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Fast trading: a disaster waiting to happen

NEW YORK - MAY 6:  Financial news todays turbulent stock market is displayed news ticker Times Square May 6

NEW YORK - MAY 6: Financial news of todays turbulent stock market is displayed on a news ticker in Times Square May 6, 2010 in New York City. The Dow Jones industrials plunged nearly 1,000 points before ending the day down at 347. (Photo by Daniel Barry/Getty Images) R:\Merlin\Getty_Photos\GYI0060372709.jpg

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roeder report

David Roeder reports on real estate at 6:22 p.m. every Thursday on WBBM-AM (780) and WBBM-FM (105.9). The reports are repeated at 10:22 p.m. Thursday and 7:22 a.m. Sunday

Updated: September 23, 2012 2:51AM

For most investors, high-frequency trading is a term they rarely encounter, except for when it pops up in the news during a market meltdown.

People remember the “flash crash” of May 2010, this year’s glitches involving high-profile initial public offerings such as Facebook (FB) and August’s runaway software episode that ruined the firm Knight Capital. Isolated incidents, you say? The evidence says no.

Carol Clark, senior policy specialist at the Federal Reserve Bank of Chicago, put out a report last week that underscores the need for more controls on frenetic, algorithm-dominated trading. She interviewed more than 30 firms involved in trading. They reported that speed trumps safety in their operations and that they tweak computer codes to invent new strategies in just a matter of minutes and put them to immediate use. Several admitted to having their own “out-of-control algorithm” experiences.

Clark said her study showed that no entity in a trade’s life cycle “has a complete picture of a firm’s exposure across markets.”

Trading firms, she said, feel a need to keep up with competitors and actually want tighter regulations. She suggested several approaches, including “kill switches” that could stop trading by certain firms.

The issue also got attention last week at a U.S. Senate Banking subcommittee hearing. It heard testimony from David Lauer, a market structure consultant who used to work on strategies in Chicago for Citadel Investment Group and Allston Trading.

His lengthy report amounted to a research paper on the topic. Lauer said “mini flash crashes” occur in individual stocks on a near-daily basis. The market narrowly escaped disaster July 30 when an inordinately vast order to sell S&P 500 futures, like the one that precipitated the “flash crash,” was executed three seconds before the market closed. He said stocks were saved by the bell; there wasn’t enough time to react.

Lauer suggested several reforms, including an end to exchanges’ habit of paying sources of orders. High-frequency trading firms say reform would kill them, Lauer said. He predicted they will do what traders always do: complain, then adapt.

AGFLATION AGGRAVATION: The research firm IBISWorld looked back at the summer’s heat and drought and toted up the winners and losers. Think the drought hurt farmers? IBISWorld finds that farmers have reason to celebrate.

The price of corn is up about 50 percent from a year ago, yet the Agriculture Department estimates production will be down only about 15 percent. The drop in output isn’t enough to cause pain the Farm Belt, and demand for corn remains strong despite the higher prices.

Soybean farmers also benefit because the crop is often a substitute for corn as livestock feed.

So who gets hurt? Downstream food producers and probably the American consumer. IBISWorld sees pressure on producers of tortillas, syrup and flavoring, flour, cereal, cookies, crackers and pasta.

The agrifinance unit of Rabobank forecasted sharp inflationary hikes in foods cost for 2013. It sees the crop price hikes placing pressure on livestock producers, who will thin herds, causing lower meat and milk output, thus supporting still higher prices. It said food prices could rise 15 percent by the end of 2013.

BERNANKE BLITZ: Brian Sozzi, chief equities analyst at NBG Productions, has suggestions if you are looking for stocks that could rally on Federal Reserve Chairman Ben Bernanke’s foray into what’s being called “QE Infinity,” the open-ended interventionist policy the Fed announced this month.

Sozzi told Yahoo Finance that he likes these stocks: Charles Schwab (SCHW), Foot Locker (FL), Hovanian (HOV) and Dollar General (DG). Foot Locker has a great back-to-school selling history, Sozzi said. Dollar General, he said, has a strong hold on low-income consumers who could get dinged by Fed-induced inflation.

NAME THE COUNTRY: Those fun-loving analysts at Chicago-based Ycharts posted a story that invites a guessing game. There’s a country whose stock market is down nearly two-thirds from its 2007 peak, but where analysts are sniffing out value. Know it?

It’s China, which has slowed to a growth rate of about 6 percent, a rate that leaves the U.S. envious. Some experts believe the Shanghai stock market is highly oversold.

Ycharts’ Carla Fried suggested using exchange-traded funds to increase exposure to China, such as Vanguard Emerging Markets ETF (VWO) or iShares MSCI China ETF (MCHI), a pure play. Another suggestion was China Mobile (CHL), with a current dividend yield of 3.4 percent. But read on.

CLOSING QUOTE: “My worry: the Skyscraper Curse. For whatever reason, there’s an uncanny correlation between architectural one-upmanship and financial crises. Examples include Dubai in 2008, Kuala Lumpur in 1997, Chicago in 1974, New York in 1930 and even in biblical times with the Tower of Babel. It’s also worth noting that China is home to nine of the world’s highest 20 buildings now under construction just as its economy is hitting a wall. Coincidence?” — Bloomberg columnist William Pesek

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