High Frequency Trading, Good or Bad?

Perhaps the hottest topic in the financial world as well as the general media lately is the subject of High Frequency Trading (HFT). What has got people so interested, angry, and puzzled by this topic is a recent book by author Michael Lewis. In it, Lewis suggests the stock market is rigged and there is a new breed of traders called High Frequency Traders that are front running average investors and making a fortune doing it. Since this story broke a few weeks ago, I have received more and more email and questions on this topic. Traders are wondering if it is even possible for them to have an edge anymore with the presence of HFT. Longer term investors are feeling cheated as they are the victim of front running and have their precious retirement capital in a stock market that is rigged against them. Before we jump to strong opinions and conclusions, let’s take a realistic look at this issue.

HFT traders attempt to enter the market fractions of a second before everyone else using a sophisticated algorithm and profit from the smallest possible fraction of a move with significant volume. If you think this is bad for the average investor, think again. HFT traders are having a big impact on markets but not in a negative way like the general media and Mr. Lewis are suggesting. Years ago, buying 100 shares of a blue chip stock would cost you around $60.00 or so in commissions and another $0.50 or more in the spread. Today, commissions have never been cheaper and spreads have never been tighter than any time in history for the average investor. Spreads have become tighter and tighter over the years simply because of the competition for profit of the spread. If you didn’t get that last sentence, please reread it… Thanks to HFT traders, market makers, and other groups competing for pennies and fractions of pennies in the market, spreads have never been tighter for the average trader/investor. Remember, HFT traders also compete with each other which again is only going to lead to tighter markets. The group that is being hurt is not the average investor but instead, banks and financial institutions who used to enjoy massive spreads and huge commissions. Also, does anyone entering the market for a significant market move really care about someone entering the market a few pennies before you? I would write more on this topic but the subject and perception is so misguided, wrong, and silly that I don’t want to waste any more of your time on it.

The other issue that was raised was the notion that the markets are “rigged.” People who think markets are rigged simply don’t understand them. It is a simple game of buying and selling. The issue is people think how you properly buy and sell in markets is somehow different from how we buy and sell things in any other part of life. The way anyone or any company profits in a marketplace is simply buying at wholesale prices and selling at retail prices. The financial markets are no different and Wall Street knows that. Average investors however are brainwashed from a young age to take the opposite action in the markets which leads to massive under performance and losses. Consider how people buy a stock. They make sure it’s a good company, with strong management, a healthy balance sheet, and the stock price needs to be in an uptrend. Then, everyone wants to buy… Well, when all these items are true in the stock, where do you think the price of the stock is? If you said at or near retail prices, you are correct. Wall Street’s sell signal is the retail investors buy signal and vice versa. When you buy stock, who do you think you’re buying it from? And, who is making all the money, you or Wall Street? I think you get the point. I won’t go into too much detail as I have written many articles on this topic. The markets are not rigged at all, its people’s brains that are misguided on how the market really works and how you really make money buying and selling in the markets.

Hope this was helpful. Have a great day.

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