Whether you’re interested in finance or not, Ken Griffin is a name that’s hard to avoid. As the founder and CEO of Citadel Securities, he has redefined the markets by building an empire based on hedge funds, asset management and trading. While the rest of the market was apprehensive of the stock rally this year, and the S&P recovered 4.9%, Citadel gained 12.6% across the board in 2023. As a company managing over $61 billion in assets, how do they consistently maximize their profit?
Before the 2000s, the stock market looked very different from today. Stocks were traded in quarter increments instead of pennies, which made high-frequency trading expensive compared to today’s prices. This changed at the turn of the millennium when rules were introduced in order to make the back end of trading more transparent, to allow brokers to compare the prices at which trades were executed and to offer more accessible, cheaper trading for clients. This was perfect for Ken Griffin. Citadel specialized in quant-driven portfolio theory, emphasizing reading the market to predict future price movements instead of only focusing on current market trends. Thus, he helped spear the campaign to make market-making a more technological, quantitative-driven field. Further rule changes in 2005 made it easier for companies like Citadel to capture more of the market as retail investors moved away from expensive regulators like the New York Stock Exchange (NYSE).
Citadel’s record-breaking profits come from the company being a market maker, which means a trading house that buys and sells market derivatives to its investors. Acting as the exchange mechanism, it continuously quotes bids and asks prices for a variety of security derivatives, from options to bonds. The lynchpin of this mechanism is the spread between the two: the difference between both prices. Using advanced algorithms and technology, Citadel can optimize its pricing and execution, making a little money out of both sides of the equation. The method by which Citadel Securities achieves this is a controversial one: payment for order flow. Payment for order flow refers to paying brokers like Robin Hood to receive orders from client investors, forcing other companies to make the prices cheaper so the market can still be competitive. Once the order is received, it offers Citadel proprietary information so that they can use algorithms to price trades better. Since greater certainty of profit reduces risk, it can price the derivatives cheaper and make trading less expensive for everyone involved.
Another hallmark of Citadel’s approach is its prowess in high frequency trading (HFT). The firm executes an impressive volume of trades through sophisticated algorithms at lightning-fast speeds. These rapid transactions capitalize on minute price discrepancies and fleeting market inefficiencies, resulting in profits from sheer transaction volume. Beyond its market-making endeavors, Citadel Securities engages in proprietary trading. Armed with its capital, the firm capitalizes on market price discrepancies, employing various arbitrage strategies to generate profits. Additionally, Citadel provides vital liquidity to the markets, ensuring efficient functioning. The firm fosters market stability and earnings from this essential service by effectively managing risks.
Modern discourse on Citadel’s activities comprises two forms: an appreciation for their technical acumen or a discussion of their recent controversies. One of their prominent current controversies includes a $7 million dollar fine as part of a settlement with the Securities Exchange Commission (SEC) for incorrectly categorizing short sales as long sales over five years. The firm attributed it to coding errors and denied any intentional wrongdoing and it took corrective actions to rectify the mistake. This recent penalty is not Citadel Securities’s first encounter with regulatory fines, according to TheStreet. In the past, Citadel was struck with an $800,000 fine in 2014 due to “trading irregularities” in the early 2010s. In 2017, the SEC fined Citadel $22 million for “misleading clients” regarding trade prices. In the subsequent year, Citadel Securities was again fined $3.5 million for falsely reporting nearly 80 million transactions over six years. In 2020, there was a settlement for $97 million after Citadel was accused of “trading irregularities” in China five years prior. Finally, Citadel influenced brokers to restrict their interactions with “meme stocks” in 2021, which destroyed the recoveries that some stocks, like GameStop and AMC Entertainment, were making. Although discussions between Citadel Securities and brokers were hinted at in documents, the matter was resolved with no evidence of collusion between the entities.
Ken Griffin has redefined the world of finance by introducing a firm that can predict future trends with a mixture of technical aspects, such as high-frequency trading, in combination with being able to handle both sides of the transaction. This makes the company one that can’t lose money, as it makes money from its hedge funds and performs as a broker for its retail investors.
