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Whitney Tilson, CEO of T2 Partners, a value based hedge fund, just wrote the following commentary about rapid trading. Tilson is very happy that the SEC is starting to crack down on the practice. Below are Tilson’s comments:

It’s great to see the SEC looking into rapid trading (from WSJ by SCOTT PATTERSON And JEAN EAGLESHAM):

Federal securities regulators are examining whether some sophisticated, rapid-fire trading firms have used their close links to computerized stock exchanges to gain an unfair advantage over other investors, people familiar with the matter say.

The wide-ranging probe, being handled by the enforcement staff of the Securities and Exchange Commission, is focusing on the computer-driven trading platforms of exchanges, including BATS Global Markets Inc., the people said.

The SEC probe illustrates a bigger push by regulators to examine less-transparent parts of the securities markets, such as the fast-growing area of so-called high-frequency trading. High-speed trading firms use powerful computer systems for rapid-fire trades, in which they often hold stocks for only fractions of seconds. They benefit by being able to move quicker than less technologically proficient investors.

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I’ve long said that what I think they’re going to find will be just as bad as the mutual fund late trading scandal, whereby mutual funds conspired with certain favored customers who, in exchange for large fees/kickbacks, were allowed to steal from all other shareholders – very small amounts from each one, but it really added up!

 

I think the same is going on here – the exchanges have sold access to high-speed traders, allowing them to put their supercomputers literally a few feet away from the supercomputers that run the exchanges, which allows the high-speed traders to “ping” the market with millions of phony buy and sell orders to detect legitimate buyers and sellers and then, based on the information gathered, front-run the legitimate investors, making a few fractions of a penny on each share – but multiplied by millions of shares, it adds up to massive, virtually risk-free returns.

 

To be clear, I don’t claim to be an expert and could be wrong about this – but if I’m not, this is a MAJOR crime that people should go to jail for because it’s a conspiracy to steal billions of dollars from average Americans who either invest directly or have their money invested for them by pension funds, big firms like Fidelity, etc.

 

For the other side of the argument, Jim Simons, the legendary founder of quantitative hedge fund Renaissance Technologies, defends high-frequency trading.  He says it reduces bid-ask spreads and market impact – which is probably true, but to quote Charlie Munger: “When you mix raisins and turds, you still have turds.”