EBay & HFT
Research for Online Investors

by John Dalt

8/03/09

EBay bought Skype in 2005 for $2.6 billion.  Now the founders of Skype have sued EBay to terminate the use of the licensed technology that makes it work.  This comes when EBay is planning to spin off Skype next year.  This is amazing.  EBay paid $2.6 billion, and did not get the proprietary software that is the base of the franchise?  That is like buying Coke and not getting the secret recipe.

This is a perfect example of corporate stupidity.  I have used EBay as an example of a company I want to avoid in our Long-Term portfolio.  They are highly profitable, but instead of growing their core business, they spend profits (shareholders money) on stupid acquisitions.  One side note, beware California.  Meg Whitman, who was CEO at EBay when this boondoggle occurred, wants to be your governor.  Just think how much good she could do with your tax money.  Times Online has the story on EBay and Skype.

There is a type of trading you may not be aware of, don’t worry, most are not.  It is called High Frequency Trading or HFT for short.  I first came across this a year ago, when I heard of traders that moved offices closer to broker’s computers to shave milli-seconds of their execution time.

HFT is not some whiz kids super secret algorithms that predict what the next move on the market is. Unbeknownst to me, and I think most traders, is that it is legal for brokers to route their information to some participants first, before other traders.

High Frequency Traders pay exchanges to have trades routed to them first.  The HFT super-computers use that information to place trades before anyone else.  Why is this important?

If you had a supercomputer that could process information at light speed, and place another order in response to that information, you would be first to react and pocket the profit. What if a large institution wanted to buy XYZ Company and it was trading for $25 per share. In order to buy 10,000 shares on one order they put in a market limit order for $25.10. XYZ trades millions of shares a day. The institution expects to buy some shares at $25.01 and some more shares at @25.02 and so on until their order is filled.

They may pay $25.07 for the last shares they buy, but the average price might be $25.04 If an HFT saw their order first, it would start buying at $25.01, and $25.02 driving the price higher in a buying frenzy, then immediately put their shares on the market at $25.07, because they know the buyer will pay up to $25.10

Did anyone get hurt? The buyer got his 20,000 shares. The HFT averaged four-cents a share profit on his shares. There was “added liquidity” in the market. The large buyer paid $25.08 average for his shares. He had his pocket picked for four-cents a share.

I have sometimes entered a limit order at a price slightly above the ask price, in order to be sure of the fill.  Never again.

I don’t understand how this cannot be called “front running.”  It ought to be illegal.  I am all for anyone making money in the stock market, but they should take some risk, not capitalize on inside information to take money out of some else’s pocket.

It is estimated that HFT accounted for up to 20% of the volume on the stock exchanges in 2008.  According to a Wall Street research firm HFT may account for up to 70% of the volume this year.

How may times have you chased a stock only to have it reverse lower after you bought it? Remember HFT the next time you are thinking of chasing a stock.

This was forwarded to me by a friend.  Thought I would pass it on.

One Question Poll:
Your Chance To Vote On Obama's Performance on Economy -AT&T/Yahoo Poll

Subscriber M.C. wrote about the Cash for Clunkers article.
“data without schooled/experienced interpretation is just that - data...nice job!”

Better be careful M.C., I might get a swell head!

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

MarketToday Home Page

Back to Top