Fast-moving, volatile equity markets are nightmarish for many big and small stock investors, but they are creating a bonanza for high-speed, high-frequency traders (HFT) and the financial technology (fintech) companies that support their activities. These firms' success has been unwittingly aided by the world's largest operator of securities exchanges, CME Group Inc. (CME), which has failed to correct a flaw in its systems that allows those super-fast traders to reap massive profits, probably at the expense of ordinary investors, The Wall Street Journal reports. "The environment where you have a lot of price changes during the day is the ideal environment for a market maker," is how Douglas Cifu, CEO of Virtu Financial Inc. (VIRT), described the situation to Bloomberg.
Winners and Worriers
The stocks of these high speed trading firms soared as stocks plunged in recent days. Virtu offers a technology platform used by many players in the high speed trading game. Roughly in concert with the spike in the CBOE Volatility Index (VIX), Virtu's share price rose by 44% from the close on February 2 through February 9. Shares of Netherlands-based Flow Traders NV, a firm offering similar services, soared by 51% from February 5 through February 12 on the Euronext Amsterdam Exchange, per Bloomberg Markets.
The soaring Investopedia Anxiety Index (IAI) reflects the environment that's allowing these high speed trading firms to prosper. The index continues to register extreme levels of concern about the securities markets among its 27 million readers worldwide, partly the result of high volatility as measured by the VIX, itself frequently called a "fear index."
Giant Loophole Aids Traders
As mentioned above, a loophole at the CME has added to high speed traders' profits. As described by the Journal, traders in futures contracts sometimes receive confirmations of their orders from the CME before these same transactions are reported to the general public via the CME data feed, a delay called latency. A study cited by the Journal found that CME futures contracts linked to the 10-Year U.S. Treasury Note recently had a median latency period of 100 microseconds, or 100 millionths of a second, while 10% of the observations had delays of more than 2,000 microseconds. These delays are more than enough for traders to exploit.
To be sure, the issue has created heated debate among investors about whether this advantage is unfair - or simply represents savvy trading by high speed players. Some traders interviewed by the Journal claim that ordinary investors are not hurt by the flaw, and that the real struggle is between high speed players, with the biggest and fastest winning at the expense of smaller and slower rivals. In any case, massive trading profits are at stake.
High Tech Front Running
Some critics say these specific high tech trades have similarities to front running, in which a market participant with advance knowledge of pending orders from other traders or investors can exploit that information to his or her advantage. The Journal offers this example: an oil futures contract is selling at $60.01; a high speed trader enters an order to buy one contract at $60.00; if that trade is executed, the high speed trader infers that a big order to sell at a yet lower price, maybe $59.99, did not hit the public data feed; the high speed trader then enters a large order to sell at $60.00, expecting to make a profit of at least 1 cent per contract. Repeat this process over and over with large orders processed at lightning speed, and the profits can reach hundreds of millions of dollars annually, per electronic trading firm Quantlab Financial LLC, as reported by the Journal.
CME 'Loophole' Persists
The CME "loophole" was first reported by the Journal in 2013, leading to an inquiry by Congress, a pledge by the CME to close it. However, some the CME's biggest customers exploit this situation, leading some to question how eager the CME is to fix the problem. "This creates a special club of firms that benefit from the informational asymmetry," as John Michael Huth, chief operating officer of Quantlab, told the Journal.