If you've been paying any attention at all since the Great Recession of 2008, you've probably heard of high-frequency trading. It's essentially this: people who have their PhD's in computer science go work for firms and set up systems that allow them to know--even if it's just milliseconds--how a stock trade (a bet, for all intents and purposes) will turn out before you do. In other words, they're Biff from Back to the Future and the rest of us are George McFly.
Terrence Hendershott, a professor at the Haas business school at the University of California at Berkeley, wanted to find out. He was recently given access to high-speed trading technology by tech firm Redline Trading Solutions. His test exposes the power of latency arbitrage the way Ben Mezrich's Bringing Down the House exposed the power of card counting.
According to his study, in one day (May 9), playing one stock (Apple (AAPL)), Hendershott walked away with almost $377,000 in theoretical profits by picking off quotes on various exchanges that were fractions of a second out of date. Extrapolate that number to reflect the thousands of stocks trading electronically in the U.S., and it's clear that high-frequency traders are making billions of dollars a year on a simple quirk in the electronic stock market.
One way or another, that money is coming out of your retirement account. Think of it like the old movie The Sting. High-speed traders already know who has won the horse race when your mutual fund manager lays his bet. You're guaranteed to come out a loser. You're losing in small increments, but every mickle makes a muckle -- especially in a tough market.
"It's clear to us these guys are just raping, pillaging, and plundering the market," as Joe Saluzzi, co-founder of agency brokerage Themis Trading put it.
As the Fortune article author notes, this is the reason why NASDAQ halted trading for a few hours on August 22. Of course, this stuff happens everyday.
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SHOW ME HOW
Ah, yes, the "free market" at work. Too bad you weren't smart enough to get your PhD in physics/math/computer science. These people are just better than you. But, seriously, how this is not illegal (it is regulated in Europe). Uh, SEC/Congress/CFTC . . . where are you?