Friday, July 8, 2011

Millisecond Trading -- The Ultimate Parasite

Adding A Tapeworm to Cancer Stage Capitalism

Although millisecond trades on the Wall Street and commodities market had "their moment in the light" for a few minutes during the last year, that faux-media "illumination" didn't have much staying power.  If a tycoon from the "barely legal" trading cartels even took notice, the embarrassment resulted in nothing more than spending an extra couple of afternoons at the golf course until the stink blew over.

We have to face it.  Millisecond trading is simply too complicated a story to ever possibly compete with the "no sex, sex scandal" of the Weiner variety.  Now that the story is not only cold, dead and buried in yesterday's news, it has had a stake quietly driven through its heart by direct order of the billionaire masters of the corporate media.

Unhappily, once the process was rehabilitated by this lack of public attention, the millisecond trading scheme is now roaring forth at full power and profit.  If you're lucky enough to have a few US currency bills, grab your wallet!  That advice holds whether you are in the stock market or not.

If MeanMesa intends to resurrect the story, a short explanation might be in order.

How Millisecond Trading Works

Abbreviated Model of Normal Investment Cycle
In the very simplified chart above, we see the traditional elements of an investment.  When a product of business has a good likelihood of turning a profit, an investor is willing to accept the risk of lending his capital to the enterprise.

The enterprise, as a result of being capitalized, is able to pursue a business plan which will create a profit and increase the value of the enterprise.  The investor then enjoys a corresponding increase in the value of his investment.  His holdings in the product of enterprise can then be sold for more than he invested.

The timetable required for such an increase varies.  Although a rapid increase in the value of an investment is not infrequent, most normal investments take a period of time which corresponds to the amount of time it takes the business to start making a profit.

During the entire period between the initial investment and the first profits of the business, the investor is exposed to the risk of his decision.  At any point along the way, the business might falter and the value of the original investment might decrease correspondingly or, in some cases, vanish all together.  Further, the momentary value of even a potentially profitable investment may often have periods of increased value and decreased value as the cycle unfolds.

One way to view this is to simply say that the investor who finally enjoys a profit from the increased value of his capital is, in fact, being "paid" for accepting the risk exposure during the time that the business might have collapsed.  The amount of profit the investor can expect from a successful venture is "spelled out" very clearly in the beginning of the process.

If the value of the business increases by a certain amount, the investor has the reasonable expectation of seeing his original investment increase by a pre-arranged percentage of that amount.  All the "ups and downs" which might occur as the business works toward a profit are, so to speak, taken in stride by the investor, and written off as a predictable part of the risk exposure he agreed to take.

From the "market perspective," the value of the business is, in fact, "gaining ground" each time its stock increases in value.  Further, the amount that the value of the business is increasing during these times is reflected in the higher value of its stock.  When the stock goes up, the business enjoys an additional value in the amount that the stock increases.

However, what happens if the business doe not receive the full value of such increases?  And, even more interesting,  how could that happen?

Now, we can examine the effect of millisecond trading as it interferes with this scenario.

Model Showing Effect of Millisecond Trading

The chart above shows that the investor is receiving a slightly less amount of the increase in the value of his investment as a result of the millisecond trading.  In fact, both the investor and the business are getting less.  During the periods when the value of the stock is increasing, the business is not getting the full additional value corresponding to the rising stock price because a small amount of the increase is being diverted to the millisecond trader.

Comparing the actual amount the business is receiving from the stock increase to the amount it would have received without the intervening millisecond trades, we see that the business suffers from a slightly diminished influx of capital value.  As the business suffers, the investor will eventually also suffer.   His investment would have increased more if the value of the business had increased more which it would have done if the full amount of the stock value increases had flowed to the business instead of being diverted to the millisecond trader.

A Few Important Observations About Millisecond Traders

The begin with, we can note that the "period of ownership" for the millisecond trader is extremely short.  This "fast turn around" idea is precisely the feature which makes a millisecond trader a millisecond trader.  Trades can be accomplished literally in milliseconds, and risk exposure is limited to the same, short time frame.

Of course, there is no actual investment in any business or product.  In fact, the nature of the enterprise which has offered its stock means nothing to the millisecond trader.  Instead, a set of highly competitive, yet profoundly sterile, algorithms scan the activity on the market, millisecond by millisecond, then "jump in" and "jump out" based on subtle trends in trading prices.

MeanMesa has looked over a few articles on this subject and selected one which seems especially direct and accessible to the "market layman."  In this article by Bryant Urstadt, a specific, successful, millisecond trader is presented as an example.  This is a rather long article (Trading Shares in Milliseconds) but a very interesting one, and a few quotations are provided here.  MeanMesa encourages visitors to spend 10 minutes with Urstadt's article.

Trading Shares in Milliseconds
by Bryant Urstadt

Narang is the head of Tradeworx, a hedge fund and financial-technology firm that makes purely automated trades; all decisions are reached and acted on at near light speed by computers running preprogrammed algorithms. “Actually, we run two businesses,” he says. “The first trades in and out of shares in about a second and holds them for an average of two or three days. That’s the medium-speed fund. The high-speed fund could make thousands of trades a second and holds them for a matter of minutes.”

By the end of the day, his computers will have bought and sold about 60 million to 80 million shares, with the heaviest activity in the last hour of trading, from three to four in the afternoon. Tradeworx and similar firms around the country will race to close billions of bets that hinge on things like tiny differences between the prices of shares in an exchange-traded fund holding the S&P 500 and the individual shares that make up the same index. The profits go to the company with the fastest hardware and the best algorithms—advantages that enable it to spot and exploit subtle market patterns ahead of everyone else. At the end of a typical day, 44the Tradeworx high-speed business holds no shares at all. Come Monday, Narang will look to trade millions more shares. It seems like a lot, and it is, but Narang estimates that he’s probably only somewhere in the middle of the top 50 traders by volume.

The article also presents the following example of some of a millisecond trader's "work."

explains a lot about how high-frequency trading works and why it angers some observers, as Joseph Saluzzi and Sal Arnuk, the principals of the New Jersey–based Themis Trading, made clear in their 2008 white paper “Toxic Equity Trading Order Flow on Wall Street.” Imagine that a mutual fund enters a buy order, telling its computer to start by offering the current market price of $20.00 a share but to take any asked price up to $20.03. A high-speed trader, Saluzzi and Arnuk explained, can use a “predatory algo” to identify that limit by “pinging” the market with sell orders that are issued in fractions of a second and canceled just as fast. It might start at $20.05 and work its way down to $20.03, canceling and reordering until the mutual fund bites. The trader then buys closer to the current $20.00 price from another, slower investor, reselling to the fund at $20.03. Because the high-frequency trader has a speed advantage, he is able to do all this before the slower party can catch up and offer shares for $20.01. This speedy player has found the buyer’s limit, gathered up and sold an order, and snipped a few pennies off for himself.

This single example explains a great deal.  In this scenario, high speed traders entered the market, "rode" this specific stock for a very brief period while it was increasing in value as a rate which satisfied the search parameters of the algorithm, then sold it, garnering the $.02 per share margin as a "trading profit."

We can also note the numeric scope of what Urstadt is reporting here.

1. Example Narang is one of 50 or so "top traders" in the millisecond market.
2. Example Narang bought and sold "60 to 80 million shares" on the day Urstadt was describing.

Let's do some math.

50 "top traders" X 60 million "trades per day" = 3,000,000,000 shares have passed through this process each market day. 

If the "$.02" margin per share traded is typical, these "top 50" traders went home with around $30 million in the day's "take."  There are roughly 330 market days per year, moving the annual profits into the $9,900 Million range, say $10 Billion dollars.

All without exposing themselves to any measurable "investment risk."

What's the Point?

All of this might be interesting to those among us who live and die on the stock market, but to MeanMesa visitors who tend to be a bit more plebian in their monetary habits, what does this story actually tell us?  That is, what's the point of this post, anyway?

There are a couple of good ones.

The first is to be reached as we simply add this millisecond trading to the accumulated damages being routinely inflicted on our economy by not only it, but many other such "little jewels."  All of these "comfy little" industries exist only in the vacuum of regulation so carefully sponsored by the autocrat and his market cronies.

Utilizing this financial gizmo, yet another example of illicit, upward wealth redistribution becomes clear.  A few well connected traders have been able to install themselves as almost invisible parasites, diverting what would have otherwise been quite legitimate investment money into their own pockets.  Under the statutory cover (i.e. the absence of regulation) provided by the GOPCon looters in the Congress, this bunch has been quietly extracting their $10 Bn per year "profits" for decades.

The second point may be more in the class of an "overview" of the larger economy considered as a whole.  Ironically, we can presume to describe this effect as inflation -- the precise "boogy man" which both the Fed Bank and the GOPCons routinely use to frighten us lesser folks.  However, this particular type of inflation is not derived from idiosyncrasies of the global market, bad weather or government spending, the "usual suspects."

Instead, this is what we might call "sponsored inflation," that is, a carefully designed scheme, quite premeditated and planned, to simply install a minute diversion process into the economic life sustaining flow of "free market" investments.  The US economy relies on this flow of investment money to fuel our basic economic process.

Every dollar of investment capital which flows through this process becomes worth just a bit less as this parasitic process continues.  Both the benefits of capitalization for the enterprises on the market and, hence, the potential return on investment for the purchaser of such stocks are routinely diminished, making a single dollar caught up in the process worth less than it would have been worth otherwise.

Urstadt's article, notably, expresses some concern about the gaseous nature of this trading process, but, after that has been said, generally finds it legal, valid and legitimate although potentially dangerous.  The Republican loot-monkeys in the Congress clearly consider it "just fine," especially with the generous campaign contributions made possible from these "businesses" with $ Billions of dollars in profits, no risk and practically no "business expenses" beyond paying off the law makers who are protecting their scheme.

Not to belabor an already well worn point, but MeanMesa wishes to remind visitors of the election approaching.  If anything is ever to be done about this on-going insult to the economic health of our country, it will begin with the results of that election.

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