Saturday, July 18, 2009

Is Goldman Front Running Its Way to Profit?

In the Max Keiser video that I posted, he briefly alludes to the fact that Goldman is making its trading profits by front running.

Front running is the market situation where a trader knows a major institution is about to place a trade that will move the market. The trader jumps in front of the trade by, say, buying before the institution does and trading out after the institution pushes the stock up. Not surprisingly exchanges have all kinds of regulations against front running.

A lot of Goldman's current profit is coming from high frequency trading. Supposedly the speed required to execute some of Goldman's trades is milliseconds. For some trades, they can't even use computers located across the river from Wall Street in Jersey City, because the milliseconds in extra time for the data to cross the river and be processed is too long.

This is all real black box stuff going on here. The problem comes in when Goldman is so close to government and exchange regulators. Who knows what kind of data they are getting before others? And because they have captured the regulators, there is no independent body that knows.

As ZeroHedge puts it:

It is imperative that Wall Street firms shed much more light into this astronomically profitable yet highly misunderstood and under the radar concept. In the absence of more information, the likelihood that Wall Street firms who dominate order flow and have material unfair advantages over virtually everyone else, should be isolated from trading up to the point where they provide sufficient information to make the market a fair and equal playing field for all investors. Until that moment, investing, trading and speculating is doomed to have the same outcome for the majority of market participants as playing roulette with 35 instances of 00, a much lower fun coefficient and no ability to be comped for your room in light of significant trading losses.
Of course, if you are a long term buy and hold trader this won't impact you much beyond the penny or two Goldman, and the like, will scrape from your trade.

How big a player is Goldman in all this? Here's ZeroHedge again:

Throw in Goldman's domination of dark pool trading through Sigma X, and one can come up to quite a sizable number - It would not be a stretch to conclude that, through various conduits, Goldman is directly responsible for over 20% of global HFT trading. 20% of $21 billion is over $4 billion a year [in profit].
Is some, any or all of this front running gain? Who knows? Its all non-transparent stuff, with Goldman having major influence over who gets to look at the trades.

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