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High-frequency stock trading goes under the microscope

Its critics call it a cancer, a tax, a form of scalping in financial markets. Its proponents say it represents progress, innovation and a form of competition that saves investors money.

Rarely has a war of words transfixed Wall Street like the one that broke out this week over high-frequency trading – the ultra-fast, computer-driven strategies that conduct thousands of transactions in the blink of an eye and account for roughly half of the trading in U.S. stocks.

The battle was triggered by Monday's release of Flash Boys by Michael Lewis, a book that portrays high-speed traders as players who distort markets for their own profit. Since then, the clash has played out on television shows, in the opinion pages of newspapers and across the Internet.

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The furor shows no signs of flagging. On Thursday, Charles Schwab Corp. stepped into the debate. High-frequency trading is "a growing cancer and needs to be addressed," said a statement from the firm's founder and chief executive officer. The practice amounts to "a technological arms race designed to pick the pockets of legitimate market participants."

Also weighing in was Eric Schneiderman, the Attorney-General of New York State, who is probing certain types of high-speed trading. "Amid all the hyperbole, one thing is clear: Some investors are using questionable practices to gain an unfair advantage over others," he wrote in an opinion piece in a local tabloid on Thursday. "This is what I am investigating."

The debate means a period of sustained scrutiny for high-frequency traders and may even provoke regulatory change.

The anti: High-frequency traders are scalpers who use an unfair advantage to front-run trades

Mr. Lewis, the foremost chronicler of American finance, is the standard-bearer for this argument, together with Brad Katsuyama, a former trader with Royal Bank of Canada. Flash Boys tells the story of how Mr. Katsuyama, while working at RBC in New York, began to suspect that high-frequency traders were raising the cost of his trades by getting a slender head start – measured in the milliseconds – on those transactions.

At RBC, Mr. Katsuyama developed a tool called "Thor" to thwart such high-speed strategies. Last year, he launched IEX Group Inc., an independent trading platform that incorporates the same speed bumps.

His arguments were echoed this week by two top executives at Charles Schwab. They argued that stock exchanges have developed special perks to benefit high-frequency traders, who are some of their most active customers. "Instead of levelling the playing field, the exchanges have tilted it against investors," they wrote on Thursday. Such benefits include preferential data feeds and special order types, they said. Of particular concern: a practice known as "quote-stuffing," where orders are cancelled and reposted in milliseconds.

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Mr. Schneiderman, the New York attorney-general, focused his critique on "latency arbitrage." By placing servers close to exchanges and getting direct access to their market data, high-frequency-trading firms get a sneak peak at the action, he said. "They are able to see the prices early, jump in and take the best one in the blink of an eye," Mr. Schneiderman wrote.

The pro: high-frequency traders have made markets more competitive and cost-effective for everyone

Proponents of the benefits of high-frequency trading have fought back. William O'Brien, president of stock exchange BATS Global Markets, tweeted that Flash Boys was an "unjust vilification of an entire industry" and took on Mr. Katsuyama in a debate on live television on Tuesday.

A trade group called the Modern Markets Initiative, established last year by four high-speed trading firms, is helping to get the message out. It has highlighted commentary by a number of experts who assert that the critiques by the likes of Mr. Lewis and Mr. Katsuyama are overblown or incorrect.

One such analysis came from Clifford Asness, a well-known hedge fund manager who heads AQR Capital Management. In an op-ed for The Wall Street Journal on Wednesday, Mr. Asness wrote that high-frequency traders are simply savvy market makers.

"How do we feel about high-frequency trading?" he wrote. "We think it helps us. It seems to have reduced our costs and may enable us to manage more investment dollars." He noted that "some of the loudest complaints about high-frequency trading come from the slower traders who used to win the races."

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Rishi Narang, who helped found the high-frequency trading firm Tradeworx, made similar arguments. "What's actually happening behind the scenes may be frustratingly complicated, but it's not immoral, unethical, harmful or illegal," he wrote, claiming such strategies don't cost ordinary investors anything.

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About the Author
U.S. Correspondent

Joanna Slater is an award-winning foreign correspondent for The Globe based in the United States, where her focus is business and economic news and New York City.Her career includes reporting assignments in the U.S., Europe and Asia. In 2015, she was posted in Berlin, Germany, where she covered Europe’s refugee crisis. More

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