New Jersey stock trader Manoj Narang says his firm has never had a losing week because his super computers are fast enough to capitalize on split-second opportunities in the market. Narang and other traders are using a legal but controversial technique called "high-frequency trading."
It played a role in a 15-minute, 600-point market meltdown last spring now known as the "Mini Market Crash." Correspondent Steve Kroft talks to Narang in a rare chance to see such a business up close. He also speaks to SEC Chair Mary Schapiro - who has high frequency trading in her regulatory sights - and others for a "60 Minutes" report to be broadcast Sunday, Oct. 10, at 7 p.m. ET/PT.
High frequency traders rely on mathematicians and computer experts to write electronic trading programs and they use expensive computers to run them. Many of the country's large financial institutions do high frequency trading and it is estimated that from 50 to 70 percent of all U.S. stock trades are made this way. Humans are becoming less involved. "Humans are way too slow to trade on the kinds of opportunities that we're trying to capture," says Narang. "Opportunities that exist for only fractions of a second," he tells Kroft.
The opportunities are gleaned from information that all traders have access to. But those with high speed computers like Narang's get that information a split second faster and can act on it just as fast. The trades can involve such a high volume that fractions of pennies made on each share of stock can add up to millions of dollars in profits. "We've had two or three days in a row where we lose money but we've never had a week, so far, where we lost," he tells Kroft. "We've never had a month that was a loser for us."
Narang and staffers at his company, Tradeworx, program his computers with algorithms instructing them to buy or sell certain stocks upon specified conditions, such as price. He trusts the machine to do it all. "The computer is monitoring real time data and knows what to do," says Narang. "Computers are very predictable because they tend not to screw up. They tend to do what they are told."
But computers can create turmoil in the market, and the results can be devastating. The market crash last May 6 was triggered by one computer algorithm that sold $4.1 billion of securities in a 20-minute period. The high-frequency trading programs' response to that - buying many of them up and selling them just as fast - exacerbated an already bad situation.
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From Wikipedia:
High-frequency trading is the execution of computerized trading strategies characterized by extremely short position-holding periods. In high-frequency trading, programs running on high-speed computers analyze market data, using algorithms to utilize trading opportunities that may open up for only a fraction of a second to several hours.[1] High-frequency trading, often abbreviated HFT, uses quantitative investment computer programs to hold short-term positions in equities, options, futures, ETFs, currencies, and all other financial instruments that possess electronic trading capability.[2] [3] High frequency traders compete on a basis of speed with other high frequency traders, not long term investors (who typically look for opportunities over a period of weeks, months, or years), and compete with each other for very small, and very consistent profits.[2][4] As a result, high-frequency trading has been shown to have a potential Sharpe ratio thousands of times higher than the traditional buy-and-hold strategies.[5]
By 2010, High Frequency Trading is accounting for over 70% of equity trades taking place in the US, and is rapidly growing in popularity in Europe and Asia. Aiming to capture just a fraction of a penny per share or currency unit on every trade, high-frequency traders move in and out of such short-term positions several times each day. Fractions of a penny accumulate fast to produce significantly positive results at the end of every day.[2] High-frequency trading has become more popular recently thanks to technological innovation, and growing awareness of its profitability.[6] High frequency trading firms do not employ significant leverage, do not accumulate positions, and typically liquidate their entire portfolios on a daily basis and as a result do not contribute to any systematic risk.[4]
