What is Flash Trading
Flash trading is a controversial computerized trading practice offered by some stock exchanges. Flash trading uses highly sophisticated high-speed computer technology to allow market makers to view orders from other market participants, fractions of a second before the information is available to others in the marketplace. This gives flash traders the advantage of being able to gauge supply and demand and recognize movements in market sentiment before other traders.
BREAKING DOWN Flash Trading
Flash trading was a topic highly debated in 2009. Up until 2009 flash trading was facilitated on most market exchanges. In 2009 the Securities and Exchange Commission proposed rules that eliminated flash trading. While these rules were never passed, most exchanges chose to no longer offer flash trading to market makers.
Proponents of flash trading believe that it helps to provide greater liquidity in secondary market exchanges. Opponents of flash trading believe that it gives an unfair advantage and can lead to higher risk of flash crashes. Many critics also compare flash trading to front running which is an illegal trading scheme that relies on non-public information.
Flash Trading Processes
Flash trading on exchanges was offered to most market makers for a fee. If subscribed, market makers were given access to trade orders a fraction of a second before these orders were released publicly. Sophisticated traders used flash trading subscriptions in a process known as high frequency trading. This trading process incorporated advanced technologies to take advantage of the flash quotes and generate greater profits from the spreads.
Flash trading for high frequency market makers was easily integrated into the standard market making exchange process. Through this process market makers match buy and sell orders by buying at the lowest price and selling at a higher price. This process forms the basis for bid/ask spreads which generally fluctuate based on market supply and demand. With flash trading subscriptions large market makers such as Goldman Sachs and other institutional traders were able increase the spread on each trade by one to two cents.
In 2009 the concept of flash trading was highly debated resulting in elimination of the offering. The Securities and Exchange Commission issued a proposed rule which would eliminate the legality of flash trading from Regulation NMS. While the flash trading elimination rule was never fully passed, most market exchanges chose to relinquish the offering for market markers.
Michael Lewis’ 2014 book “Flash Boys: A Wall Street Revolt” detailed the processes of high frequency trading and the use of flash trading by Wall Street traders. Lewis’ book takes a deeper look at the availability of flash trading, its uses by high frequency traders and some of the practices that are now illegal such as spoofing, layering and quote stuffing.