Fair societies require fair markets

Our modern financial system is largely based on the concept of trade, specifically that which takes place in exchanges/markets. The trade that takes place in these exchanges can vary in nature but it is the trading of stocks (a percentage ownership of a corporation [1]) in stock exchanges, and how this is being done unfairly by some, that will be considered in this article.

High-frequency trading (HFT) firms have recently emerged as one of the most prominent parties involved in the trading of stocks and their tactics have profoundly changed the nature of trading [2]. These firms can be characterized by five common traits [2].

  1. They employ complex computer algorithms that use a defined set of inputs to automatically make decisions based on changing market conditions.
  2. They make trades very quickly, measured in milliseconds and even microseconds.
  3. They execute a massive number of trades per day (accounting for 50–70% of the total US trade volume).
  4. They do not hold a position at the end of the trading day (i.e. do not hold a significant number of any stock at the end of each day).
  5. They trade with their own money, rather than on behalf of an investor.

There is nothing necessarily wrong with these traits; HFT firms are simply trying to outsmart other traders which has taken place since the conception of the stock exchange. However, some of the largest HFT firms have been combining their technical prowess and other traits with structural unfairness, provided to them by some of the largest stock exchanges. This has allowed HFT firms to systematically generate profits and essentially game the markets [3]. The manner in which this has been done is extremely convoluted and secretive, thus rendering an in-depth analysis of these tactics beyond the scope of this article. Simply put, these tactics involve the collusion with stock exchanges in order to gain preferential access to market information in combination with the preferential and technical ability to act quickly on such information and to manipulate markets. This allows HFT firms to essentially buy stocks they know will soon be bought by others and to then proceed to sell the stocks to those same buyers at a slightly higher price (a price small enough that traders rarely notice, but done often enough to yield immense profits) [3].

These and other similar tactics have allowed HFT firms to systematically accumulate money from the trading activity of others, activity including the trading and investing conducted by and for regular people (e.g. pension funds, invested savings accounts, etc.). The effective allocation of financial resources throughout the economy, both in the investment in corporate ventures and in the personal investments of individuals, has been hindered by this systematic accumulation of money [2]. Furthermore, the ability to partake in such tactics requires extremely large capital and physical infrastructure (telecommunications, data storage and processing, etc.), rendering such activities economically and technically inaccessible by most of society. This leads to a system which decreases fairness by allowing select parties to systematically extract money from the rest of society.

The remainder of this article will examine one of the most popular and influential proposed solutions to this issue and provide a recommendation for action regarding the solution in terms of how best to ensure fairness.

The Investors Exchange

The Investors Exchange (IEX) was founded by a group of individuals who worked in the financial industry and who began to notice the effects that HFT firms were having on the markets [4]. They found themselves struggling to understand the markets and to make effective decisions, leading them to investigate the possibility of creating an entirely new stock exchange which would be designed in such a way so as to prevent such unfair tactics. Launched in 2013 and having gained official approval from the Securities and Exchange Commission in 2016 [5], IEX has grown to handle just under 2% of the total trade volume in the US [6].

At its core, it is claimed that “IEX is a fair, simple and transparent stock exchange dedicated to investor protection” [4]. This is achieved through the incorporation of technologies and rules in the design of the exchange. One such design decision is the use of a coiled cable located at the exchange through which all trades must travel, causing a time delay of approximately 350 microseconds. This delay imposes a physical limitation on the speed with which traders can obtain price and activity information, something with consequences primarily for those HFT firms partaking in unfair practices [2]. Another design decision lies in the simplified structure of order types available in the exchange [3]. Order types are used each time a trade is made in an exchange and they inform the exchange of precisely how the trade should be handled. One of the unfair practices that HFT firms have employed involved the effective collusion with stock exchanges to design very complex order type structures that favoured HFT activity, with hundreds of different order types available but with very little transparency as to how and when to use the different order types [2]. This allowed HFT firms to use special order types, often unknown to most traders, in order to obtain useful information and to have their own orders treated differently than the orders of regular traders. IEX has designed a very simple and transparent order type structure, eliminating the chance for special order types to allow certain traders (such as HFT firms) to be treated differently within the markets [7]. In addition to these two design decisions, IEX has made clear that it will not partake in the practices of other exchanges in favouring certain traders over others or in providing preferential access to information and preferential treatment of trading activity.

This has led investors, both small and large, to express interest in IEX and to support its growth as a way to limit the extent to which HFT firms can game the markets [8]. IEX has also made it clear that they are not against the participation of HFT firms in their exchange but rather want to ensure that neither HFT firms nor any other traders will be treated in a manner different from that with which others are treated. Thus, it is difficult to argue that IEX should not be supported as a potential solution to the problem of fairness as it itself does not have the power to force any party to act in a specific way nor does it prevent any party from participating fairly in the stock exchange. Their proposed solution simply provides an alternative to traders who desire a stock exchange in which the issues present in other exchanges are ideally solved. It is purely up to the markets themselves to determine whether or not IEX is a good solution and whether or not it will succeed. The growth of IEX should not be interfered with unless there is evidence to support claims from critics [9] that it is interfering negatively with the markets (e.g. that IEX’s time delay decreases market efficiency). Until then, IEX should be given the opportunity to improve the fairness of financial markets and, in doing so, to improve the fairness of society.


[1] “Definition of ‘Stocks’ — The Economic Times,” The Economic Times. [Online]. Available: http://economictimes.indiatimes.com/definition/stocks. [Accessed: 30-Nov-2016]

[2] J. Adrian, “Informational Inequality: How High Frequency Traders Use Premier Access to Information to Prey on Institutional Investors,” Duke Law Technol. Rev., vol. 14, no. 1, pp. 256–279, 2016 [Online]. Available: http://scholarship.law.duke.edu/cgi/viewcontent.cgi?article=1291&context=dltr. [Accessed: 30-Nov-2016]

[3] V. Pandey and C. Wu, “Investors may take heart: A game theoretic view of high frequency trading,” vol. 28, no. 5, pp. 53–57, May 2015 [Online]. Available: http://dx.doi.org/. [Accessed: 30-Nov-2016]

[4] “About | IEX.” [Online]. Available: https://iextrading.com/about/. [Accessed: 02-Dec-2016]

[5] N. Popper, “IEX Group, Critical of Wall St., Gains Approval for Stock Exchange,” The New York Times, 17-Jun-2016. [Online]. Available: http://www.nytimes.com/2016/06/18/business/dealbook/iex-group-gains-approval-for-stock-exchange.html. [Accessed: 02-Dec-2016]

[6] “Stats | IEX.” [Online]. Available: https://iextrading.com/stats/. [Accessed: 02-Dec-2016]

[7] “Investors Exchange Rule Book,” Investors Exchange LLC, Oct. 2016 [Online]. Available: https://iextrading.com/docs/Investors%20Exchange%20Rule%20Book.pdf. [Accessed: 02-Dec-2016]

[8] M. Levine, “The ‘Flash Boys’ Exchange Is Growing Up,” Bloomberg View, 16-Sep-2015. [Online]. Available: https://www.bloombergview.com/articles/2015-09-16/the-flash-boys-exchange-is-growing-up. [Accessed: 02-Dec-2016]

[9] “Debunking the Myths of High Frequency Trading,” FIA. [Online]. Available: https://secure.fia.org/ptg-downloads/debunking_the_myths_of_hft.pdf. [Accessed: 02-Dec-2016]