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Citadel versus the SEC: Ken whines that making the market fairer will mean less profits for him

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In an upcoming court case to be heard on the 25th October, Citadel versus the SEC, the market maker is trying to stop the regulator from imposing the new D-Limit order, which would prevent Citadel, and other latency arbitrage players, from picking off displayed lit orders.

In a nutshell, this lawsuit is being brought by Citadel because they’re annoyed that the SEC effectively wants to stop them from making money by having insider knowledge of price movements in real time before the rest of the market gets to see them.

Citadel has the capability to both profit from, and manipulate the market through a strange anomaly which gives them access to data about trades in the microseconds before the rest of the world. In many people’s opinion, this is insider trading driven by technology, and it goes completely against the idea of a free and fair market on a level-playing field.

So Kenny’s company, Citadel, has decided to sue the regulator and try to stop them from effectively banning them from being able to make huge wads of cash at your expense.

For those who prefer a video to reading, Finance News succinctly outlines what’s going on here:

Of course Citadel versus the SEC wants latency arbitrage to continue – they make millions from it.

The D-limit order basically came about because the SEC thought that Citadel (and other high-frequency traders) were gaining an unfair advantage, and they were trying to plug the hole in the regulations. Citadel has decided to take this to the court of appeal for the District of Columbia Circuit.

The unbelievable chuzpah of the argument being made in Citadel versus the SEC is that D-Limit orders are bad for retail investors… ironically, the idea of Citadel acting like they are the champions of the retail investor, is laughable indeed. Of course, this case has absolutely nothing to do with the fact that this is just one of the ways they make money for nothing to the detriment of retail investors getting the best price. Nope, absolutely NOTHING to see here…

The SEC failed to properly consider the costs and burdens imposed by this proposal that will undermine the reliability of our markets and harm tens of millions of retail investors,

Citadel spokesperson in hilarious defence of latency arbitrage

What is latency arbitrage?

Firstly, let’s define arbitrage. This occurs when a stock has a slightly different price on one exchange to another. For example, a stock could be selling at $10.05 on one exchange, but only $10.00 on another. This provides an opportunity if you’re quick enough to buy it one exchange and immediately sell it on the other, meaning you’ve effectively made a nice tidy profit in a microsecond. In itself, arbitrage is not illegal.

Latency arbitrage occurs due to the fact that sometimes it takes a few seconds for market orders to effectively be updated. This gives high frequency traders, like Citadel, a massive advantage, because they can execute trades already knowing what’s about to come (even though it could just be in a few fractions of a second). Essentially, this crystal ball like ability may have potentially allowed Citadel and other firms to net millions just based on their architecture. Therefore, the market provides an ability for those with power and influence (and a bloody big ICT department) to gain an unfair advantage from latency arbitrage.

In fact, according to a study by the British Financial Conduct Authority (the FCA), latency arbitrage costs retail investors around $5B per year, saying hedge funds who use high-speed methods to gain an advantage in the stock market are effectively imposing a “tax” on other investors.

IEX CEO Brad Katsuyama built his business on the fact that latency arbitrage is basically computerised market manipulation, and spoke about it in his book ‘Flash Boys’, which famously alleged that the U.S. stock market is “rigged for the benefit of insiders”.

Citadel versus the SEC: Retail investors cheer on the regulator

Retail investors who are supposed to be protected by the SEC are for once cheering on the SEC as it defends it’s policies from the tentacles of Citadel. We will of course be reporting the outcome of the hearing, as well as further updates on the d-limit order and latency arbitrage in general.

Over 20% of trading volume takes place in races….because of the large volume, these small amounts add up. The “latency
arbitrage tax”…..amounts to about GBP 60 million annually in the UK. Extrapolating from our UK data, our estimates imply that latency arbitrage is worth about $5 billion annually in global equity markets.

Conclusion of Quantifying the High-Frequency Trading “Arms Race”, FCA Occasional Paper no 50. [EDITED FOR BREVITY]

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