This Is the Troubling Future of High-Frequency Trading

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The rats are fleeing their listing ships...

Of course, that's not surprising.

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...

How High-Frequency Trading Is Done

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.

In fact, this business model is worse than you think. Get all of Shah's Insights & Indictments before the next batch of orders gets picked off right here.

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...

HFT Players Are Feeling the Pressure Now

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.

There's Good News and There's Bad News

Anything that reduces the risk TBTF banks take with depositors' and taxpayers' money is a good thing.

The bad news is that these same banks will just buy big brokerage operations in order to sell their order flow to the HFT players. And those players will pay them handsomely to pick off their brokerage customers. In fact, they'll be able to pay even more to peek under skirts everywhere, because not being "banks" means they won't be subject to having their own skirts looked up and will pay their traders whatever they're worth.

The TBTF banks are already selling out their brokerage customers. They're selling raw order data to HFT desks and giving their own HFT desks access to their clients' dark pool orders.

Barclays is under investigation for abusing its dark pool clients, and inquiries have been sent to Goldman Sachs, UBS, Deutsche Bank, and Credit Suisse about how they operate their dark pools.

What does this all mean? Nothing. It's just moving around deck chairs - on the Titanic.

Until HFT is brought to heel, it will remain a legalized, institutionalized pick-off-the-suckers game. All the exchanges will make their profit, and so will all the trading desks.

It's business as usual. Like the song goes...

"The strong seem to get more, while the weak ones slave. Empty pockets don't ever make the grade. Momma may have and Poppa may have, but God bless the child that's got his own."

Editor's Note: Are you in the "dark" about dark pools? You're not alone. Hardly anyone really understands them. That's a huge problem because high-frequency traders and dark pools erode the very foundations of our capital markets. Luckily, Shah does understand. Protect yourself before it's too late. Get all of his Insights & Indictments before the strong HFT rats get stronger right here.

About the Author

Shah Gilani is the Event Trading Specialist for Money Map Press. He provides specific trading recommendations in Capital Wave Forecast, where he predicts gigantic "waves" of money forming and shows you how to play them for the biggest gains. In Short-Side Fortunes, Shah shows the "little guy" how to make massive size gains – sometimes in a single day – by flipping large asset classes like stocks, bonds, commodities, ETFs and more. He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.

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