Is quicker trading a risk to market?

LOS ANGELES — The cramped computer room in an office building overlooking the Harbor Freeway can't match the color and tradition of the New York Stock Exchange.

No traders, opening bell or operatic din. Just floor-to-ceiling racks of Dell and Hewlett-Packard computers spitting out a monotonous drone.

But while the NYSE remains the center of the global markets, much of the world's stock trading emanates from drab computer rooms such as this one in downtown Los Angeles, or in outposts such as Kansas City, Mo., or Jersey City, N.J.

These are the epicenters of high-frequency trading, a breed of lightning-fast computerized trading that dominates today's stock market, but that critics say carries risks for investors and for the market itself.

Regulators have yet to pinpoint the cause of Wall Street's white-knuckle plunge May 6, when the Dow Jones industrial average sank 700 points in less than five minutes. High-frequency trading isn't believed to have sparked the sell-off but may have contributed to it.

Detractors argue that high-frequency firms gain an edge through predatory trading tactics that harm other investors. Worse, they say, split-second trading has the potential to destabilize the market at turbulent moments.

"They're destroying the market from which they're making so much money," said Joe Saluzzi of Themis Trading in Chatham, N.J.

The high-speed industry dismisses such criticism. They say they've made trading cheaper and more efficient for all investors, and contend they're being made scapegoats for the perceived transgressions of others on Wall Street.

"Everybody wants to blame high-frequency trading for any sort of malice that's occurring on Wall Street," said Manoj Narang, chief executive of Tradeworx Inc., a Red Bank, N.J., investment firm that does high-frequency trading. "It's a ridiculous blame game."

Speed and automation

The rise of high-frequency trading is the culmination of more than three decades of automation on Wall Street.

Ever-more-sophisticated software, coupled with new government rules to cut investor trading costs and speed up the market, spawned a fresh generation of high-speed traders and new all-electronic stock exchanges catering to them.

The NYSE's share of trading in its own listed stocks has slumped to 34 percent from 76 percent four years ago, according to Equity Research Desk in Greenwich, Conn.

Firms that engage in high-speed trading, such as Tradebot Systems and Getco, account for an estimated 60 percent to 70 percent of U.S. trading volume, and their market share is on the rise.

The high-frequency game is all about speed. The goal is to be the first to buy or sell at the most advantageous moments.

Federal regulators have proposed rules to crack down on some practices.

The Securities and Exchange Commission is seeking to ban so-called flash trading, which critics say allows high-speed outfits to get an early glimpse of orders from other investors before they're accessible to the entire market.

Market's underpinnings

A more pressing problem, some experts said, is the underlying structure of the market.

An unintended byproduct of the SEC's move to encourage electronic trading has been a weakening of the NYSE specialists and Nasdaq market makers that traditionally maintained orderly trading. They were required to step in and buy during heavy sell-offs, thus limiting the magnitude of free falls.

Their role has diminished as their profits have shrunk, experts said. That's because high-speed traders fill many of the orders once handled by traditional firms. But unlike specialists and market makers, high-frequency players can choose not to trade during turbulent moments, such as when the Dow plummeted May 6. Experts say that may be a big reason stocks fell so hard so fast that day: There was no one to step in and buy.

"Over $1 trillion of market value evaporates in less than 15 minutes and people say, 'Who is to blame?'" Themis Trading's Saluzzi said. "No one is to blame. This is the market that we have. This is the byproduct of a market structure that has gone horribly wrong."