Z200 (59.04)

High Frequency Trading

May 21, 2012 – Comments (2)

An e-mail I sent to Mad Money, will see if I get any response on this one.

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I hear you talk about how high frequency trading needs to be outlawed or regulated, however it has a much longer history than you might remember. I used to work in telecom and one of our clients was one of the early developers of high frequency trading software, but not for the stock market. Going back to the late 1980's and early 1990's the major electric companies built a national grid to share resources. This started off as a simple switch that when one side of the grid had more wattage than the other, the switch would sell some of the wattage from one side of the grid to the other. This was fine and simple, but then the government "Deregulated" the electric grid. So now you no longer needed to be an electric company in order to own and operate once of these switches between two bordering electric companies. Any company with the resources and licensing to operate a switch could install one, buy from one company and sell to the other company. It was then discovered that due to how there was such huge amounts of power involved that the actual switchover between buying and selling could take time, even though it is only a few microseconds. This then became a short term futures market, so if one side had the price increasing, you could buy the wattage from one side, and wait a microsecond or two for the price to continue to rise (or fall) on the other side. Software was developed to take advantage of this futures market, and thus high frequency trading was born.

Actually not such a bad idea, but then enters Enron! The name Enron itself beings up all kinds of accounting and fraud fiasco's, yet most people forget what happened to the price of electricity in California the year before Enron collapsed. A good idea had been taken advantage of because it was so complex and convoluted, no one would be able to tell if there was fraud going on in the trading until after a complete meltdown. Since then high frequency trading on the electrical grid has become understood and properly regulated to hopefully prevent another "Enron" incident.

Enter high frequency trading on the stock market. Again, no one understands all the possible ways that fraud could be used in this system because it has not been explored deeply enough to protect against it. However since most in the stock market are not aware that our national electrical grid is deeply entrenched and dependent upon the same form of trading platform, they do not understand that improper regulations applied to the NYSE, AMEX or the like might then be forced back to the electric companies causing nation wide power blackouts! Because of this possible backlash it could not be simply outlawed and abandoned. It needs to be fully examined and well understood so that regulators can properly police such types of trading. Most likely this will happen after then NEXT "Enron" comes along and crashes the whole market and steals 100 billion dollars so the politicians are forced to wake up.

Booyah!