutes segment dedicated to author Michael Lewis' newest book, Flash Boys, which chronicles some of the big players in Wall Street's favorite new toy.
High frequency trading, in essence, is a method of computer-driven algorithmic trading that allows investment banks to make lots of money by circuiting conventional biological limitations of time and space. These financial institutions exist only to make money, and most of the time it isn't for you. It's kind of like the opposite of the Office Space scheme, where the heroes plot to siphon fractional pennies from company deposits over a period of years. That scam turned out to be illegal too, but with considerably more hilarious results.
Speaking at the New York Law School on March 18th, Attorney General Eric Schneiderman told the audience that he planned "to urge stock exchanges to consider curbing such features and adopting proposed safeguards to ensure investors are competing on an equal playing field." Why not just level the playing field by giving everyone access to computers and laser beams?
All of this shit is confusing because it is designed to be, much like most nefarious and destructive financial techniques, which are quite literally the predatory spawn of unscrupulous financial geniuses, so the visualization below comes in handy. It shows 10 milliseconds of HFT with the stock of the pharmaceutical company Merk. Slowed by a factor of 40,000, the clip is still nearly seven minutes long.
From the description:
In 1/100th of a second (10 ms), light (and therefore information) travels just 1,860 miles (3000 km) under ideal conditions. In reality it takes a bit longer, for example, it takes about 30 ms for information to travel from New York to California (2,400). Which means by the time a computer in California received the first quote shown in this animation, the last quote had been canceled 20 milliseconds earlier. When computers in London received the first quote, the last quote had been canceled about 30 milliseconds earlier. The average camera shutter speed is 8 ms. One frame of a Hollywood film lasts about 40 ms. The average human eye-to-hand reaction time is 215 ms.
Just to reiterate: you are watching 1/100th of a second.
The New York Post notes that "Schneiderman has likewise singled out stock exchanges that have allowed high-frequency traders to “co-locate” their computer servers at the exchanges’ own data centers, giving them a potential speed advantage over competing traders," as a practice warranting further investigation.
Citing advantages unavailable to regular investors, "such as access to superfast data feeds," the WSJ explains that the investigation is picking up steam, and the FBI, Attorney General, and the SEC all trying really hard to decide if something like using computers to trade stocks at light speed in order to extract significant amounts of money in a series of individually negligible exchanges is illegal.
"The stock market is rigged," said Lewis on 60 Minutes, with a note of disbelief, as if this news is a disheartening shock to all those optimistic traders-to-be out there. Let's hope we catch these guys before anything bad happens.
