What the Hell is THAT? Vol. 3

I am going to keep doing this...

Editor's Note: It’s vacation time… I’m still caffeinated beyond reason, and Corona Light is on the way… but still explaining financial wizardry through my stream of consciousness...

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Dear Fellow Traveler:

Today, I want to introduce you to what I’ll call the “Megasecond Mafia.”

Here’s what happens when you buy 100 shares of Apple or Exxon at “market price.”

You click "buy" on your trading app or brokerage platform...

It takes a few milliseconds for your order to hit the exchange…

In that time… a high-frequency trading algorithm may have figured out those market patterns.

It also probably positioned itself across multiple exchanges…

Then it competed with other algorithms for the best prices for those assets.

Then it executed thousands of trades while your order is still bouncing through routers.

You still haven’t bought anything…

But in that time, it’s used enough electricity to put down a member of the Bonnie and Clyde gang…

Welcome to High-Frequency Trading… or HFT…

What Is High-Frequency Trading?

Michael Lewis famously wrote the book Flash Boys to cover this story…

Essentially, HFT uses powerful computers to execute trades at speeds that are impossible for humans to understand.

These algorithms execute thousands of trades per second.

They place and cancel orders in microseconds.

They respond to market signals faster than the blink of an eye.

They profit from fractions of pennies… but you have to multiply those gains over massive trading volumes. And it’s a ton… a ton of volume.

HFT now accounts for approximately 50% of U.S. equity trading volume, according to OxJournal. I’ve seen higher estimates, but I honestly have no way of proving that…

So, I go with what the academics say…

HFT is the carnal force of modern markets.

It's like a casino where some players have access to faster information and can react before others even know what's happening.

I know we think that having a TON of money is an advantage to winning in markets.

It’s not.

Speed matters more than anything…

HFT firms spend hundreds of millions of dollars to gain speed advantages through co-location.

This means they spend money to place computers physically closer to exchanges.

They invest in faster data connections (especially ones you can’t get access to yet commercially).

They develop advanced predictive algorithms.

They build custom hardware optimized for trading.

This Ain't a Scene, It's an Arms Race

I don’t like Fall Out Boy, the band. But all I can think about when I have 30 seconds of a thought about HFT is this lyric…

This ain't a scene, it's a goddamn arms race…

It is. That line… perfectly captures the HFT arms race.

Listen to this…

In 2010, Spread Networks spent $300 million to drill through the Allegheny Mountains…

They laid out a fiber optic cable from Chicago to Carteret, New Jersey.

A hole… through the mountains.

What did that do?

It saved a whopping… 3 milliseconds off the time it took to process information, from about 16 milliseconds to 13 milliseconds.

Yes… That’s how fast this is…

Three milliseconds may not seem like much.

But it’s a ton in the world of HFT.

The blink of a human eye lasts 400 milliseconds.

Three milliseconds is probably an "eternity" for high-frequency trading firms.

Other HFT companies have used microwave towers since radio signals travel faster through the air than light through fiber optic cables.

Seriously… milliseconds determine winners and losers.

Brother, Can You Spare a Penny

Regulators think to themselves, well, it’s just a penny per trade.

The same applies to the retail army, which doesn’t think on exponential levels.

When multiplied across billions of shares daily, pennies become billions over time.

It’s really about scale and speed.

Imagine that Leave a Penny, Take a Penny jar at the Seven-Eleven.

Except at 9:30 am, the roof of the store caves in, and the entire square block is covered with pennies within a few hours.

That’s where we are…

A profit of 1 cent per share on 1 million shares is about $10,000/day.

Over 250 trading days, that’s $2.5 million per year…

The money comes from tiny advantages extracted from virtually every trade in the market. And it hasn’t gone away…

The Liquidity Mirage

I worked on K Street for a while.

And because most people on Capitol Hill don’t pay attention, they just listen to the lobbyists. What do the lobbyists say over and over again to make HFT look sane?

They tell people that HFT firms provide "liquidity."

If we put up more capital, it’s easier to buy and sell stocks for Americans.

HAHAHAHA. That’s adorable.

During normal market conditions, some HFT activity does narrow bid-ask spreads and provide liquidity.

But let me tell you about…

COVID… Archegos… the GILT Crisis… the SVB Crash… the Nikkei Crash… and the most recent 2025 Trade Collapse.

Liquidity goes POOF when you need it most.

During market stress, like the Flash Crash in 2010, a lot of HFT algorithms just shut down.

This leaves a lot of people panicking as volatility picks up.

As high-frequency traders run to the door… the resulting lack of liquidity caused shares of some prominent companies, such as Procter & Gamble and Accenture, to trade at insane spreads.

Put, this is like having a fire department that provides great service on sunny days but goes offline during actual emergencies.

The Rigged Casino Debate

Traditional investing involves researching companies, making informed decisions, and holding for long-term gains. That’s pretty much been dead in the wake of the 2008 crash, and worsened by passive investing strategies and massive liquidity surges…

That’s also how HFT got us where we are…

Today, algorithms just detect market patterns, exploit speed advantages, and profit from itsy bitsy inefficiencies and anamolies across all that volume...

One has to ask the point of all this.

Is the market actually serving the broader economy and regular investors as it was intended?

You're no longer buying and investing in a completely open, transparent market.

You’re the guppy in a huge ocean, and the sharks are always circling. .

The algorithms are always watching, detecting patterns, and extracting value from the speed differences in the system.

A Simple Fix (That Won't Happen)

A financial transaction tax of about just 0.1% per trade would eliminate much problematic HFT overnight.

That’d be a tax so small you'd mistake it for a rounding error…

But if you're an HFT firm, it's the apocalypse. HFT depends on ultra-low transaction costs. Even a tiny tax would disrupt many high-frequency strategies.

Why won't it happen?

Money, silly…

Everyone’s getting paid.

Powerful lobbying protects existing interests.

Note: Italy became the world's first country to introduce a tax specifically targeted at HFT in September 2013, charging a levy on equity transactions lasting less than 0.5 seconds. In response… equity trading declined… bid-ask spreads widened… and information wasn’t reflected in prices as quickly as it had previously been…

Economic Value?

I won’t just trash all of this.

Yes, there is increased liquidity during normal times, narrower bid-ask spreads for some trades, faster price discovery between related markets, and lower trading costs for some participants.

The net effect remains hotly debated among economists and regulators.

Since this is how it is… you just have to make a choice in how to trade and invest.

Easy solutions for you are to buy and hold to reduce trading frequency.

You should always be using limit orders instead of market orders anyway…

You should choose low-cost index funds that trade infrequently…

And you’d better understand how your broker routes orders.

High-frequency trading represented a huge shift in market operations.

Speed now matters more than fundamental analysis..

The associated tech determines winners and losers…

Markets are now designed for machines, not humans…

And our the complexity of the entire thing creates new risks (especially around liquidity and leverage) that I’m still trying to comprehend.

The real question: Is this the financial system we want?

I know Citadel wants it… but seriously… do we?

After all, this really isn’t investing.

It's latency warfare.

Stay positive,

Garrett Baldwin

P.S. I’ll do "Payment for Order Flow" soon. You’ll see how that free trading app you’ve been using makes a ton of money by selling your order information to HFT firms. Remember, when the product is free, you're usually the product.