A few weeks ago “60 Minutes” had a segment titled, Is the US Stock Market Rigged? This segment was on High Frequency Trading (HFT) firms and the arguable value they bring to the current US stock market.
Physicists and mathematicians have designed algorithms for high-speed computers to more or less insert their trades in between the seller of a stock and end purchaser. By doing this, they are able to literally see a trade coming through, buy it, and sell it back to that same buyer, making fractions of a penny on the trade. Does this seem profitable? Well, it is if you have enough trading volume. However, as more HFT activity picks up, they are cannibalizing each others profits.
How fast are these computers, and how profitable is this? In the “60 Minutes” segment, they talked about a HFT firm paying $300 million to increase their speed by a few milli-seconds! So, how fast is that? Well, there are 1,000 milli-seconds in a second, and if someone is willing to spend $300M for that speed increase, speed must be very important, and the profits must be huge!
Is this new? Mike Binger, CFA, Sr. portfolio manager at Gradient Investments, states, “Before HFT came about, the bid-offer per share of stock was much bigger – sometimes as much as a quarter per share. The floor brokers got that, so in reality, the HF traders have vastly narrowed the bid-ask pricing of stocks, making it cheaper for retail clients to buy and sell. Investing has certainly changed for individual, do-it-yourself investors.”
So all this about HFT isn’t necessarily a new concept, just more 21st century. That doesn't mean it still shouldn’t be concerning to the everyday investor. If it’s concerning to them, it should also be concerning to you.
Since the beginning of time, knowledge has always been a key to success. Investing in the markets is no different. Being a do-it-yourselfer is oftentimes a very bad idea. Would you ever pull your own teeth, or do your own knee surgery? Probably not. So why would you think you could do your own investing?
Remember, most of the time there is no rhyme or reason for the stock market movements. Do you remember when Greece announced that they couldn’t pay their bills, and many people lost money in their portfolios the very next day? If you don’t understand why, then you probably shouldn’t be managing your own investments.
Here are some good questions to ask yourself. Do I really understand my own risk tolerance? Am I an emotional investor? (Oftentimes, minor market corrections do not harm long-term growth as much as emotional decisions do). Is the rule of 100 right for me? How might HFT trading affect my portfolio?
Although HFT might be the topic of the day for the media, it’s very clear that there will always be people who have an advantage with the proper knowledge. One of the best ways to level the playing field is to work with a very good advisor.