How Speed Traders Are Changing Wall Street

Steve Kroft Gets A Rare Look Inside the Secretive World of "High-Frequency Trading"

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The computer doesn't know or care whether a company is well managed. "It doesn't know who the CEO is or what that CEO's background is. Doesn't know the management team," Narang said.

"Whether he's going through a divorce?" Kroft asked. "Whether he's just been sued for sexual harassment?"

"Right. It knows information that you can quantify about the company," Narang explained.

Asked if it's all math, Narang said, "It's all probability and statistics - a procedure that you can define precisely."

The trading instructions are programmed into the computers with complicated mathematical formulas called algorithms. Narang showed us how it works with a simple, hypothetical example he uses for demonstration purposes.

"I'm gonna test a strategy where if a stock went down five percent for the past week, I'm going to buy $5 of that stock. And if a different stock went up ten percent last week, I'm going to sell $10 of that stock. And I'm gonna do that for every stock that's in my tradable universe simultaneously," he told Kroft.

"Which is how many?" Kroft asked.

"There's over 4,000 stocks, about 4,500 stocks," he replied.

The strategy, which could only be successfully executed with a high speed computer, would result in almost as many losing trades as winners, but over the past eight years would have produced a tidy profit - something that Narang and other high frequency traders have gotten used to.

Asked how successful he and his firm have been, Narang told Kroft, "We've had two or three days in a row where we lose money. But we've never had a week, so far, where we lost. We've never had a month that was a loser for us."

Just four years ago, high frequency traders accounted for 30 percent of the stock trades in the U.S. Today, estimates range as high as 70 percent. And institutional traders, like Joe Saluzzi of Themis Trading LLC, have come to believe that the game is rigged.

"How can you make money day after day? There was even one firm that said they made money four years in a row every single day. Well you have to be getting information that other people don't have, otherwise statistically that's an impossibility," Saluzzi said.

Actually, high frequency traders are getting the same market information that Saluzzi gets. They are just getting it a little bit sooner - it's only a few fractions of a second sooner, but if you are running supercomputers, Saluzzi says, it can be an eternity.

"What you're saying is the people with the fastest computers have an advantage? They get the best deals?" Kroft asked.

"Every time. Absolutely. There's no doubt about it. I mean, if they're spending that kind of money, and they're using that type of infrastructure, they're doing it for a reason. And it is to get a speed advantage, in that respect," Saluzzi replied.

It's not just the speed of the super computers that's important - it's also their physical location. The closer they are to the stock exchange's server the quicker they will be able to get critical market information.

Larry Leibowitz, the chief operating officer of the New York Stock Exchange, believes its massive new data center in Mahwah, N.J. will help the exchange regain some of the market share it has lost to electronic trading platforms. And he is busy persuading traders to lease space in the center's stark black boxes for their super computers.