• High frequency trading, dark pools and one company’s solution.
By Ronald L. Ray —
From its inception, the United States stock market has tried to separate the masses from their money, transferring it over time to the plutocrats. Industries of “experts” exist to convince the little guy that he can “goose” the system and become wealthy through less than hard work. But the system, like a mobster’s casino, has been “gamed” by its owners, and few can win against the house. Modern computer networks have made it a virtual certainty. Hope, nevertheless, for honest and just trading recently has been reborn in the efforts of six-month-old Investors Exchange (IEX)—and even Goldman Sachs, immortalized by Rolling Stone’s Matt Taibbi as the “great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money,” may become a believer in the new market morality.
Deception, distrust and dirty tricks are the long-standing rules governing many traders’ efforts to beat the other guy out of a buck. And in the past decade or more, developing technology has raised the practice of cheating to an art form. Foremost in the field is Goldman, which controls as much as 70% of stock market activity.
“High frequency trading” is one method by which the big boys attempt to bury competition, not only from individuals, but even brokerages and some large investment firms. It has gained recent notoriety from a new book, Flash Boys: A Wall Street Revolt, by Michael Lewis.
In today’s investment world, speed is supreme. The faster someone can place his order, the better his chance of paying the desired price for stocks and making his fortune. Entire corporations fight for milliseconds, microseconds, nanoseconds—tiny fractions of the blink of an eye. Those with the wherewithal pay huge sums for faster connections and hardware closer to the point of actual trading on the exchange, where money is now made by complex computer algorithms and brief, repeated trades occurring in less than a moment.
For years, though, brokers and institutional investors have noticed that the market does not function as formerly. One enters a large block trade, and, instead of going through, it disappears in cyberspace, and the stock price jumps. This has introduced greater instability in markets and reluctance by brokers to commit cash.
Thanks to the research of Brad Katsuyama and associates, founders of IEX, we now know that the largest banks and investment houses like Goldman have been cheating. In theory, everyone has an equal shot at a purchase or sale. In reality, those physically closest to the action can see the other orders coming and jump in ahead—the ultimate insider trading. If huge companies like investment firm T. Rowe Price can get ripped off, imagine how little chance the workingman has to multiply his meager savings.
Worse, much of this conniving happens in “dark pools”—barely regulated, massive, secretive pools of money designed to fuel greater trading and thus the pool owners’ own profits with complete anonymity of the players. Here almost anything can happen, because it is unseen. The dark pools’ managers are free even to trade against their own clients or to route trades differently than requested. Ethical restraint seems not to exist. The leading dark pool is Goldman Sachs Group’s SIGMA X.
Against this background, IEX began in October 2013 as a new stock exchange, combining honesty and simplicity. No investors may be owners of IEX. The owners must place trades through brokers like everyone else, and there are only three types of trades. Most importantly, a level playing field is created by actually slowing down the speed of trades through the low-tech solution of 38 miles of fiber-optic cable coiled in a box. No one gets a jump on the other guy.
Results? Many small- and medium-size traders climbed in immediately, surpassing expectations. But the top firms still fight to keep their secret advantages.
Things began to change in December, however, when Goldman Sachs finally placed a significant trade, pushing volume past AMEX in hours. JPMorgan and others followed, and IEX is growing rapidly, with Goldman’s surprising blessing.
Honesty, bred by IEX’s intentional fairness, is becoming a popular commodity and has a chance to change stock market operations for everyone’s betterment.
Goldman has announced both potential closure of its profitable SIGMA X and further moves toward IEX. Maybe their new-found morality is motivated more by a fear of lynching, if their dark pool activities become known. Regardless, it is a positive change, to which we say, “Thank you, IEX.”
Ronald L. Ray is a freelance author and an assistant editor of THE BARNES REVIEW. He is a descendant of several patriots of the American War for Independence.