For the past several years Street operators have assumed that the computer jockeys who were being employed by proprietary trading departments on The Street were developing algorithms that would find other algorithms that represented buyside orders so prop desks could trade against those orders.

Another trading prop that has been occurring for years is certain firms feed their electronic trading systems into prop desks so traders can see in real time money flows into and out of stocks and groups.

However recent revelations are forcing the Street to consider the possibility of automated front-running on an unfathomable scale. The two “front-running” issues are: 1) “queuing” [of orders] - finding orders loaded into a system, particularly limit orders, and trading against them; and 2) “latency” - discovering and then front-running electronic orders or a penny or more by exploding the latency or lag in execution.

HFT (high frequency trading) is being done on every electronically traded item on a global basis. Ergo, firms could be making pennies a few billion times per day … It was imperative for the NYSE and other exchanges to price securities in pennies to disguise “HFT” and to provide ample trading opportunities.

While the Street is percolating with anger and curiosity about “High Frequency Trading” there is also frustration and astonishment that the media, regulators and our duly elected are not addressing what could be the biggest financial abuse story of our times, if not history.

Though the blogoshpere is all over the ‘HFT’ trading story an important piece of the puzzle has not been publicized enough. Few people realize that exchanges actually pay firms to trade against order flow when they act as a SLP - “Supplementary Liquidity Provider”.

Exchanges will pay firms ¼ of a penny if they “provide liquidity” when an order appears in their system. This is extra incentive to front run order flow … Theoretically a firm could “scratch” all day and profit.

Over the past decade the move to electronic trading and pricing in pennies was heralded by Street insiders as a means to improve liquidity for clients. This appears to be a deception. Virtually every facility benefitted proprietary trading at a select few firms. Who’s the patsy?

Anyone with a modicum of industry experience understands that “providing liquidity” is at best a euphemism for front-running order flow.

Source: Bill King, The King Report, July 10, 2009.