High Frequency Trading Issues Hit Broker Stocks - Analyst Blog

Shares of TD Ameritrade Holding Corporation AMTD and E*TRADE Financial Corporation ETFC declined during intraday trading on Apr 3, following a statement criticizing high frequency trading by another brokerage firm, The Charles Schwab Corporation SCHW. The statement condemned high frequency trading as “a growing cancer that needs to be addressed”.

Notably, shares of TD Ameritrade decreased 5.3% to close at $32.02 while E*TRADE slumped 6.5% and closed at $22.17. Moreover, Schwab's shares fell 1.9%, ending the day at $27.37.

TD Ameritrade, E*TRADE and Schwab are all involved in high frequency trading. High frequency trading is the use of complicated technological tools and computer algorithms to trade securities in a matter of fraction of seconds.

Why is High Frequency Trading in News?

High frequency traders have existed for many years. However, of late, these are coming more prominence.

The new-found interest in high frequency trading is owing to announcement of a probe by New York Attorney General, Eric Schneiderman in March. Further, several other law enforcement agencies including the Securities and Exchange Commission (SEC) as well as Federal Bureau of Investigation are investigating high frequency trades for possible violations of the law.

Intensifying matters, last Monday, Flash Boys: A Wall Street Revolt by Michael Lewis, which deals with similar issues, hit the stands. With Schwab's top executives putting their heads together to discuss the matter, questions regarding the legitimacy of high frequency trading remains under introspection.

Increasing Concerns

There are regulations in place that sought to protect retail investors by giving priority to their orders over professional orders. However, to attract high frequency trading operations to markets, stock exchanges tend to give preference to professional orders.

Further, stock exchanges let high-frequency traders buy faster data feed with detailed information related to the trading activities. This faster access to information gives these high-frequency traders an advantage over retail investors. Hence, this has been creating undesirable disparity.

Further, in 2013, certain high frequency traders reaped profits for 99% of their trading days. This is after taking into account the termination of 95% high-frequency trader orders. Hence, it appeared that there was some advantage that carefully hidden.

Answers on the Horizon

It is incumbent to find the means to curb high frequency trading. At present, there are no limits to giving millions of orders in a fraction of seconds and then withdrawing the same. This is primarily the way in which profit worth billions of dollars are reaped through high frequency trading.

Under the present circumstances, it seemed a good idea to start levying cancellation fees to put off the practice of reversing the orders. Notably, the idea was mooted last year by the SEC and the Commodity Futures Trading Commission. High cancellation fees are expected to entirely stop high frequency trading.

Another way to solve the issue is to make high frequency trading illegal. Additionally, stock exchanges should not give any preferential treatment to these high frequency traders. The exchanges should stop allowing high frequency traders to jump the line and execute orders right away.

The above-mentioned measures could do away high frequency trading and the advantages that it automatically begets.

Are Solutions Adequate?

Advanced technology has been the main reason behind high frequency trading coming into being. Hence, even if these solutions are implemented, it does not ensure that stock prices will not be rigged in any other way going forward.

Earlier this week, The Goldman Sachs Group, Inc. GS was in the news for being engaged in talks with IMC Financial Markets to vend its floor-trading business. The floor trading business is losing its importance with the advent of high-end technology as the latter facilitates trading with much ease and accuracy, thereby eliminating the necessity of manual help.  Given this scenario, Goldman's latest move comes as no surprise.

In conclusion, we believe that high frequency trading is here to stay. The only way to stop its misuse is to regularize it.