High-Frequency Trading - There's Good News and There's Bad News

The Financial Times reported yesterday that high-frequency traders are leaving investment banks for hedge funds, prop trading houses, and their own startups. Oh, you didn't realize that regular, Too Big to Fail investment banks had high-frequency trading desks? Surprise, surprise, surprise...

High-frequency trading isn't the exclusive purview of specialized trading shops.

High-frequency trading is a proven money-raking machine, and today I'm going to tell you that's why it's part of most so-called investment banks' trading operations...

High-frequency trading (HFT) is a complicated game - um, I mean, business model.

Super-smart computer scientists design mega-fast machines that intercept trading orders from the airwaves or cable conduits. Their machines read these orders - the orders you send to your discount broker, the orders institutions send to dark pools - everybody's orders.

And before all those orders can be brought together and matched up so a trade gets executed, high-frequency traders pick off the orders they want.

They also send out their own orders - billions of them every day.

Now, they don't want these orders executed, but want other machines to see their orders and move after them, which are canceled before they can be acted on.

It's about faking out other traders' machines to set them up to be picked off.

It's beautiful.

But what's the endgame?

Insider trading. Legalized insider trading.

These aren't tips from an insider. It's trading on inside data flows that aren't protected, but sold to HFT desks to be traded against, with an advantage that only the HFT players have.

But things aren't so cushy anymore...

The HFT rats are fleeing the TBTF ships because of the Volcker Rule.

The Volcker rule, which has to be implemented by July 2015, puts an end to certain "proprietary" trading. Proprietary, or "prop," trading is that done for the house and not on behalf of any clients.

Yes, banks trade for clients. And yes, banks are liars about trading for clients by taking the other side of their clients' trades and not calling that what it is... prop trading.

Anyway, prop trading is going to get a closer look as we get to July 2015. European banks are looking at maybe two years before they get their own Volcker-type rules.

So, the rats are leaving their listing ships (they're listing because their trading revenue streams are going to dry up) for swamps where they can run wild and get paid what they're worth.