NEW YORK — If you saw a penny on the sidewalk, would you pick it up?
You may think it’s not worth the effort, but a breed of investors who have been in the news do. Using super-fast computers, high-frequency traders in effect bend down to pick up pennies lying about in the stock market — then do it again, sometimes thousands of times a second.
More than a week after the Dow Jones industrial average fell nearly 1,000 points in a matter of minutes, regulators are still sifting through buy and sell orders to figure out what sparked it.
One big focus is orders placed by high-frequency traders, or HFTs, and for good reason. These quick-buck firms barely existed a few years ago but now account for two- thirds of all U.S. stock trading.
In other words, all those TV pictures of the stately New York Stock Exchange building on the evening news are an illusion. The real action on Wall Street is far away, where HFTs ply their trade.
High-frequency trading firms, which number over 100, use computers programmed with complex mathematical formulas to comb markets for securities priced too high or too low because traders haven’t had to time to react to the latest data. The computers then buy or sell in a split second, locking in a profit.
The opportunities seem hardly worth noting. But those pennies can add up to a lot of money, enough to draw the attention of Goldman Sachs Group Inc., the giant Chicago hedge fund Citadel Investment and other big financial firms. In recent years, they’ve paid hundreds of millions of dollars for stakes in high-frequency trading companies.
“It (the stock market) used to be an oligopoly, an old boy’s club,” said Irene Aldridge, head of an HFT shop called Able Alpha Trading and author of “High-Frequency Trading.” “But now it’s a completely level field.”
Critics of high-frequency trading say all this talk about narrowing spreads for ordinary investors distracts from a key problem: Split-second trading without human supervision is a recipe for disaster.
Exhibit A: the May 6 crash.
One theory about the drop is that, unlike the NYSE, the new exchanges and trading networks catering to HFTs didn’t apply any “circuit breakers.” These are designed to halt trading momentarily during a freefall to stop selling from feeding on itself. In others words, without circuit breakers the computers went crazy.
