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The firestorm sparked by Michael Lewis’ new book on high-frequency trading, Flash Boys, raged on this week, with both opponents and supporters of high-frequency trading entering the fray. In a heated debate on CNBC’s Power Lunch, Lewis and the founder of IEX – a new exchange designed to limit high-frequency trading – repeated the charge that the U.S. stock market is “rigged.” Defending ultra-fast traders and the stock exchanges on which they operate was William O’Brien, president of the BATS exchange, who accused IEX of distorting the facts to promote its own business model. Charles Schwab also weighed in, with a scathing statement that described high-frequency trading as “cancer” and “a technological arms race designed to pick the pockets of legitimate market participants.”
Whichever side is right, it’s clear that high-frequency traders have gone to huge lengths to gain mere milliseconds in trading time and other informational advantages. As reported by the Wall Street Journal, some high-frequency trading firms have spent hundreds of millions of dollars to lay specialized fiber optic cables between the New York and Chicago exchanges, while others have developed sophisticated lasers to beam information between exchanges.
What is also clear is that these high-frequency trading practices raise fundamental questions whether regulatory reforms can keep up with an ever-changing and hyper-competitive market. The SEC and other regulators must be nimble enough to recognize new trends in the market, and be able to articulate whether and when these practices cross the line. Since the SEC is up against the nearly unlimited capital and creativity of Wall Street, that also means that the SEC must be given adequate resources to do the job. If the high-frequency trading industry can invest billions to boost their trading speed by a few milliseconds,we should invest at least an equivalent amount to protect investors.