In Part 1, I defined a few terms associated with High Frequency Trading (HFT) and it bears repeating here:
|Co-location||A setup wherein the broker’s computer is located in the same area as the Stock Exchange’s server. This gives a 10:1 (typically) speed advantage for the broker.|
|Front running||Outrunning others using sheer speed advantage to corner the market in specific bulk sell/ buy orders (e. g. Institutional Investors, Mutual Funds etc.)|
|Spoofing||Since the HFT systems are fast, they float fake, high priced, sell/ buy orders of a share to create an illusion that the prices will go up drawing new customers to place high priced bids, which they clean up since HFTs have a block of options on the same shares.|
According to the whistleblower, on top of the inherent advantages enjoyed by HFT firms as listed above, National Stock Exchange (NSE)’s top brass, in connivance with some top bureaucrats in the Finance Ministry and (drum roll please!) powerful ministers in the United Progressive Alliance (UPA) government, manipulated and milked the system for all it was worth.
It must be borne in mind that the effect of HFT is not felt unless someone goes looking for it.
During this period, on one hand, the whole market was incurring losses while on the other hand, a handful of HFT operators made illegal gains of at least Rs. 50,000-75,000 crores (cr) ($7.7B – $11.5 B) in the melee. They were making every day gains of about Rs. 50-100 cr and considering 25 working days in a month, then the minimum monthly gain stands at Rs 1250 cr and it adds up over a five-year period (see Figure 1 below).
It must be borne in mind that the effect of HFT is not felt unless someone goes looking for it. If you are a trader (and I was, for all too brief a period), you will see the actual trade and then a list of small charges, which eat into your profits. Most of these are deducted before your profit gets credited into your account. The effect of HFT is also one small charge but this does not show up on your statement!
Let us take a simple example. A owes B Rs. 50 and if he does not pay on the due date, it is essentially a fraud on B by A. But if B were to receive Rs. 1000 from A but were only given Rs. 975 (when should actually be receiving Rs. 1000), then the question arises as to who pocketed the difference of Rs. 25. This is where the HFT firms come in. A small group of them, co-located at the stock exchange (NSE for the most part) siphoned off the Rs. 25. Now if they were to do this on each and every transaction, then that builds up into a large amount.
A few firms benefitted against the whole market (with a trading volume of close to Rs. 2-3 lakh crores ($30B – $46B) per day) by gaming the system, with the connivance of a few unscrupulous people, who I have already listed above.
1. The conversion rate used in this article is 1 USD = 65.122 Rupees.
2. Text in Blue points to additional data on the topic.
3. The views expressed here are those of the author and do not necessarily represent or reflect the views of PGurus.