Original Wall Street Journal on Ultrafast Trading article found at www.wsj.com
High-frequency traders earn nearly $5 billion on global stock markets a year by trading shares at slightly out-of-date prices, imposing a small but significant tax on investors, a new study says.
The study—released Monday by the U.K.’s financial regulator, the Financial Conduct Authority—sheds light on a controversial practice called “latency arbitrage,” in which ultrafast traders seek to react to fresh, market-moving information more quickly than others can.
Such information could range from corporate news to economic data to price fluctuations in other stocks or markets. Electronic trading firms invest in sophisticated technology, such as networks of microwave antennas linking exchanges thousands of miles apart, to process such information and execute trades in millionths of a second.
The FCA’s study comes as politicians in both Europe and the U.S., including Sen. Bernie Sanders (I., Vt.) and Sen. Elizabeth Warren (D., Mass.), have pushed for a financial-transaction tax, a policy aimed in part at curbing high-speed trading. The study could also fuel efforts by exchanges to restructure their markets to limit latency arbitrage—for instance, by introducing split-second delays before trades, known as speed bumps.
Some firms use microwave transmissions to process information needed to quickly execute their trades. PHOTO: DANIEL ACKER/BLOOMBERG NEWS
Many experts say latency arbitrage raises costs for investors by making everyone in the markets less likely to post competitive price quotes for stocks, knowing that those quotes could get picked off by speedy traders. That, in turn, means investors get slightly worse prices whenever they buy or sell shares, traders say.
Advocates of high-frequency trading say concerns about latency arbitrage are overblown, and they have disputed past studies that suggested the practice reaps billions of dollars a year in profits. Precise data on latency-arbitrage profits is unavailable because of the opaque nature of most high-frequency trading firms.