Academic

I've been busy with semester-starting, Glom Master-organizing, FAR-form-reading, home remodeling, etc., so the flash-trading ruckus has been lurking on the periphery of my consciousness.  Yesterday's WSJ article intrigued me, though.

What's flash trading?  According to the article it's "a particular variety of high-frequency trading that briefly previews some orders to a few dozen market participants and trading platforms in hopes of finding a match."  Huh? 

Last week flash-trading proponents Chris Hynes and Donald Luskin described it this way:

 ...it is simply a way for one customer to query other customers to see if they will take the other side of a trade.

Let's say that among all the exchanges, the highest bid for stock XYZ is 10, and the lowest offer is 10.5. Bob enters a flash order to buy 500 shares in between, at 10.25. This order exists in Direct Edge's system for mere milliseconds, but in that time the high-speed computers of other participants might decide to sell Bob the 500 shares he wants to buy. So Bob gets a price better than the best offer, and the seller gets a price better than the best bid. If a trade can't be executed, then Bob can try other markets.

In this example, because the flash trade comes in between the best bid and the best offer, it does not contribute to market volatility. Buyer and seller have entered into a trade in which they both feel they have achieved the best possible deal, or they wouldn't have traded. And the flash order created an opportunity for new liquidity to enter the market.

Flash trading is definitely a big deal. A NYT article says:

An explosion of computerized trading has helped drive volume on the New York Stock Exchange alone up by 164 percent since 2005. Stock exchanges say that more than half of all trades are now executed by just a handful of high-frequency traders, who use rapid-fire computers to essentially force slower investors to give up profits, then disappear before anyone knows what happened.

I'm still not quite sure I get exactly how flash trading works.  But I do get the stories. 

N.Y. Sen. Charles Schumer claims these deals create:"a two-tiered system where a privileged group of insiders receives preferential treatment." He wants the SEC to ban them.  Basically the story goes that it's unfair to the rest of us that these insiders get to make these special trades.  It's the "rich people get access we don't" story.

Hynes and Luskin tell a story of Direct Edge as scrappy little guys trying to buck the establishment (NYSE), taking too much market share, and being unfairly picked on.  With Direct Edge accounting for 12% of U.S.-listed stock trading, it's a plausible David-vs.-Goliath story: NYSE sees a threat to its turf, and sics the SEC on the plucky upstart. 

Who's right?  I don't feel like I understand enough of the mechanics to say.  But look for SEC rules on flash trading and "dark pools" this fall.