I can’t find the cartoon right now, but about ten years ago I noted that small investors are important to Wall Street in the way that stranded motorists are important to horror movies. This appears to be more true than ever these days:
Nearly everyone on Wall Street is wondering how hedge funds and large banks like Goldman Sachs are making so much money so soon after the financial system nearly collapsed. High-frequency trading is one answer.
And when a former Goldman Sachs programmer was accused this month of stealing secret computer codes â€” software that a federal prosecutor said could â€œmanipulate markets in unfair waysâ€ â€” it only added to the mystery. Goldman acknowledges that it profits from high-frequency trading, but disputes that it has an unfair advantage.
â€œThis is where all the money is getting made,â€ said William H. Donaldson, former chairman and chief executive of the New York Stock Exchange and today an adviser to a big hedge fund. â€œIf an individual investor doesnâ€™t have the means to keep up, theyâ€™re at a huge disadvantage.â€
For most of Wall Streetâ€™s history, stock trading was fairly straightforward: buyers and sellers gathered on exchange floors and dickered until they struck a deal. Then, in 1998, the Securities and Exchange Commission authorized electronic exchanges to compete with marketplaces like the New York Stock Exchange. The intent was to open markets to anyone with a desktop computer and a fresh idea.
But as new marketplaces have emerged, PCs have been unable to compete with Wall Streetâ€™s computers. Powerful algorithms â€” â€œalgos,â€ in industry parlance â€” execute millions of orders a second and scan dozens of public and private marketplaces simultaneously. They can spot trends before other investors can blink, changing orders and strategies within milliseconds.
High-frequency traders often confound other investors by issuing and then canceling orders almost simultaneously. Loopholes in market rules give high-speed investors an early glance at how others are trading. And their computers can essentially bully slower investors into giving up profits â€” and then disappear before anyone even knows they were there.
The house always wins of course, but it’s as if they’ve entirely given up on the pretense that you might beat the odds.