Tuesday, July 28, 2009

Adam Smith’s Invisible Hand or Wall Street’s Slight of Hand?

Most traders are well aware of the current ruckus taking place concerning ‘flash orders’ which is a subset of HFT or high frequency trading programs. Flash orders essentially allow a party to execute marketable orders in-house when that market is not at the national best bid or offer, instead of routing those orders to rival markets.

Opponents of the practice claim that flash orders create a two-tiered market, giving professionals receiving the flashes a significant advantage over other investors. Getco, a market maker firm, states that non-public quotes could "negatively affect the broader market, including retail investors who rely on the NBBO (National Best Bid & Offer) to ensure that their orders obtain the best, reasonably available price,"

Proponents of the trading strategy such as William O'Brien, CEO of Direct Edge counters the criticism claiming that the ELP (Enhanced Liquidity Provider) program gives participants a choice about how they want their order flow handled, and enables customers to lower their market-impact and transaction costs. O’Brien also asserts that the strategy effectively democratizes access to dark liquidity sources by enabling retail customers to choose to interact with that liquidity to seek larger-size executions and potentially better prices."

Several years ago Robert Greifeld President and Chief Executive Officer of The NASDAQ Stock Market, Inc. stated:

“Quality of execution is the measure by which we judge a market… We believe investors want to have a say in what constitutes best execution, which can mean different things at different times to the same investor. Best execution can at varying times be about speed, price, certainty of fill or market impact… Technology is not an end in and of itself but a vehicle that allows us to provide not only speed, but transparency. Technology allows all buying and selling interest to be displayed globally – at multiple levels. It means buyers and sellers in all markets are visible to all interested parties all the time. The markets were traditionally closed, but over time they have become completely open."

The controversy hinges on the notion of transparency in the market place. Several questions are raised:

  • Is there a two tiered system at work in today’s markets, giving advantage to firms with the technology to unfairly manipulate markets?

  • Conversely, is high frequency trading yet advancement in trading that technology has brought to the market place?

  • Is the practice the same as 'front running' a stock?

  • Are firms like Goldman Sachs and Direct Edge merely pursuing their self–interest consequently resulting in a fairer market place due to the power of Adam Smith’s famous ‘invisible hand’?

  • Is 'Flash Trading' a legitimate enhancement to market liquidity or is it an furtive arbitrage strategy?

  • Is this strategy a Wall Street ‘slight of hand’ that will result in unfair advantage and inequity in the free market paradigm?

  • Is this an area where more market regulation is warranted inorder to protect the investing public?

  • Does the individual retail trader, trading for his own account, stand a chance in todays high-tech market place?

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