Some may or may not have heard of High Frequency Trading or HFT. To discuss what this is and what this means to the market, Managing Director of DLG Wealth Management, Andy Guzzetti, breaks it down.
High Frequency Trading is the computerized trading of stocks. Computers, using sophisticated technological tools (algorithms), are trading stocks at lightning speed and can make 20,000 to 50,000 trades in just seconds. As an example of how fast these computers trade, slap your hand on your desk, in the time it took you to slap the desk, a computer can do 50,000 trades. By conducting high frequency trading, traders can buy or sell millions of shares in a short period of time. These HFT firms are looking for very small differences in the bid and ask of an equity or option. Computers do not worry about traditional analysis of companies such as earnings, profits etc. Positions are held for very short periods, from seconds to hours. Some argue that HFT provides no actual value to the market, but rather absorbs capital from slower trading platforms.

Currently, high frequency trading, accounts for 50 % of the volume in the market. On the New York Stock Exchange (NYSE), they account for 70 % of some individual stocks. This type of trading is affecting the markets and the traditional investors who are trying to save for retirement, increase their income or save for their kids’ education. These HFT programs thrive in volatile markets even as proponents will argue HFT reduces volatility.

Is high frequency trading a good thing?

FLASH TRADING
One area of concern relates to “flash trading”. Flash trading allows certain participants to see incoming orders to buy or sell securities earlier (30 milliseconds) than the general market participants in exchange for a fee. Many exchanges have opted out of these programs, but there are some exchanges that still offer the program. Many opponents of HFT site this flash trading as a program that creates a two tiered market giving a certain class of traders the ability to “front run”.

2010 FLASH CRASH
HTF has come under increased scrutiny since the practice has been linked to the “2010 FLASH CRASH” that occurred May 6, 2010. Investors lost $800 billion of net worth in 20 minutes. Investigations pointed to a program trade that was incorrectly submitted by a trader at a mutual fund company. The trade triggered HFT trading that caused the DOW to plunge to its largest intraday point loss in history. The computer programs either pulled bids and asks or widened them. In any case HFT caused the plunge or exacerbated the down fall in prices. Many market observers point to this FLASH CRASH as one of the reasons retail investors have not participated in the 1st Quarter rise in the markets. They fear this volatility and the chance for another May 6th event.

STOCK MARKET AS AN ECONOMIC INDICATOR
The stock market has always been a leading indicator to the direction of our economy. If you look at the performance of the markets in the 2012, the 1st quarter seems to be indicating a rebounding economy. Many analysts were surprised when we started to see weaker job numbers. Many investors are questioning the value of the stock market as a indicator of our economy when 50% of volume now is HFT. Computers do not discuss company earnings, company revenues or company hiring. These areas would be great indicators of the strength or weakness of the economy. The equity markets were set up to help raise capital for businesses, and allow investors the opportunity to own corporations, building their net worth. The equity markets were not set up to be a race track that rewards the faster program. This situation has to be investigated before we have another “FLASH CRASH”.

For more information on managing your finances, or other financial advice, contact DLG Wealth Management. You can also see Andy Guzzetti every Monday morning on WXXA Fox – Albany.