The effect of the existing system on these savings is not trivial. In early 2015, one of America’s largest fund managers sought to quantify the benefits to investors of trading on IEX instead of one of the other U.S. markets. It detected a very clear pattern: on IEX, stocks tended to trade at the “arrival price”—that is, the price at which the stock was quoted when their order arrived in the market. If they wanted to buy 20,000 shares of Microsoft, and Microsoft was offered at $40 a share, they bought at $40 a share. When they sent the same orders to other markets, the price of Microsoft moved against them. This so-called slippage amounted to nearly a third of 1 percent. In 2014, this giant money manager bought and sold roughly $80 billion in U.S. stocks. The teachers and firefighters and other middle-class investors whose pensions it managed were collectively paying a tax of roughly $240 million a year for the benefit of interacting with high-frequency traders in unfair markets.
Anyone who still doubts the existence of the Invisible Scalp might avail himself of the excellent research of the market-data company Nanex and its founder, Eric Hunsader. In a paper published in July 2014, Hunsader was able to show what exactly happens when an ordinary professional investor submits an order to buy an ordinary common stock. All the investor saw was that he bought just a fraction of the stock on offer before its price rose. Hunsader was able to show that high-frequency traders pulled their offer of some shares and jumped in front of the investor to buy others and thus caused the share price to rise.
The rigging of the stock market cannot be dismissed as a dispute between rich hedge-fund guys and clever techies. It’s not even the case that the little guy trading in underpants in his basement is immune to its costs. In January 2015 the S.E.C. fined UBS for creating order types inside its dark pool that enabled high-frequency traders to exploit ordinary investors, without bothering to inform any of the non-high-frequency traders whose orders came to the dark pool. The UBS dark pool happens to be, famously, a place to which the stock-market orders of lots of small investors get routed. The stock-market orders placed through Charles Schwab, for instance. When I place an order to buy or sell shares through Schwab, that order is sold by Schwab to UBS. Inside the UBS dark pool, my order can be traded against, legally, at the “official” best price in the market. A high-frequency trader with access to the UBS dark pool will know when the official best price differs from the actual market price, as it often does. Put another way: the S.E.C.’s action revealed that the UBS dark pool had gone to unusual lengths to enable high-frequency traders to buy or sell stock from me at something other than the current market price. This clearly does not work to my advantage. Like every other small investor, I would prefer not to be handing some other trader a right to trade against me at a price worse than the current market price. But my misfortune explains why UBS is willing to pay Charles Schwab to allow UBS to trade against my order.