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High-speed stock trading fuels market swings, worry

By Graham Bowley
New York Times / October 9, 2011

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NEW YORK - Regulators in the United States and internationally are cracking down on computerized high-speed trading that crowds today’s stock exchanges, worried that as it spreads around the globe it is making market swings worse.

The cost, critics say, is the confidence of ordinary investors in the markets and, ultimately, their belief in the fairness of the financial system.

“There is something unholy about them,’’ said Guy P. Wyser-Pratte, a prominent longtime Wall Street trader and investor. “That is what caused this tremendous volatility. They make a fortune whereas the public gets so whipsawed by this trading.’’

Regulators are playing catch-up. In the United States and Europe, they have recently fined traders for using computers to gain advantage over slower investors by illegally manipulating prices, and they suspect other market abuse could be going on. Regulators are also weighing new rules for high-speed trading, with an international regulatory body to make recommendations to global leaders in coming weeks.

In addition, officials in Europe, Canada, and the United States are considering imposing fees aimed at limiting trading volume or paying for the cost of greater oversight.

Perhaps regulators’ biggest worry is over the unknown dynamics of the computerized stock market world that the firms are part of - and the risk that at any moment it could spin out of control.

Some regulators fear that the sudden market dive on May 6, 2010, when prices dropped by 700 points in minutes and recovered just as abruptly, was a warning of the potential problems to come. Just last week, the broader market fell throughout Tuesday’s session before shooting up 4 percent in the last hour, raising questions on what was behind it.

“The flash crash was a wake-up call for the market,’’ said Andrew Haldane, the executive director of the Bank of England responsible for financial stability. “There are many questions begging.’’

The industry and others say that the vast majority of trading is legitimate and that its presence means many extra buyers and sellers in the markets, drastically reducing trading costs for ordinary investors.

James Overdahl, an adviser to the firms’ trade group, said that they are in favor of policing the market to stamp out manipulation and that they support regulators’ efforts to improve market stability. The traders, he said, “are as much interested in improving the quality of markets as anyone else.’’

High-frequency trading took off in the middle of the last decade when regulatory reforms encouraged financial exchanges to switch from floor-based trading to electronic. As the computers took over, daily turnover of stocks rose to 8 billion shares in the United States today from about 6 billion in 2007, according to BATS Global Markets.

The trading, done by independent firms or on special desks inside big Wall Street banks, now accounts for two out of every three stock market trades in America.

Susanne Bergstrasser, a German regulator leading a review of high-speed trading for the International Organization of Securities Commissions, said authorities have to be alert for “market abuse that may arise as a result of technological development.’’

After a six-week consultation with the industry, the organization will present its recommendations to G-20 finance ministers this month on how to address high-frequency traders and their complex algorithms, as well as broader structural shifts brought by the birth of new electronic exchanges and trading venues.

In the United States, the Financial Industry Regulatory Authority last year fined Trillium Brokerage Services, a New York firm, and some of its employees $2.3 million for layering. Trillium paid the fine without admitting guilt, the agency said. Since then, FINRA has requested proprietary computer code from “a couple’’ of unnamed firms after noticing “unusual trading patterns,’’ said Tom Gira, head of the authority’s market regulation unit.

Even the traders’ authorized activities are coming under fire, especially their tendency to shoot off thousands of buy or sell orders a second and suddenly cancel many when their strategy for that stock changes. Long-term investors like pension funds complain that the practice makes their trading harder.

The Securities and Exchange Commission has been looking into the new market structure for almost two years, seeking comments from investors and other major players. In July, it approved a “large trader’’ rule, requiring firms that do a lot of business in the markets including high-speed traders to offer more information about their activities in case regulators need to trace their trades.

After the flash crash, exchanges introduced circuit breakers to halt trading if stock prices move violently. Bart Chilton, a commissioner at the Commodity Futures Trading Commission, this month called for regulators to go further. He wants compulsory registration of high-frequency firms and pre-trade testing of their algorithms to make sure they won’t go out of control.