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August 1, 2010

So Not Fast!

By By John D'antona Jr. and Peter Chapman

Chris Nagy, managing director, order routing, sales and strategy, at TD Ameritrade, told the SEC in a letter that "rapid order placement and high cancellation rates have only exacerbated flickering quotations, which undermine retail investor confidence in the execution quality they obtain."

Even some within the ranks of electronic trading are calling for caution.

Thomas Peterffy, chairman and chief executive of Interactive Brokers and a pioneer in the use of technology for trading, said at a recent industry conference: "There is generally an issue with automation that you have to put many, many safety valves on your technologically sophisticated systems. The oil spill is a woeful example of that. Yes, automated systems can run away. So if you do not have very significant facilities to prevent them from running away, it's a problem."

And while most exchanges defend speed and say it is part of the natural evolution of the markets, at least one is not completely comfortable with it. Nasdaq OMX told the SEC in a letter: "Speed is not inherently unfair or harmful; it is the misuse or misapplication of speed that may harm investors or markets." In other words, traders who use their speed advantages to engage in manipulative activities should be censured.

The earliest beneficiaries of the market's drive to zero latency have been the high-frequency crowd employing speed-based strategies. Hedge funds and broker-dealers using high-frequency trading strategies have embarked on an arms race to employ better-and faster-technology that has driven trading speed into the microseconds, or millionths of a second. Black-box traders have pushed exchanges and other suppliers of infrastructure to rev up their engines, provide them with direct data feeds and sponsor co-location. In return they have pumped enormous amounts of volume into the market centers. And while the drive to zero latency has resulted from a partnership between exchanges and high-frequency traders, it is the HFTs that have borne the brunt of the criticism.

But their growing presence is speeding up the markets, and faster markets have some participants worried.

The issue of speed has manifested itself in two ways: a sense that market prices are more volatile, and a that some players-namely, those using HFT strategies-have time and place advantages over others.

Market Volatility

At its most benign, the instability of pricing manifests itself as flickering quotes, critics of hyper-fast trading say. At its most virulent, the volatility emerges on days such as May 6. Although there is little evidence that trading in milliseconds or microseconds exacerbated the market's flip-flop on May 6, the perception exists that it did.

Joe Cangemi, head of equity sales and trading at ConvergEx Group's global electronic trading unit, maintains that speed had to do with the short-term duration of the flash crash.

"We built a fast market with Reg NMS," Cangemi said. "And we had on May 6 the fastest crash and recovery. We should have expected this. A fast market creates fast crashes and fast recoveries."