Flash Trading Definition

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Flash Trading Definition

What is Flash Trading?

Flash trading is a contentious practice in which selected customers with advanced technology may see orders before the rest of the market.

Key Takeaways

  • Flash trading is a contentious practice in which selected customers with advanced technology may see orders before the rest of the market.
  • Proponents of flash trading argue that it increases liquidity in secondary market exchanges, while detractors argue that it gives an unfair advantage and increases the possibility of flash collapses.
  • Flash trading has been voluntarily withdrawn by most exchanges due to a wave of criticism, particularly after many market-roiling occurrences, however it is still available by select stock exchanges.

Understanding Flash Trading

Flash trading makes use of very sophisticated high-speed computer technology to enable market makers to see orders from other market participants fractions of a second before the rest of the dealers in the marketplace. This provides flash traders an edge in recognizing changes in market mood and gauging supply and demand before other traders.

Proponents of flash trading argue that it contributes to increased liquidity in secondary market exchanges. Opponents of flash trading argue that it provides an unfair advantage and increases the possibility of flash collapses. Many opponents also link flash trading to front running, an unlawful trading practice based on non-public information.

Before it was allowed on most major exchanges, flash trading was a hotly discussed subject in 2009. The Securities and Exchange Commission (SEC) suggested measures to prevent flash trading in 2009, however these rules were never implemented. Flash trading has been voluntarily withdrawn by most exchanges due to a wave of criticism, particularly after many market-roiling occurrences, however it is still available by select stock exchanges.

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Flash Trading Processes

Most market makers were provided flash trading on exchanges for a price. Subscribed market makers have access to trade orders a fraction of a second before they were made public. In a method known as high-frequency trading, sophisticated traders employed flash trading subscriptions. This trading strategy used modern technology to take advantage of flash quotes and create higher spread gains.

The integration of flash trading for high-frequency market makers into the normal market making exchange procedure was simple. Market makers use this procedure to match buy and sell orders by purchasing at the lowest price and selling at a higher price. This technique serves as the foundation for bid/ask spreads, which vary according to market supply and demand. Large market makers, such as Goldman Sachs and other institutional traders, were able to boost the spread on each deal by one to two cents using flash trading subscriptions.

Is Flash Trading Legal?

In 2009, the notion of flash trading was heavily disputed, culminating in the discontinuation of the product. The Securities and Exchange Commission proposed a regulation that would make flash trading illegal under Regulation NMS. While the flash trading elimination regulation was never completely implemented, the majority of market exchanges elected to discontinue services for market markers.

Michael Lewis’s 2014 book Flash Boys: A Wall Street Revolt described the methods of high-frequency trading and Wall Street traders’ usage of flash trading. Lewis delves more into the availability of flash trading, its use by high-frequency traders, and some of the now-illegal techniques such as spoofing, layering, and quote stuffing.

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