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August 1, 2010

So Not Fast!

By By John D'antona Jr. and Peter Chapman

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Never before in the history of equity trading has so much stock traded so quickly. According to data from Chicago-based market data vendor Nanex, on a typical day Citi stock trades about 24 times every second, compared with only five times per second in 2006. Ford trades about five times per second, versus about once per second in 2006. And while there is little variation in price on a second-to-second basis, within one second there are myriad peaks and valleys, according to data from Corvil, a latency consultant.

While the increased speed of trading is cited as a natural outgrowth of the drive toward efficiency and firms engaged in high-frequency trading are generally praised for providing liquidity, there are many who believe trading at warp speed is going too far. They contend that the stock market exists to match long-term investors with businesses seeking to raise capital, and that hyper-fast trading conditions breed speculators who only make raising capital more costly for corporations.

The SEC has put forth at least three ideas that, if they became rules, could alter the playing field: set a minimum trading speed; require a minimum amount of time a trader must maintain a quote; and require exchanges to batch process their trades.

Michael Goldstein, a professor at Babson College in Boston, explained that batching trades not only allows traders a brief moment to check the markets, but to double-check for events that algorithms aren't programmed for-like an event that dislocates pricing, such as a national catastrophe, whether man-made or a natural disaster. He suggested leveling the playing field by executing batches of buy and sell orders in 10-millisecond intervals.

"Trading happening at one millisecond or faster isn't the purpose of the stock market," Goldstein said. "It's to allocate capital, and I believe it hasn't been doing that since 2007."

Goldstein raised the issue of overly fast trading at an SEC market structure roundtable in June, suggesting that the SEC should consider imposing minimum and maximum speed limits on trading, as the government does on the nation's highways.

Concerns that trading is happening too fast are not limited to Washington and academia. Industry executives are also questioning the need to trade in microseconds. And they are letting the SEC know how they feel.

The Industry Speaks

At the SEC market structure roundtable, Kevin Cronin, director of global equity trading at Invesco, a money management firm with $581 billion in total assets under management, told the SEC he was concerned that too much speed might be negatively impacting the market's price-discovery process. "I'm not sure the two aren't inversely related at some point," he said. "The more speed you have, the less price discovery you have."

At a hearing conducted by both the SEC and the CFTC in June, Jeff Engelberg, a trader with Southeastern Asset Management, told the regulators that speed exacerbated the May 6 crash. "It appears that low-latency co-located strategies were calibrated for a more stable environment, [but on May 6] they continued to trade by the microsecond, reinforcing and strengthening the downward negative spiral," he said. "There are few events in life requiring decision-making which can be altered in less than a blink of an eye. We do not feel that securities trading falls into that category."