I remember the date vividly. The news was abuzz about the upcoming IPO that was coming out…that IPO was on Facebook. Everyone was talking about it and hopes were high by many people that they’d get their hands on some shares. I mean, who wouldn’t want to get some shares? The company has supposedly over 900 million users and is bound to be a successful public company. The hoped-for hoopla was short lived due to a little followed, but growing issue known as high frequency trading that caused chaos on the opening day of the Facebook IPO. Some would argue that the issue of high frequency trading has been a problem since the market plunge back in October 1987 and was seen in causing the Flash Crash in 2010 amongst other instances. So, bear with me as I let my inner trading geek out as we look at the issue of high frequency trading.
What Exactly is High Frequency Trading?
High frequency trading employs highly quantitative algorithms, run by computers, that look to buy and sell securities in a very quick fashion. For a typical high frequency trading firm, the normal holding time for a security is a matter of seconds to several hours at the most. High frequency traders invest in stocks, options, ETF’s, currencies, and futures; any equity that can be traded electronically is fair game to a firm involved in high frequency trading. It is highly unlikely that you’ll find an individual investor involved in such trading as high frequency trading is commonly left to small, but growing firms that are usually trading with their own money.
What Are the Effects of High Frequency Trading?
“So what?” you might be thinking, “how does this affect me as Mr./Mrs. Investor?” The answer is that it can affect you quite a bit. One of the main effects of high frequency trading is that through the aforementioned algorithms they’re able to see how other, more everyday investors are trading milliseconds before they make their own decision. Does this sound right? No, it does not. Better yet, many exchanges also offer minuscule small kickbacks to those traders that arrive first with their orders. So, over time the high frequency trading firm is able to make money through these kickbacks. For anyone who’s seen Office Space, it’s similar to the scam they ran. Yes, these two effects do make me pause and wonder if we should put more regulations on high frequency traders. Some studies have argued that we benefit from high frequency trading as it lowers the price for retail investors and brings liquidity to the market. I am not entirely sold on their argument yet though.
What Are Other Countries Doing About it?
I’ve read numerous articles over the last few weeks about how other countries are dealing with high frequency trading. Each article recounted how many of these countries had modeled their markets after ours and wanted to be like the markets in the U.S. What they all went on to say was they’re seeing what’s becoming of the American market and don’t want to run into similar issues. Countries across Europe, to Australia and Canada are either looking into, or are putting measures in place to regulate high frequency trading. Generally I am not one to think that government regulation is always the best solution. But, what does it say when many of our friends are initiating regulations because they do not want to become like us? What does it say when these firms are forming groups that are lobbying lawmakers to not regulate them? It causes me to sit back and ponder whether or not we would benefit from regulations on high frequency trading.
Should We Just Give Up Investing?
Gone are the days where people line up on the market deciding on what price a stock should be bought and sold at. Does this mean we should all give up on stock investing and bury our heads? My irrational side says yes, to heck with the market and just put my money in CD’s or under my mattress. But, part of being frugal requires us to be informed and make wise decisions with our money. In the end, I am still involved in the market and will be investing in stocks and other investments for years to come. Yes, there are things about high frequency trading that concern me and hopefully some of it does to you as well. The solution though is not to give up on stock investing all together as I see it as a key to saving for my retirement. Part of the solution has to be increased education about how to invest and how your investments are doing. Maybe it also means that you contact your Senator/Congressperson to tell them you think we should have regulations on high frequency trading. At the very least, it should mean that you stay more informed about your investments and what’s going on in the market.
Is this the first time you’ve heard about high frequency trading? Does it cause you to want to be more informed in regards to what’s going on in the market?
Photo courtesy of: brcwcs