Given the impact that dark pools and high-frequency trading can have on financial markets, it is not surprising that both practices are garnering more attention from government agencies as well as banks and investment firms. High-frequency trading involves using powerful computers to trade stocks at very fast speeds ahead of other investors. By using complex algorithms that analyze multiple markets and execute orders in fractions of seconds, high-frequency traders are able to gauge the intent of other investors, buy shares desired by those investors and sell the shares to these investors at a higher price without them realizing it.
According to Reuters, high-frequency trading firms account for more than half of all trades in the U.S. stock market. Consequently, a variety of government organizations such as the Securities and Exchange Commission (SEC), the Federal Bureau of Investigation, the Commodity Futures Trading Commission and the New York attorney general’s office are taking a much closer look at high-frequency trading. Two key events serve as examples of this increased interest.
In one event, Reuters reported that the New York attorney general filed a lawsuit accusing Barclays of misleading customers and providing an unfair advantage to high-frequency traders. This caused the volume in Barclays LX dark pool to drop by 79% within a week and a half. Dark pools are electronic trading arenas that allow investors to trade shares in private away from more transparent stock exchanges. As a result, the market is not aware until after the trades are complete which reduces the risk of share prices changing to the disadvantage of investors.
In addition to the Barclays lawsuit, Reuters reported that the SEC’s ongoing probe into high-frequency trading has been seeking information regarding some of the largest trading firms in the U.S. More specifically, the SEC has been seeking complaints and tips related to Allston Trading; Merrill Lynch, Pierce, Fenner & Smith; Octeg; Latour Trading; Tradebot Systems; Hudson River Trading; Virtu Financial; Two Sigma Investments; and Two Sigma Securities. Although it is not clear whether the firms broke any laws, it is apparent that the SEC suspects something. If you are curious about the catalyst for these events, see the “60 Minutes” interview with Michael Lewis, the author of “Flash Boys: A Wall Street Revolt.”