Thursday, July 16, 2009 EST

Just when you thought you heard about the last major scam on Wall Street... 

Mark posted a comment on the forum regarding a white paper that discussed how companies are able to scalp a penny, or two, or three from each trade. Basically at no risk. The white paper showed that this is done by "Automated Market Makers" or AMM.

These are computer applications that make the market, where people on the exchange floor (Specialists) use to make the market (or trades). Now programs have algorithms that search out pending trades to inflate prices by pennies, buy it, short it, then drives the stock down. Then the next AMM member comes along and picks it up cheaper, turns around an dumps it and make a penny or two. Really you have to read the white paper to get it all. 

The real slap in the face is these computers have to be on the floor of the exchange. Right now it is only at the NYSE. You can thank the SEC ( ) and the NYSE again for taking money out of investors pockets. 

White Paper: Toxic Equity Trading on Wall Street (from Themis Trading)

Themis has another white paper discussing "Where Has All The Volume Gone?" In this paper they show that most of the volume on the exchanges have come from these AMM and not from Mutual Funds.

This you have to read this... here is a comment from the paper.

“We saw our full-service institutional clients retrench this quarter subsequent to significant declines in their assets under management, while our direct market access clients increased business with us,” said Howard Naphtali, Chief Financial Officer - Investment Technology Group.

Institutional block trading has fallen for several reasons:

1. Asset deterioration. A survey by Greenwich Associates found that U.S. investment managers' portfolio assets declined in value by an average 31% in 2008.

2. Mutual fund outflows. Investment Company Institute data on equity mutual funds shows a $25 billion outflow in February and overall redemptions of more than $185 billion since September 2008.

3. Hedge fund redemptions. estimates that hedge fund industry assets of $1.724 trillion are 41% lower than their peak in June 2008.

Clearly, the buy and hold, long only equity fund managers have slowed their trading activity. Instead, what we are seeing is high volatility days leading to more high frequency trading and higher volume. In turn, this is confusing traditional investors about the true direction of the market. "

So it sounds like so much volume comes from these AMM trades that volume shoots up, it appears the market is moving up, but really it is a bunch of micro-second round trip trades. This nonsense will make technical analysis even tougher and really steps on the toes of the average investor.