Across the country, several of Tradeworx’s counterparts did the same. In a blink, some of the most powerful players in the stock market today — high-frequency traders — went dark. The result sent chills through the financial world.
After the brief 1,000-point plunge in the stock market that day, the growing role of high-frequency traders in the nation’s financial markets is drawing new scrutiny.
Over the last decade, these high-tech operators have become sort of a shadow Wall Street — from New Jersey to Kansas City, from Texas to Chicago. Depending on whose estimates you believe, high-frequency traders account for 40 to 70 percent of all trading on every stock market in the country. Some of the biggest players trade more than a billion shares a day.
These are short-term bets. Very short. The founder of Tradebot, in Kansas City, Mo., told students in 2008 that his firm typically held stocks for 11 seconds. Tradebot, one of the biggest high-frequency traders around, had not had a losing day in four years, he said.
But some in Washington wonder if ordinary investors will pay a price for this sort of lightning-quick trading. Unlike old-fashioned specialists on the New York Stock Exchange, who are obligated to stay in the market whether it is rising or falling, high-frequency traders can walk away at any time.
While market regulators are still trying to figure out what happened on May 6, the decision of high-frequency traders to withdraw from the marketplace is under examination.
Did their decision create a market vacuum that caused prices to plunge even faster?
“We don’t know, but isn’t that the point? How are we ever going to find out what’s going on with these high-frequency traders?” said Senator Edward E. Kaufman, Democrat of Delaware, who wants the Securities and Exchange Commission to collect more information on high-frequency traders.
“Whenever you have a lot of money, a lot of change, little or no transparency, and therefore, no regulation, you have the potential for a market disaster,” Senator Kaufman added. “That’s what we have in high-frequency trading.”
Some high-frequency traders welcome the closer scrutiny.
“We are not a no-regulation crowd,” said Richard Gorelick, a co-founder of the high-frequency trading firm RGM Advisors in Austin, Tex. “We were all created by good regulation, the regulation that provided for more competition, more transparency and more fairness.”
But critics say the markets have become unfair to investors who cannot invest millions in high-tech computers. The exchanges offer incentives, including rebates, which can add up to meaningful profits for high-volume traders as well.
“The market structure has morphed from one that was equitable and fair to one where those who get the greatest perks, who have the speed, have all of the advantages,” said Sal Arnuk, who runs an equity trading firm in New Jersey.
High-frequency traders insist that they provide the market with liquidity, thus enabling investors to trade easily.
“The benefits of the liquidity that we bring to the markets aren’t theoretical,” said Cameron Smith, the general counsel for high-frequency trading firm Quantlab Financial in Houston. “If you can buy a security with the knowledge that you can resell it later, that creates a lot of confidence in the market.”
The high-frequency club consisting of 100 to 200 firms are scattered far from the canyons of Wall Street. Most use their founders’ money to trade. A handful are run from spare bedrooms, while others, like GetCo in Chicago, have hundreds of employees.
Most of these firms typically hold onto stocks for a few seconds, minutes or hours and usually end the day with little or no position in the market. Their profits come in slivers of a penny, but they can reap those incremental rewards over and over, all day long.
What all high-frequency traders love is volatility — lots of it. “It was like shooting fish in the barrel in 2008. Any dummy who tried to do a high-frequency strategy back then could make money,” said Manoj Narang, the founder of Tradeworx.
A quiet man with a quick wit and a boyish enthusiasm, Mr. Narang, 40, looks like he came out of central casting from the dot-com era. Wearing jeans, a gray T-shirt and a New York Yankees hat, he takes a seat in front of his computer terminal and quietly answers questions about his business, glancing occasionally at the Yankees game in one of the windows on his PC.
After graduating from M.I.T., where he majored in math and computer science, Mr. Narang bounced around Wall Street trading desks before starting Tradeworx in the late 1990s.
At the time, Wall Street was at the beginning of a technological evolution that has changed the way stocks are traded, opening a variety of platforms beyond the trading floor.
The Tradeworx computers get price quotes from the exchanges, decide how to trade, complete a risk analysis and generate a buy or sell order — in 20 microseconds.
The computers trade in and out of individual stocks, indexes and exchange-traded funds, or E.T.F.’s, all day long. Mr. Narang, for the most part, has no idea which stocks Tradeworx is buying or selling.
Showing a computer chart to a visitor, Mr. Narang zeroes in on one stock that had recently been a winner for the firm. Which stock? Mr. Narang clicks on the chart to bring up the ticker symbol: NETL . What’s that? Mr. Narang clicks a few more times and answers slowly: “NetLogic Microsystems.” He shrugs. “Never heard of it,” he says.
If high-frequency traders crave volatility, why did Tradeworx and others turn off their computers on May 6?
Mr. Narang said Tradeworx could not tell whether something was wrong with the data feeds from the exchanges. More important, Mr. Narang worried that if some trades were canceled — as, indeed, many were — Tradeworx might be left holding stocks it did not want.
Now that the dust has settled, however, he has mixed feelings. “Several high-frequency trading firms that I know about stayed in the market that day,” he said, “and had their best day of the year.”