How do flash traders handle payments?

[Stephen Tashi]

How do firms that do flash trading (i.e. computer trading) handle the payments for the stock that is traded?

If I buy or sell stock, my broker (somehow) gets funds from somewhere and transfers money into my account. If I sell stock he takes money from my account or directly from me by check or cash. Those things can be done electronically, but they aren't necessarily done in microseconds.

So if flash traders execute trades in microseconds, how do they handle the transfer of funds that is implied by the trades? Do they keep a running ledger during the trading day and settle up after the market closes by electronic transfers of money to banks? Do the flash traders employ brokers? Does the exchange on which the trades take place have a role in transferring money?

 

[Greg Bernhardt]

So if flash traders execute trades in microseconds, how do they handle the transfer of funds that is implied by the trades?

I have no idea and I am interested too, but if trades are electronic and bank records electronic, why can't the money flash around in microseconds too?

 

[CWatters]

It could but historically they have had a few days for the paperwork to settle...

https://www.reuters.com/article/us-...ent-cycle-for-securities-trades-idUSKBN16T1SW

 

[CWatters]

Many brokers will allow you to sell a stock and buy a new one immediately with the proceeds without waiting for the funds from the sale to arrive. They can do this because they know they don't have to pay for your purchase until after the settlement period - so they could cancel or unwind the trades if there is a problem.

I don't know if they will do this with the proceeds if you write options, which are the equivalent to selling a stock you don't own.

I'm also not sure if settlement periods are the same on all exchanges? Could you sell a stock on an exchange with a 2 day settlement and buy another on an exchange with a 3 day settlement period? That would mean you have both the stocks and the money for a day :-)

 

[strangerep]

Back in the old days, trades were done on the exchange floor with little chits of paper. Back-office people would process all of it and check that the respective chits matched. The whole point of an "exchange" is that you can have confidence in trades being settled, since brokers needed to have suitable accounts, backed up with funds from client accounts.

Of course, this all became progressively computerized. E.g., in a modern stock exchange, for each specific stock there's one list for people wanting to sell (at their specified price) and another for people wanting to buy (also at their specified price). If/when the prices match up (or when buy price is higher than sell price), the exchange computer automatically executes the trade and the back-office systems reconcile it all among the respective brokers' accounts. It takes a few days for the end buyer and seller to get their respective shares/money because banks still typically have overnight runs to check/reconcile the day's transactions, and often multiple banks are involved.

 

[fresh_42]

How do firms that do flash trading (i.e. computer trading) handle the payments for the stock that is traded?

The stock exchange does it at the end of the day. It's called clearing. The program balances the positions on one hand and the accounts on the other. The German terminus technicus is to draw smooth.
I guess that's why they suspend trading certain assets in case of a stop-loss cascade.

 

[jtbell]

If I buy or sell stock, my broker (somehow) gets funds from somewhere and transfers money into my account.

When I sell shares, the proceeds appear in my settlement (sweep) account two days later. Until then I can't actually withdraw the money, e.g. by transferring it to my bank checking account. Until sometime last year, the settlement period was three days.

Nevertheless, during that period I can use that money to buy shares of something else, so long as the money stays within the brokerage, and everything works out in the end, that is, after the settlement periods have passed for both trades.

I don't know what would happen if I sold $2000 worth of stock A on Monday, bought $1000 worth of stock B on Tuesday, and then tried to transfer $2000 from the settlement account to my bank on Wednesday. When I initiate a transfer from the settlement account, I always get a warning to take into account any pending trades, but have never actually tried such a transaction: would they deny the transfer, or cancel the purchase of stock B?

If I had a margin account, I think I'd be able to do it, but then I'd be borrowing $1000 from the brokerage, and would have to pay them interest on it until I sell $1000 worth of something.

 

[Stephen Tashi]

It could but historically they have had a few days for the paperwork to settle...

https://www.reuters.com/article/us-...ent-cycle-for-securities-trades-idUSKBN16T1SW

It seems that a computer trading program gone haywire could bankrupt its owner in a few seconds. If that happened, I wonder who suffers besides the computer trading company. For example, I don't know whether the brokerage (e.g. my broker !) insures transactions it handles in any way.

If the broker actually possesses both the shares involved and the funds involved, the broker can detect if there are insufficient funds or insufficient shares to execute the transaction and simply call it off. However, no single broker can handle all transactions, so there is probably a system for brokers to communicate asset information with each other. I wonder if it can detect a problem within milliseconds of it happening.

Another complication is that companies that are brokers also engage in their own computer trading.

 

[fresh_42]

I wonder if it can detect a problem within milliseconds of it happening.

No, but there are security measurements at work, e.g. in case of stop-loss cascades. Furthermore, unintended transactions can be reversed, which might take some time. Not only the computer trading is nowadays part of daily business, the risk confinement methods are as well. I think floor trading nowadays is only a marginal part of the process and more a relic and a set-up for tv-news than the main trading place. The large sums are moved either by computer programs or at the phone.

 

[BWV]

They use Margin - the traders only need to demonstrate the financial ability to settle.

A lot of the trading also has zero net exposure at the end of the day. Most HFT is really market -making, providing liquidity to market participants, just as human floor traders did a generation ago

 

[Vanadium 50]

The stock exchange does it at the end of the day. It's called clearing.

Exactly right. My sister used to do this, although for bonds and not stocks. Bond traders don't actually trade bonds. They promise to trade bonds. My sister actually did the trading.

 

[BWV]

bonds don’t trade on an exchange and most HFT happens off the stock exchanges in ‘dark pools’ - private transactions between buyers and sellers. HFT only is profitable for providing liquidity for large institutional trades - so if a mutual fund is selling a large block of stock, rather than go to the exchange and broadcast the fact that it is selling - it will go to one of the private exchanges where it can be anonymously matched with buyers

 

[fresh_42]

Most

bonds don’t trade on an exhange

 

[Stephen Tashi]

most HFT happens off the stock exchanges in ‘dark pools’ - private transactions between buyers and sellers.

I don't know where most HFT happens, but, according to what I've read, much HFT trading happens on the well known exchanges. (e.g. NYSE https://arstechnica.com/tech-policy/2009/08/nyse-builds-computer-trading-mothership-worries-abound/ )