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Friday, October 8, 2010

60 Minutes: Steve Kroft Gets A Rare Look Inside the Secretive World of "High-Frequency Trading"

How Speed Traders Are Changing Wall Street

"Humans are way too slow to trade on the kinds
of opportunities that we're trying to capture,"

(CBS) New Jersey stock trader Manoj Narang says his firm has never had a losing week because his super computers are fast enough to capitalize on split-second opportunities in the market. Narang and other traders are using a legal but controversial technique called "high-frequency trading."

It played a role in a 15-minute, 600-point market meltdown last spring now known as the "Mini Market Crash." Correspondent Steve Kroft talks to Narang in a rare chance to see such a business up close. He also speaks to SEC Chair Mary Schapiro - who has high frequency trading in her regulatory sights - and others for a "60 Minutes" report to be broadcast Sunday, Oct. 10, at 7 p.m. ET/PT.

High frequency traders rely on mathematicians and computer experts to write electronic trading programs and they use expensive computers to run them. Many of the country's large financial institutions do high frequency trading and it is estimated that from 50 to 70 percent of all U.S. stock trades are made this way. Humans are becoming less involved. "Humans are way too slow to trade on the kinds of opportunities that we're trying to capture," says Narang. "Opportunities that exist for only fractions of a second," he tells Kroft.

The opportunities are gleaned from information that all traders have access to. But those with high speed computers like Narang's get that information a split second faster and can act on it just as fast. The trades can involve such a high volume that fractions of pennies made on each share of stock can add up to millions of dollars in profits. "We've had two or three days in a row where we lose money but we've never had a week, so far, where we lost," he tells Kroft. "We've never had a month that was a loser for us."

Narang and staffers at his company, Tradeworx, program his computers with algorithms instructing them to buy or sell certain stocks upon specified conditions, such as price. He trusts the machine to do it all. "The computer is monitoring real time data and knows what to do," says Narang. "Computers are very predictable because they tend not to screw up. They tend to do what they are told."

But computers can create turmoil in the market, and the results can be devastating. The market crash last May 6 was triggered by one computer algorithm that sold $4.1 billion of securities in a 20-minute period. The high-frequency trading programs' response to that - buying many of them up and selling them just as fast - exacerbated an already bad situation.

"The events of May 6th scared people," says SEC Chair Mary Schapiro. She had already proposed more transparency rules for such trading operations before that event, but is considering even more now. "It's unsettling for all investors if an algorithm behaves in an aberrant way and causes a lot of volatility, or causes markets to act in an irrational way," Schapiro tells Kroft.

Some financial people think high-frequency trading with its reliance on speed rather than hard facts about the company or market is bad for Wall Street. "Valuation is irrelevant. It's just about moving the price up and down the ladder…so you have to question the true valuation of the markets now," says Joe Saluzzi, an institutional trader at Themis Trading. He also says he sees predatory behavior made possible by the speed advantage, where practitioners can execute and cancel thousands of trades to see which way a market is going and then capitalize on that advantage.

But to Larry Leibowitz, the chief operating officer of the New York Stock Exchange, the charges are nothing new. "There's always been charges for as long as trading has existed that people are front running orders, manipulating stocks," he says. Add in the mystery a machine like a computer can inject into the formula and the stage is set for mistrust he says. "I think high frequency trading is the natural evolution of applying technology to the problem of how do I trade the cheapest and most efficiently," Liebowitz tells Kroft.

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