Speed trading threatens Terminator event

The buying and selling of shares by computers has frightening implications, writes David Potts.

By InvestSMART · 12 Aug 2012

By InvestSMART ·
12 Aug 2012

Comments

The buying and selling of shares by computers has frightening implications, writes David Potts.

'Dark pools" sounds like something particles whizzing around the Hadron Collider at almost the speed of light might find.

If only. Fact is they are a by-product of something more sinister: speed trading, where computers initiate, uh interface, share trades with each other so fast that if you blink you've missed 150 of them.

If it's possible to travel faster than the speed of light, these computers will be the first to know.

Not that they'll tell anybody. The problem with speed trading is nobody, least of all the ASX or Australian Securities and Investments Commission (ASIC), knows what the computers are up to.

There's no human intervention, apart from the design of the algorithms in the first place. From there, the computers are on their own and can run rampant with a faulty algorithm until somebody pulls the plug, invariably too late.

Remember the "flash crash" two years ago, when Wall Street dropped 1000 points in 20 minutes? Speed trading. Even scarier, it's spread to commodities and, gulp, derivatives, bringing wild price fluctuations with it.

A Wall Street trader, Knight Capital Group, recently blew $440 million in an hour as its computer went haywire - distorting the prices of 150 stocks in the process - and nearly went under.

And what if it had? Good riddance you say - only that could have been another Lehman moment. It was the collapse of the non-collapsible Lehman Brothers that pushed the global financial system to the brink.

Yet speed trading is encouraged by the ASX, which happens to earn a fee for every quote, so a few more million sure won't hurt it.

Trouble is, the computers are trading with each other for starters.

Besides, the computer programs vault to the top of the queue because they know your order before the ASX's computer does and, the way things are going, I dare say even you. They'll undercut a seller and overbid a buyer to get in first. Cripes, they can beat you even at the same price.

Or they're flooding the market with fake bids, suggesting something's happening and there's momentum, only to cancel them a nanosecond before the market opens. That's called manipulation and would land a broker who tried it in jail.

This is pushing more trades off the exchange into dark pools owned by banks and brokers, which has the ASX whingeing to ASIC.

Still, it says dark pools are the antithesis of what a sharemarket should be about - transparency and a level playing field. While ASIC and ASX are sending papers to each other on how to control dark pools, the cause of them - speed trading - is accelerating, so to speak.

What scares me is that they've already lost control and don't even realise it.

Follow David on Twitter @moneypotts

Go to Google News, then click "Follow" button to add us.

Share this article and show your support

Frequently Asked Questions about this Article…

What is speed trading (high-frequency trading) and why does it matter for everyday investors?

The article describes speed trading as computers executing huge numbers of share trades with almost no human intervention, often in milliseconds. It matters for everyday investors because faulty algorithms or rapid automated activity can cause extreme price swings (like the cited 'flash crash'), distort market prices and make the market less predictable and less fair for regular investors.

What are dark pools and how do dark pools affect market transparency?

According to the article, dark pools are off‑exchange trading venues owned by banks and brokers where trades happen away from the main exchange. Dark pools reduce transparency and the level playing field the sharemarket should provide, because more trades are moved off the public exchange and out of view of ordinary investors.

How did speed trading play a role in past market disruptions like the 'flash crash'?

The article links speed trading to past market disruptions, noting a 'flash crash' on Wall Street when markets plunged rapidly (the piece references a 1,000‑point drop in about 20 minutes). It warns that automated trading can ripple into commodities and derivatives, producing wild price fluctuations and sudden market disorder.

Can faulty trading algorithms create systemic risk in financial markets?

Yes. The article highlights a real example where Knight Capital Group's automated system blew US$440 million in about an hour, distorting prices across roughly 150 stocks and nearly collapsing the firm. The author warns such events could become systemic and compares the potential fallout to serious past crises like Lehman Brothers.

Is the ASX encouraging speed trading and why might that be a concern?

The article claims the ASX effectively encourages speed trading because it earns fees for every quote, so higher automated activity increases revenue. The concern is that this creates incentives that may conflict with ensuring a transparent, fair market for ordinary investors.

How do high‑frequency trading algorithms get an advantage over regular investors?

The article explains that algorithms can jump to the top of the execution queue because they see and react to order information faster than the ASX systems or individual investors. They can undercut sellers or overbid buyers in a fraction of a second, and may even place then cancel orders so quickly that it looks like momentum—behaviors the piece equates with manipulation.

What are regulators like ASIC doing about dark pools and speed trading?

The article says ASIC and the ASX are exchanging papers and discussing how to control dark pools, but warns that speed trading—the root cause of the problem—continues to accelerate. The author expresses concern that regulators and exchanges may have already lost control and might not fully realise the scale of the issue.

As an everyday investor, how should I think about the risks of speed trading and dark pools?

The article's tone is a warning: everyday investors should be aware that automated speed trading and dark pools can increase market volatility, reduce transparency and create price distortions. While it doesn't give specific portfolio advice, the clear takeaway is to recognise these structural risks when assessing market behaviour and sudden price moves.