My first experience with the speed of light was as a young caddy.   As I looked across a fairway I saw a golfer hit a tee shot some distance away.   The player hit the ball, finished his swing, and then – what seemed seconds later in the hot humid air – I heard a CRACK sound.   I was puzzled.   At the time, I didn’t know the speed of light traveled 671,000,000 MPH which was dramatically faster than the speed of sound (761 MPH).   But I did experience it.   It was my introduction to something that would occur much later in my life, high-frequency trading.

Computers have been used at the New York Stock Exchange since the early 1980s.   But in 2005 the exchange transitioned from a non-profit to a FOR- profit organization.  That change would upend the active investment management business.   High-frequency trading firms began paying the exchange for the right to put computers next to those on the exchange floor.   It was called co-location.  This placement gave HFT firms nanoseconds of advantage over competing firms that couldn’t/or wouldn’t do that.  In a world of nanoseconds, location made a difference.   It also obscured price discovery.

The following year 25% of exchange trading volume was being done by HFT computers; three years later it was 62%!   None of it was real volume.  Real volume is for price discovery; stocks that are bought and sold by investors.   That is why an exchange exists.  HFT volume was fictional.  It’s presented to the world as though it’s real volume but it has nothing to do with price discovery.  It’s whose computers are the fastest.   A fast computer would buy a stock it knew a slower computer was instructed to buy and sell that stock back to the slower buyer at a higher price.  There was no risk involved, only gain.  If a human did that it would be front running and illegal.  With computers it’s presented as real (price discovery) volume.  In truth, it was (note past tense) a sophisticated game of pinball with HFT players controlling the plastic fins and the bounces of the steel balls.

I have put HFT trading in the past tense because it is – albeit slowly - decreasing.   The use of microwave communications – replacing fiber optic signals – now allows computers to reach speeds close to the speed of light.  According to Albert Einstein, that is as fast as we can go.  It is a phenomenon that substantially reduces HFT profitability and the number of traders doing it.   This increased speed also eliminates the canard that they are market makers.  Rather, they are market takers.   If you think about it, who among us would want to compete against computers?  Obviously, they have an inherent speed advantage.  Undoubtedly, this is why – according to a Morgan Stanley study – individual investor’s participation in the market has fallen to an all time low of just 11%.

Not only have high-frequency traders been nothing but obfuscators of price discovery, they have also obfuscated the difference between trade execution and investment management.  These “quants” like to pretend they are money managers.  It gives them the feeling of being investment professionals.  They are not.  They are simply trade executioners.  And with computer transmission approaching the speed of light they are now losing even that self-serving advantage. 

-Francis Patrick Boland