The 1980’s was known as the “Yuppie” decade and saw Ronald Reagan take office, Steven Spielberg build fame with movies like “E.T.” and “Raiders of the Lost Ark”, and a musical revolution take place through the introduction of the first music television station known as MTV.
This decade also brought us the most influential invention in our lifetime …
The computer age kicked off in the late 80’s and immediately began reshaping industries by revolutionizing the speed at which information could be disseminated.
Stock traders suddenly had the ability to access data on a level they never thought possible and in the early 1990’s, the SEC ruled in favor to create electronic stock exchanges laying the groundwork for a new type of trading known as “High Frequency Trading” or “HFT “. HFT became popular very quickly allowing firms to trade over a thousand times faster than traditional human-to-human stock trading. In just a few short years, HFT accounted for over 10% of the entire stock market’s daily trading volume. (1)
What is HFT?
High-Frequency Trading is an automated trading process which executes buy and sell orders automatically from computer generated outcomes known as algorithms. This approach allows large financial firms, banks, and hedge funds to trade millions of shares every day using transactions completed in less than a second. (2)
How Does it Work?
The algorithms used by these computers do not attempt to solve what might be the next great stock, which way the market is heading, or what companies have the biggest profits. Instead, these computers are programmed to trade both sides of the market and capture the difference of a stock’s current buy and sell price, also known as the “bid-ask spread”. HFT firms use this recipe to make a small profit per trade on millions of transactions every day.
Why has HFT Become So Popular?
High Frequency Trading has grown in popularity for one reason, it works! Virtu Financial, one of the largest HFT firms in the world, is known for reporting only one losing day over a 6 year period. They made money 1,237 days out of 1,238. (The one losing day was due to a large dividend payment they made.) (3)
So What is the Problem?
Author Michael Lewis, is known for his provocative investigative type books such as “The Big Short” which became a blockbuster movie in 2015 and uncovered the back story how a few investors were able to profit from the real estate collapse of 2008 at the expense of others.
His latest book, “Flash Boys” focuses on High-Frequency Trading with evidence of market rigging through HFT “front running” trades. (Front running is the practice of stepping in front of orders placed or about to be placed by others to gain a price advantage using information not yet obtained by others) (4)
A day after the book was released, the Federal Bureau of Investigation (FBI) announced investigation into several HFT Firms and exchanges. In May of 2015, the SEC announced a $4.5 million fine on three market exchanges for improper HFT practices.
Lewis estimates the impact of HFT trading costs to traditional investors is between $5 billion and $15 billion per year. (5)
On average, 80% of the daily trading volume comes from High-Frequency Trading resulting in a major impact to the stock market’s normal price movements. (6) Traditional mutual fund managers have protested the disadvantage High Frequency Trading brings to retail investors by hurting the performance of mutual funds through market imbalances.
However, as traditional managers and investors have fought hard to keep High Frequency Trading at bay, regulators have not only let this segment continue, but to flourish. April 2015, marked the first IPO (Initial Public Offering) of an HFT Firm allowing anyone to buy stock as an investor in this growing trend. This announcement forced a crossroads on the fund managers who had protested this practice for years.
Mutual Fund Managers suddenly had to choose between:
1) Investing in the very same HFT companies they had been fighting against to increase their return potential for investors which leads to higher inflows into their funds or:
2) Stick to their mutual fund morals by refusing to participate or help perpetuate the problem, thereby accepting under performance which would ultimately lose business.
How does this Affect You?
High speed trading, electronic networks, and computer algorithms are here to stay. No one debates this phenomenon has changed markets as we know it in a major way.
Research has shown a HFT has created both advantages and disadvantages for every day investors like you and me including: (7)
1) Increased liquidity
2) Reduced transaction charges by exchanges
1) Increased volatility
2) Extreme price swings
3) Market Influence
4) Increased price action to news and events
5) Imbalance of supply and demand
What Should You Do Going Forward?
We are not suggesting to run out and invest your life savings in a High Frequency Trading platform (not that you could anyway), but just be aware of the impact this phenomenon is having on markets and investing.
At this Point You have 2 Choices:
1) Continue investing as you always have or …
2) Look into something NEW
If you would like to learn information concerning a non-traditional investment method that embraces volatility and adapts as markets change feel free to contact us at 859.231.6622 or firstname.lastname@example.org to schedule a complimentary CPR – Comprehensive Planning Review to assess your current situation and introduce new options so you can determine if you are already doing everything you can or if there might be a better way to consider.
Disclaimer: This newsletter is a publication dedicated to the education of individual investors. This newsletter is an information service only. The information provided herein is not to be construed as an offer to buy, sell or hold a stock of any kind. All economic and performance data is historical and not indicative of future results.
Current performance may be lower or higher than what is shown. There are many factors that affect investment performance including, but not limited to, general economic and market conditions including market volatility. There can be no assurance that these factors will affect future investment performance in the same manner as historical performance. All investments and investment strategies involve a risk of loss.
Advisory services offered through Enhance Wealth, a member of Advisory Services Network, LLC, 660 Peachtree Dunwoody Road, Embassy Row 600, Suite 575, Atlanta, GA 30328. 770-352-0449 Insurance products and services offered through Enhanced Capital, LLC. Advisory Services Network, LLC and Enhanced Capital, LLC are not affiliated.
The opinions expressed herein are solely those of the author and do not reflect the opinions of Advisory Services Network, LLC or any of its other advisory representatives.