Fighting Fire With Fire: Beating the High Frequency Traders at Their Own Game

From the Globe and Mail:

Kelly Reynolds has found a way to turn the tables on high-frequency traders who have been using their speed advantage to grab profits from slower investors.

As the head trader at Hillsdale Investment Management in Toronto, she sees a lot of offers to buy or sell stocks that she knows are from high-frequency traders, firms that use ultra-fast computers to trade stocks thousands of times a day to make money from tiny market changes. She also knows that the HFTs are bluffing: their orders are an attempt to get her to reveal what she wants to buy and sell.

• Algorithms accelerate the day trading game
• Market watchdogs work to prevent another crash
• Regulators probe rapid stock plunge

High-frequency traders can then use their faster computers to exploit that information. Once they know Ms. Reynolds or any other investor wants to buy shares of a particular company, they can quickly pull back their offer to sell it to them – only to resubmit it later a fraction of a second later at a less attractive price.

Such bait-and-switch strategies, often grouped under the fancy term “latency arbitrage,” are believed to generate billions a year in profit for high-frequency traders. Critics say those profits come at the expense of longer-term investors such as mutual funds that don’t have the technology to match the speed of high-speed trading firms, which now account for an estimated 30 per cent of stock trading in Canada, and more than 50 per cent in the U.S.

Ms. Reynolds, however, is a test user of a new technology that is just being unveiled by the brokerage arm of Royal Bank of Canada that she says has neutralized that strategy. The new system is built as a specific countermeasure to high-frequency traders, and Ms. Reynolds says that she’s now able to grab those bluff orders before the HFTs can withdraw them – every time. The RBC system is “very, very impressive,” she says....MORE

HT: The Market Ticker who headlines his post
"Your Bazooka? It's Up Your Butt. Go Ahead And Fire." and goes on to mention one of my favorite bits o'securities law:

...Look folks, this is simple: Section 9 of the Securities Act of 1934 makes it unlawful for any person to create a false and misleading appearance of trade, or to influence a price, or to induce the purchase or sale of securities by others....

The '34 act is known as the "Exchange Act" among the cognescenti, to distinguish it from the act of '33.

That quibble aside, Mr. Denninger could be proposing the SEC Attorney Full Employment Plan of 2011.

And it uses existing law.

No need for the SECAFE Act of 2011.