Tradeworx hedge fund makes millions with high speed trading

a picture of traders on the stock exchange circa 1936

Tradeworx and other high frequency hedge funds using powerful computers have replaced humans on the trading floor for two thirds of all stock market transactions. Flickr photo.

Companies like the Tradeworx hedge fund are where the action is on Wall Street these days, although Tradeworx isn’t on Wall Street. It’s not even in New York. Tradeworx is in New Jersey.  High-frequency trading companies like Tradeworx are little more than rooms full of computers in obscure locations across the country.

High frequency trading dominates stock market

The traditional image of a frantic traders shouting and gesturing at the New York Stock Exchange is all for show now. Super-powerful computers at high-frequency trading firms can buy and sell 10 million shares an hour. The Tradeworx hedge fund is one of a growing number of high-frequency hedge funds. A few years ago there were none. Today, high frequency trading makes up two-thirds of all U.S. stock trades.

High speed trading selloff

Tradeworx went from obscurity to the front page after the Flash Crash when the Dow Jones industrial Average plunged nearly 1,000 points in a few hours earlier this month. Regulators trying to figure out what triggered the massive selloff have high-speed trading in their crosshairs. The theory goes that high-frequency traders didn’t trigger the market slide with huge volumes of trading. They actually caused the problem by not trading at all — for a few seconds.

Trading billions of shares a day

Tradeworx and the other 100 or so high-speed traders account for 60 percent of all trading on every stock market in the country. Some of the biggest trade more than a billion shares a day as though they were same day cash loans. The New York Times reports that the founder of high frequency hedge fund Tradebot, in Kansas City, Mo., said his firm typically held stocks for 11 seconds. On the afternoon of May 6, as the stock market began to plunge due to fears of a European debt crisis, high-speed trading computers were commanded to sell everything and shut down. In a nanosecond the most powerful players in the stock market went dark. The result rocked the financial world.

How does high speed trading work?

Tradeworx and Tradebot use computers programmed with complex mathematical formulas to comb markets for securities priced too high or too low, the Associated Press reports, because human traders haven’t yet reacted to the latest data. The computers then buy or sell in a split second, locking in a profit, often a penny or less. The pennies add up to a lot of money at a billion trades a day. Tradeworx, Tradebot and other high-frequency hedge funds make money by buying or selling in 15 millionths of a second. If a stock’s price rises, the high-speed trading computer buys it at the lower price before the index fund that includes it can adjust. After the index fund adjusts — a fraction of a second later — the computer sells them again at the higher price.

Is high speed trading ethical?

Many institutional money managers are uneasy about how the high-frequency trading computers anticipate their transactions. Reuters reports that asset managers worry there might be information leakage about their trading intentions — a critical issue.

“High-frequency trading, fundamentally, when you look at what their algorithms are finding, they’re almost a structured way of trying to front-run,” said Jim McCaughan, chief executive of the asset management arm of Principal Financial Group, where he oversees about $215 billion in assets. “That just seems to me ultimately as doing it at the expense of other investors.”

High frequency market confidence?

Whether high speed trading by Tradeworx, Tradebot and other high frequency hedge funds directly contributed to the May 6 Flash Crash hasn’t been determined. In fact, reports that many experts credit high-frequency traders for helping with the sudden recovery on May 6. They say that as automated trading systems recognized good buys, they pounced and the markets recovered as liquidity quickly returned. The New York Times reports that high-frequency traders believe this liquidity they provide to the market enables investors to trade more easily. When investors can buy a security knowing they can resell it at anytime, confidence in the market is maintained.