The Negative Impact of Ultrafast Stock Trading

In recent years, stock trading has evolved from a negotiation between a buyer and a seller to a mostly electronic system. This means any person with a computer can start trading, but it also means those investors with faster computers may see advantages. In particular, Wall Street giants like Goldman Sachs, or well-capitalized hedge funds are able to develop super computers that can execute millions of trades in a split second of time. This can significantly impact how the market behaves on the whole.

High Speed Trading Systems

High speed trading systems are only possible with the advent of new technologies. For example, computer chips designed by companies like Intel have become powerhouses of information processing. While executing a command used to take a minute, then a few seconds, then a split second, it now can take only a few thousandths of a second. This means a tiny chip can be used to execute trades at a pace an average investor can never be expected to keep up with.

Add to this the fact that programmers have developed programs that can act as virtual stock traders, buying and selling without a single human command. These programs use algorithms, or mathematical formulas developed by traders and programmers, to determine when to buy, sell or just watch a stock or bond. With the combination of algorithms for trading and speedy computer processors, robots can make trades at a pace virtually untraceable to an average person. They can be in and out of a trade before anyone even knows they were there, and all that is left is a changed price on the stock.

Profit for First Trades

One way these systems manipulate profits for financial firms is by capitalizing on fees for first trades. Some exchanges offer small fees or commissions to high volume traders who get to a trade first or most frequently. A computer can always beat a person to the punch with this issue. The computer can issue then cancel a trade almost immediately, walking away with either a small loss or a neutral result. Even if the firm loses money on the whole, it will capitalize on these tiny fees, often just a portion of a penny on each trade. At a high enough volume, the firm can win even if it loses money.

The Effect of Flash Orders

Flash orders complicate the issue even further. There is a loophole in regulation that allows some investors to see the activity on a stock just a few fractions of a second before other investors. If the computers see a number of investors are looking to purchase a certain stock, it can jump in and purchase the stock first, a split second before the investor. Then, the computer is holding the stock at a higher price, ready to sell for the investors who were already in the process of ordering a buy. The result is rapidly climbing stock prices, even if the underlying asset is not values as highly as the purchase price. This can create bubbles for certain stocks that may eventually lead to collapse for many investors, but the computer systems have already walked away.

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