If you created a computer system that could send signals close to the speed of light, would it make you a successful investor?   You might respond, “What does the speed of light have to do with investing?  That’s astrophysics.”  You would be correct; it has nothing to do with investing.   So why have astrophysicists made most of the money in the investment business for the past 10 years?  It’s not because of their investment acumen.  They’re using knowledge few others have … to legally steal money because of a tenuous legal distinction. 

This distinction was created by the structure of exchanges.  Each stock exchange (there are 13) must make its best price available to a central facility.  That information is then used to establish National Best Bid and Offer market (NBBO) for the general public.   The exchanges then sell faster data feeds to traders who gain an advantage with their computers over the public information.   Of course, they pay the profit making exchanges for that data.  Also, they pay additional money for collocation which is putting their computers next to the exchanges’ computers.  Doing that saves even more time.

These customers are high-frequency traders.  Such firms can execute over 100,000 trades a second for a single customer.  Last year they were half of all stock exchange volume and collectively made 800 million down from eight BILLION in 2010.  This means half of all trades on an exchange have no price discovery purpose.  Combined with passive funds (30%-35 %%) there is an overwhelming maelstrom of non- relevant trading.  This is THE reason for active managers’ underperformance for the last 10 years.  Price discovery determines fair price, not “got ya” computer heists.

Amazingly, 95% of their trades are instantly cancelled.  This is called “spoofing” and is illegal if caught and proven.  Spoofing is the attempt by one computer to get another to reveal its trading mission so the faster one can take advantage of the slower one.   It’s a pure Darwinian experience and shows the importance of achieving speed close to the speed of light.  Ironically, this need for ever increasing speed makes it more difficult to make money.   Its transmission has progressed from underground fiber optics to microwave towers to laser beams. 

The subject of speed brings us to “THE HUMMINGBIRD PROJECT.”  It sounds as though it could be a John le Carre novel, but it is a movie about the drama of high-frequency trading.   Friday March 15 is the release date.  The film is set in the early days of HFT 2011-2012.   The hummingbird – which can achieve speed over 60 MPH - is a metaphor for the computerization of the stock market.  In this movie, it is about a race between competing parties to build an underground fiber optic cable from Kansas to New York City.  If one party can build it before the other, they will have an advantage of a one hundred of a millisecond in communication.   That is 16 milliseconds instead of 17 … and that says the protagonist “can make us 500 MILLION a year.”The absurdity of it is that it was allowed to happen and still goes on.  But there is an irony.  As speed increases, the money made by HFT goes down as does its impact on price discovery.   The speed issue thus becomes a poison chalice for its creator.

-Francis Patrick Boland