It is not very often that a financial story comes along that requires referencing the Einstein’s theory of relativity to explain, but we have finally come to this.
One week ago, the Fed made an important surprise announcement — that it would not be reducing its bond buying program. The result of this announcement was that the price of stocks, bonds, and gold skyrocketed. In order for markets to be fair, everyone must receive this information simultaneously. However, in the crazy world of relativity, there is no such thing as simultaneous. And somebody used this fact in order to make a lot of money.
This is how it went down. Anyone who has watched the “Back to the Future” movies (or the movie “Trading Places”) knows that if you know in advance which way the markets are going to move, you can make trades that will make you rich beyond your wildest dreams. But in this case, you don’t need to own a DeLorean that can travel in time. After all, it is already the future somewhere else.
When the Fed makes a market moving announcement like this, they release the news at a very specific time. In this case 2pm in Washington DC, “as measured by the national atomic clock“. Now here is where it gets tricky. According to the theory of relativity, information cannot travel at faster than the speed of light. So it should take at least 3.2 milliseconds for this information to get from DC to Chicago (a millisecond is 1/1000 of a second, and light travels around 300 kilometers in one millisecond). But someone cheated the speed of light, and received this information in Chicago at exactly 2pm, which to them is 3.2 milliseconds early. With modern high speed stock trading systems (available only to the financial elite of course), that was just as good as having their own time machine.
Receiving the information a few milliseconds before anyone else in Chicago allowed them to make several hundred million dollars in trades before anyone else. One to two milliseconds after 2pm (Chicago relative time), someone made (according to estimates) around $600 million in trades.
Why should you care about this? Because the money made by high-speed trading systems taking advantage of quirks like this is money that is siphoned away from everyone else, including you. It is money that your retirement nest-egg investment doesn’t make. And since billions of dollars are being spent on high-speed trading systems (including special high-speed light-carrying fibre optic communication lines, advanced computers, programming talent, and other resources that allow the ultra rich to execute an equity trade in around 10 microseconds), you know that they are taking a lot more than billions of dollars from people like you. In 2010, high-speed trades accounted for around 75% of all US equity trades. Which is a big reason why almost all the money made in the last decade has gone to the top 1%.