Time to control the trading machines

The nasty community implications of the 'legalised insider trading' or so called high-frequency trading are becoming better understood in New York, Germany and, to some extent, Australia.

You will remember that high-frequency trading is the scheme where big institutional investors pay stock exchanges large sums so they can have a direct pipe into the trading computer to cream money from smaller players, all in the name of providing the market with liquidity.

In Australia, many of the smaller players are ordinary Mum and Dad superannuation savers who invest in professionally managed funds or self managed funds and don't have a 'legalised insider trading' pipe.

Alan Kohler was one of the first commentators in the world to explain how the system works to penalise small investors (High-frequency trading is cuckoo, 11 April).

Then I explained how the high-frequency traders in New York were discovering they could not only make money from getting into the market first but could extend that to being faster to act on new announcements (Getting the jump on high frequency trading, July 18).

Since then The New York Times has been very critical of high-frequency trading. That encouraged Elke Knig, the head of the Germany's Federal Financial Supervisory Authority (BaFin), to be one of the first regulators to talk openly about some of the bad features of about high frequency trading.

Dr Knig, who took a 50 per cent pay cut when she moved from the insurance industry to head Germany's securities industry regulator, told Der Spiegel magazine that she believes high frequency trading contributes to "extremes on the market”.

"The liquidity apparently created is an illusion because many of those deals are never actually executed”, she said. "The automobile industry has built cars capable of travelling very fast, yet the industry has agreed that 250 kilometres an hour should be the upper limit. Along the same lines, I wonder precisely what economic good we achieve by trading at nanosecond speeds."

Der Spiegel: "What can be done to prevent that?"
Knig: "We could attach fees to these transactions that would render large-scale gambling for marginal yields unattractive. It would really make a lot of sense to institute this kind of a financial transaction tax”.

So Germany is looking at charging the high frequency traders a fee. Lets hope its a big one and puts them out of business.

Back in New York they have discovered yet again how dangerous automating trades can be.

Last month a computer malfunction at high-frequency trader Knight Capital Group caused considerable disruption in the market and may have contributed to the one per cent fall on Wall Street on the day.

Knight, founded in 1995, was handling 11 per cent of New York trading and Knight's automated stock program flooded the market with millions of trades at blinding speeds.

The company lost $440 million but we saw yet another illustration of the dangers the global securities industry faces. According to The New York Times, high speed traders account for half of all activity on American markets.

In response to the event, the chief executive of the NYSE, Duncan Niederauer said in a conference call, "we are all understanding – meaning we, market participants, and most importantly the regulators – are understanding that speed is not always better.”

Much of the blame for "legalised insider trading” has been put on stock exchanges. However the stock exchanges have limited choice because once one takes the high-frequency money the others are at a disadvantage.

The Australian regulator, the Australian Securities and Investment Commission, is promising tighter regulations.

I am not optimistic they will be anywhere tough enough but it's a start.