22 October 2016
Investors Exchange offers an alternative trading system to surmount the problems encountered by ordinary investors in high-frequency trading. Photo: Reuters
Investors Exchange offers an alternative trading system to surmount the problems encountered by ordinary investors in high-frequency trading. Photo: Reuters

Flash Boy’s stock trading platform gains SEC nod

Investors Exchange (IEX) has won approval from the US Securities and Exchange Commission as a national securities exchange.

The trading platform has a so-called speed bump of 350 microseconds, which is within the 1 millisecond now allowed by the SEC.

This allows automated securities prices to have a small delay or speed bump when being accessed.

IEX operates as an alternative trading system intended to surmount some of the problems resulting from high-frequency trading.

The US stock market adopts a cross-platform principle, which allows many stocks to be traded on different exchanges.

The IEX is the 13th national exchange approved by the SEC.

It’s up to the brokerages and investors which exchange they would like to trade on. That’s why different exchanges have to find their own edge, by offering either low commission fees or a reliable system.

More exchanges have sought speed as high-frequency trading gains popularity in recent years.

However, IEX has opted for the opposite. It has deliberately introduced a speed bump of 350 microseconds, considerably slower than the average speed bump of 100 microseconds in most exchanges.

It says the delay is aimed at protecting small and medium-scale investors, as rapid-fire traders use powerful computers and automated algorithms to take advantage of the system.

It’s estimated that high-frequency trading already takes up nearly 70 percent of total trading in US markets, which means ordinary investors could serve as virtual robbery victims of institutional investors.

Brad Katsuyama, the founder of IEX, has slammed the prevailing high-frequency trading, saying it has violated the original intentions of the stock market.

In fact, Katsuyama himself was once recognized as one of the world’s best practitioners of algorithm trading. At 27, he headed the technology trading department of the Royal Bank of Canada.

However, he started to realize the evils brought about by algorithm. He found that a great number of institutional investors on Wall Street have used high-frequency trading not only to improve efficiency but also to reap illegal profits from a flawed system.

Katsuyama is the inspiration of “Flash Boys”, a best-selling book about high-frequency trading written by Michael Lewis in 2014.

The book shocked global markets, and no less than US President Barack Obama formed a committee to look into the legality of high-frequency trading.

Katsuyama also won support from Bain Capital, MassMutual Ventures and Franklin Resources to set up an alternative trading venue.

He believes that a speed bump could neutralize high-frequency traders’ ability to profit by buying, selling or canceling transactions before other participants can react to quickly-shifting market conditions.

Katsuyama has been trying to convince all stakeholders that “fast does not mean good”.

For him, protecting small investors and safeguarding a fair market environment hold the key to the healthy development of markets in the long run.

IEX has already won support from several major brokerages such as Goldman Sachs, which, quite interestingly, is one of the pioneers in high-frequency trading.

Why did the financial giant suddenly shift its stance? Like many other traditional brokerages, Goldman is concerned that they will be eliminated from the game eventually as technology companies are set to take the lead.

Right now IEX already accounts for 2 percent of the daily volume of stock trading in the United States, putting it in the fifth place among US stock exchanges.

The green light from SEC will help IEX to expand its presence and exert pressure on its bigger rivals like the New York Stock Exchange or Nasdaq.

This article appeared in the Hong Kong Economic Journal on June 30.

Translation by Julie Zhu

[Chinese version 中文版]

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