Be sure to click 'include' if you're day-trading on Form 4s.

High-Speed Traders Avoid Low-Speed Website

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Here is a sequence of events that sometimes happens these days:

  1. The Wall Street Journal reports that some information provider -- Thomson Reuters, Business Wire, Marketwired -- is giving news to paying subscribers before it goes to the general public.
  2. That seems sort of unfair.
  3. New York Attorney General Eric Schneiderman gets mad, calls it "Insider Trading 2.0" and threatens the information provider with dire consequences if it keeps making things unfair for the little guy.
  4. The information provider caves and stops providing early access to subscribers.

Today the cycle begins again, with a Wall Street Journal story about how one important information provider gives "Hedge funds and other rapid-fire investors ... access to market-moving documents ahead of other users." So this very much fits the standard pattern. But there's a sweet new twist: The information provider is the Securities and Exchange Commission. Oops!

The story: Companies file stuff with the SEC on its Edgar platform. The article, and the underlying working paper, focus on Form 4 filings. Form 4 is an "insider trading" form: When corporate insiders buy or sell stock of their companies, the companies file Form 4 to alert everyone to their trading. (I mean, after it's happened, but still.) The companies send the filings to the SEC, and the SEC sends them to "a group of roughly 40 paying subscribers, including newswire services." If you subscribe to those newswires, you get the filings from them. If you don't, you get the filings when they go up on the SEC's website. The researchers found that the website was usually slower than the newswires, often by as much as 15-30 seconds, because the newswires are in the business of disseminating news and the SEC is in the business of being a government agency. Incentives matter!

And some of the people who get the newswires seem to be trading on Form 4 information before it goes up on the website, meaning that they make use of the information before the general public can react.

Is this bad? I mean, look, one: It doesn't matter at all. We'll get to that. But, two: Sure, it's bad! It's symbolically stupid. The point of the Form 4 is that the SEC wants everyone to know when corporate insiders buy or sell stock, so that all the little investors can compete on a level playing field. As a goal, this has its problems, but it's a goal. For the SEC itself to give this disclosure to the little investors after professionals get it is not a great look. (Especially when the SEC has fined stock exchanges for similar activities.) "We have reviewed the working paper and are taking the issues raised by it seriously," says the SEC, and expect to see a fix implemented pretty soon. Meaning, basically, that the SEC will make its website load faster, which is always harder than it sounds.

But when I say it doesn't matter at all, I mean, it does not matter at all. The idea here is that subscribing to a news service or data terminal gives "professional traders an edge over mom-and-pop investors." The article really says that. Now, this seems pretty obvious. Most of the time, professionals using professional tools will be better at doing things than amateurs using amateur tools. There are very few fields of human endeavor where professionals do not have an edge over moms and pops. But investing might come closest! You and your mom and your pop can just index! It is great, you will beat the majority of professional fund managers every year.

Or you can do dumb stuff. Here's the key example in the article:

The timing discrepancy can be seen in trading in Balchem Corp., a New Hampton, N.Y.-based chemicals company. On Nov. 9, 2012, a corporate insider filed a form disclosing the purchase of 6,000 shares of the company’s stock. Some direct-feed subscribers received the filing at about 1:45:25 p.m. Eastern time, several seconds before at least two newswire services, including Dow Jones & Co., distributed the filing, according to people familiar with the data.

At about the same time as the direct feed was delivered, trading volume in the company jumped and the price of the stock rose from about $31.90 a share to $32.13 a share. The same information was posted to the SEC’s website at 1:45:48 p.m., according to the people familiar with the data. That was after the price jumped.

Okay! First of all, if you are a mom-or-pop investor, and you are day-trading the stock of a $950 million specialty chemicals company based on your instant reaction to news that a non-executive director has bought $194,000 worth of stock, then you have already lost all your money. Nothing that I, or the SEC, or Eric Schneiderman, could ever do will help you. You are doomed. Doomed! I told you to index a couple of paragraphs ago, but you didn't listen to me. You had to day-trade Balchem stock by following insider activity, and now you are poor. What were you thinking? Why would you expect that you, a mom or a pop, could make rapid and informed trading decisions about a small-cap stock and do it better than people whose job it is to trade stocks all day, and who have access to fancy computers and professional trading tools?

But leave that aside. Here's the chart of Balchem trading activity over those seconds:

I don't know to what extent that chart is to scale. But let's focus on two things: the trading spikes and the arrows connecting the labels to the chart. Here's what happens when the information goes out to newswires:

The direct feed subscribers get the information, and they're already trading. Whatever the scale of this chart is, it is too gross to distinguish between the time that the "rapid-fire investors" get the information and the time that they trade on it. For its purposes, they trade instantly. That makes sense: They are algorithms, programmed to react to news, and competing to react to it quickly. By a second or two after the news is out, they've done what they needed to do, and their trading drops off, though it picks up again a second or two later.

Here is what happens when it goes to the public:

Look at that line staying flat! For two or three seconds after the news gets out on the website, no one -- literally zero people -- trade on it. Look!

What can you conclude? Intuitively, when "professional traders" and "rapid-fire investors" get information from newswires, they trade on it, for all purposes relevant to humans, instantly. Humans take at least two seconds. If you got the information at precisely the same time as the algorithms, and traded two seconds later, you'd be behind basically all of their buying.

And two seconds later is the best you could do! That's for the eye-twitching day-trader moms and pops, not the ones who are too busy taking care of the kids or running their quaint bed and breakfasts to constantly refresh the Edgar website. The otherwise-employed moms and pops probably will have to wait whole minutes, maybe even hours or days, maybe forever, before they trade on Balchem Form 4 information. I myself have never traded on Balchem Form 4 information. I just learned of Balchem's existence this morning.

Look: The SEC's pattern of releasing information early to newswires helps big professional managers, who subscribe to newswires if they want to trade rapidly, and hurts small semi-professionals, who day-trade by constantly refreshing the Edgar website. Actual moms and pops who invest via actively managed mutual funds might benefit a tiny bit, since those funds tend to be run by big professionals, though on the other hand they're probably not buying Balchem milliseconds after a Form 4 comes out. Actual moms and pops who invest in single-name stocks will never notice this sort of intra-minute price activity. All of this is an utter irrelevancy to normal humans. It's just about fairness among day traders.

Of course, even day traders are entitled to fairness. The SEC should, and surely will, change this practice to make the website more in line with the news services. But the trick is to be fair to the day traders without encouraging them. You can say that day traders should not be arbitrarily hosed without saying that they should compete on a level playing field with professionals. That will never happen. The professionals will always have faster computers, better sources of information and more time to focus on making investing decisions. Amateurs can never beat the professionals.

Except that they can! You can just hire professionals to manage your money, for instance, and they will do all the worrying and news-watching for you. Or you can passively index, and outperform a majority of professional active money managers. The trick is not to try to compete with professional investors in your investing, any more than you compete with professional surgeons when you need surgery or with professional football players when you want to watch a game. If you remember that you're an amateur, you can avoid all of these problems. If you get seduced by the promise of equal opportunity for all investors, professional and amateur alike, that's when you run into trouble.

  1. Never the Wall Street Journal! Doesn't it seem weird that newspapers can give news to their paying subscribers but not everyone else? Worth pondering.

  2. Disclosure! Bloomberg LP operates a newswire, and sells terminals that distribute news to investment professionals. I am employed by Bloomberg. You are reading this on a Bloomberg website, or on a Bloomberg terminal. It is in my, and my managers', long-term economic interests if lots of people subscribe to the Bloomberg terminal. In fact, if after reading this post you decide to take the plunge and get a Bloomberg terminal, please tell your sales rep that I referred you. I have no idea if that actually would bring me any financial advantages, but it would be kind of fun.

  3. Though this is debatable. Measuring time is a surprisingly complicated business. Even more surprisingly, when the researchers measured the actual time at which one direct subscriber got information, it found that 43 percent of the time, the website got the information before the subscriber. (See Table 4 of the working paper.) I don't know what to make of this exactly. It either means that the measurement of time here is suspect, or that the SEC's technology is pretty random, or both. Both are very plausible!

  4. You know what I mean, net of fees, majority by money managed, fund managers in the market that you're indexing, etc. By definition buying the market means you'll get average performance, and at lower costs than the average active manager.

  5. Balchem has a market cap of about $1.9 billion now; its stock is now in the $60s, but at the relevant time it was in the $30s. In late 2012 it had about 29.4 million shares outstanding; at a price of $32.13 that's $944 million of equity market cap. Here's the relevant Form 4, identifying the buyer as director Paul Coombs (you can find his bio on page 5 here) and the purchase prices as $32.25-$34.446, for a total spend of $194,480.

  6. I mean, Balchem has had a good run recently, but you were probably short for all of it. Ugh, I don't even know why I bother with you, you're an embarrassment.

  7. In part because, look, to be fair, if you got like an earnings release or a bankruptcy filing or some other non-Form 4 filing 30 seconds behind everyone else, you'd be pretty annoyed. Form 4s of small companies are maybe the silliest things to trade on, but the SEC handles some pretty important information.

  8. I'm being imprecise because I don't fully understand the scale. I read that chart to mean that there is a lot of volume at 1:45:24, versus none at 1:45:23 and little at 1:45:25. That is, the volume is aggregated into seconds, dots are drawn at each second, and then lines are drawn between them, so that it doesn't actually ramp up and down in the precise way that the chart implies. (Incidentally, the article says the direct subscribers got the news at "about 1:45:25," which I guess means 1:45:24?)

    So similarly I read the website one as: It's posted at 1:45:48; the first subsequent trades are in the 1:45:51 second, i.e. the center of that next spike, not its sides. Other readings are possible though it doesn't change much.

    Also it's possible that the chart is not to scale at all and I'm over-interpreting, but I'm confident that the basic intuitions -- that humans take longer to make decisions than algorithms do -- hold up regardless. The chart is just a fortuitous illustration.

  9. I don't have kids, though; that might change how I look at Balchem's Form 4s.

  10. I mean, they probably still lose a speed battle to high-frequency traders, but they get the information at the same time. One way to read that chart is that the second spike at around 1:45:27 is human investors who got information from the newswires and reacted as quickly as humans can, though I don't know that that's a very convincing reading.

  11. Not investing advice! You can do other good things too, like invest with the money managers who will outperform the index. And index funds have costs and tracking error so those comparisons in the link aren't perfect either. And there are difficult asset-allocation questions no matter how "passive" you think you are. Still.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matthew S Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net