What Is Ultrafast Trading?

Ultrafast trading uses software to pinpoint and exploit momentary discrepancies in stock prices, buying and selling shares in nanoseconds. It is more commonly known as high-frequency trading (HFT) or low-latency trading.

There is considerable debate over whether the practice is unfair to other investors. There is some discussion among regulators in the U.S. and Europe of imposing a tax on high-frequency trading or retooling the stock exchanges to prevent it. That would involve delaying trades by a split second, thus adding a virtual "speed bump."

Key Takeaways

  • Ultrafast trading uses algorithms to pinpoint and exploit tiny discrepancies in stock prices.
  • This form of computerized trading can be used to buy and sell stocks in nanoseconds.
  • Ultrafast trading is effectively a fully automated form of arbitrage, and usually goes by the name high-frequency trading (HFT).

How Ultrafast Trading Works

Ultrafast trading, also known as high-frequency trading, is entirely automated and is conducted online, although it is facilitated by brokerage firms. Using sophisticated algorithms, computer programs, can identify a price discrepancy in a stock, buy shares, and then sell them, all in a fraction of a second. By making trades repeatedly based on tiny discrepancies in stock prices, they rack up a substantial profit before the market has time to correct. In other words, this type of trading can be a form of computer-operated or algorithmic arbitrage.

Ultrafast trading requires a vast amount of resources to employ. It also requires close proximity to the exchanges, leading some professional investors to pay hundreds of millions of dollars a year to locate their servers as close to the exchanges as possible.

Ultrafast trading has been criticized for increasing the severity of stock price and contributing to the manipulation of stock prices. Advocates of the software say it does the opposite and improves efficiency in trading.

Ultrafast Trading in the Headlines

Ultrafast trading hits the headlines periodically. In 2010, Sergey Aleynikov, formerly of Goldman Sachs, was accused of stealing the code for the bank’s ultrafast trading algorithms with the intention of giving it to a competitor. It was said that the code was responsible for $300 million of the firm’s 2009 earnings, a fraction of its total earnings of $45 billion but still a substantial amount of money.

After a legal battle that lasted a decade, Aleynikov was convicted of stealing proprietary information from Goldman Sachs with the intention of taking it to the hedge fund company he had recently been hired by, Teza Technologies. It was reported that Teza Technologies had offered to triple his pay from Goldman Sachs. (He would serve 11 months in prison before his conviction was first overturned and, later, reinstated.)

Ultrafast Overkill?

Ultrafast trading reportedly accounted for less than 10% of all stock trading in the early 2000s. That figure had climbed to as much as 61% in 2009.

Today, many of the big brokerage firms have the technology to compete in the ultrafast trading sector. Since Goldman Sachs fought that lawsuit, profits on this type of trading may have begun to decrease.

In 2017, profits from companies executing high-frequency trades fell below $1 billion for the first time since the recession of the mid-2000s. With more companies attempting to take advantage of small market fluctuations, there are fewer of them available to exploit. And, in a period of low market volatility, there are yet fewer opportunities.

While the overall industry is reluctant to provide information, a popular book, Flash Boys: A Wall Street Revolt by Michael Lewis, describes the world of high-speed trading through the eyes of Wall Street participants.