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Flash Trading

Scenario 1:

A. An investor or trader places an order. The order is sent to the stock exchange.

B. The stock exchange holds the order for up to 0.5 seconds, and "flashes" it to the High Frequency Trading (HFT) firm's super computer. This sneak peak in essence, gives the HFT firm first crack at the order.

C. The HFT firm's super computer strategically places an offsetting order to take the other side of the investor/trader's order.

D. The HFT firm's super computer decides it does not want to take the other side of the order, and the order can now be publicly executed.

This creates a two-tiered market system. The HFT firms get a definitive edge over the rest of the investing public. The 0.5 second "look" may as well be an eternity, because their super computers can process orders in nanoseconds. A nanosecond is one billionth of a second.

In summary, if the HFT super computer figures it can make money by taking the opposite side of your order, it takes it. If not, it allows the order to go through to the exchange for public execution.

Scenario 2:

The HFT firm uses the information gained from the "flash" to front run an institutional order.

Eg. Security XYZ

Current Bids in the Limit Book:

Price

Size

$30.15

5,000

$30.13

3,000

$30.12

4,000

$30.11

2,000

$30.09 5,000

An institution places an order to sell 14K shares at the market price.

The order is flashed to the HFT computer.

The HFT computer "front-runs" the institutional order by selling short up to 14K shares in the open market. It sells the 5,000 shares at $30.15, the 3,000 shares at $30.13, the 4,000 shares at $30.12, and the 2,000 shares at $30.11. It then bids the 14K shares it just sold short at $30.10 to take the opposite side of the institutional order coming in. It covers the 14K share short positon, making a tidy risk-free profit of $440.

The institution should have gotten a better fill price, but because it was front run, it ended up getting $440 less for it's stock.