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Don't fear high-frequency trading
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Bill Radke: We talked earlier in the show about how small investors are fleeing the stock market. We gave some possible reasons -- maybe they're nervous about the economy, maybe they prefer the safety of bonds. Or maybe people are just still freaked out from the "flash crash".
Remember the stomach-dropping plunge this spring when almost 1,000 points just vanished from the Dow in just a few minutes, and then reappeared just as fast? Well, a group called the Financial Industry Regulatory Association is still struggling to explain exactly what happened. But over the weekend, it announced a probe that could lay some of the blame on high-frequency trading. We've told you about these -- those high-tech,
high-speed computer trades that now account for most of the buying and selling on Wall Street.
Well, commentator Matt Samelson says high-frequency trading might sound intimidating, but let's not make it the enemy.
Matt Samelson: Wild swings in the stock market always trigger a hunt for a bogeyman. Short sellers used to be the favorite target for blame, then algorithmic traders. Today, it's high-frequency trading.
It's easy to blame high-frequency trading, because most people know little about it. Talk of superfast computers and complicated algorithms makes it sound like a sinister plot line in the movie "The Terminator."
In reality, high-frequency trading is quite simple. It generally involves the frequent buying and selling of securities to profit from small changes in prices. The computers used in high-frequency trading are extremely smart: They're programmed to spot the best time to make the trades. They're quite fast, too: Orders are often executed in about one-ten thousandth of a second.
Being faster, and maybe even smarter, than a human trader isn't a bad thing. High-frequency strategies squeeze every ounce of value out of the market in ways that humans can't. They add value in other ways, too. In some instances, they buy and sell stock purely to collect rebates. By doing this, they provide shares that otherwise wouldn't be available, easing the pressure of supply and demand. They also identify stocks in which the market price has diverged from fundamental value. In taking advantage of these instances they correct the mispricing, pushing market prices back in line with fundamental price.
In other words, rather than creating problems in the market, high-frequency trading often solves them. It provides more stock for people to buy and sell, it often results in better execution prices, and it helps smooth out the ups and downs in price movement.
Nobody has yet managed to work out what caused the near 1,000-point drop in the Dow on May 6, but we do know that high-frequency traders helped correct the problem. The tremendous drop in the market prices of certain securities was stopped fairly rapidly thanks to high-frequency traders. They were the first to see prices were far lower than they should have been. They bought in, and they drove the market back, almost to where it had started.
It's true that high-frequency trading is reshaping our stock markets, and it's right that regulators should want to investigate. Hopefully, once regulators and legislators gain a full understanding of HFT, they'll see the enormous benefits that it can bring. Hopefully, then, we'll stop hearing paranoid rants about the rise of the machines.
Radke: Matt Samelson is a principal at the independent consulting firm Woodbine Associates.
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This is the 2nd story I've heard about small investors leaving the stock market and am wondering why the reasons put forth never include "people may have lost their job and are cashing out of the stock market because they HAVE to".
I'm just saying.................
YOU are the bogeyman! We don't believe you anymore. You and your greed have lost all credibility for the last time! Go look elsewhere to support your inate ill money grubbing thievery. Remember everyone, these are the people whose lobbyists worked and paid so much to keep legistlation from passing that also included simple language that made it illegal for brokers to put themselves ahead of the interests of their investors! Have they no shame!
Matt Samuelson forgets or ignores his basic economics. Profit is not value, but economic inefficiency that supply-and-demand is supposed to minimize. That law cannot operate effectively in high-frequency finance. Exploiting market inefficiencies as HF traders do only promotes toxic profit bubbles. Please visit profitandentropy.com for a complete picture.
Why am I surprised that a consultant who works for a company that describes itself as: "Woodbine Associates is a unique research and advisory firm serving companies and professionals operating in and supporting the capital markets industry." (http://www.woodbineassociates.com/Home_Page_1VZO.html) is quoted as trying to calm those who distrust programmed trading.
I distrust programmed trading because it has no benefits other than making people richer at the expense of those who cannot afford the cost of co-location of their servers at the exchanges and the immense cost of programming these services. And everybody else too.
Here is a quote from a networking magazine, Lightwave "According to a TABB Group report, it is estimated that a 1-ms advantage can equate to more than $100 million in financial transaction revenue per year. With a decrease of 1 ms in latency equating to up to $100 million for its trading partners, NYSE Euronext decided to launch the first commercial application of serial 100-Gbps technology." (ms for the non-techies is a millisecond - one one-thousandth of a second, Gbps is one billion bits per second - this service is about 10,000 faster than a first-class broadband connection!)
NYSE will gladly accommodate you if you have the money. Google "NYSE Euronext colocation" and you get numerous documents like this: http://www.nyse.com/pdfs/Colocation-NYSE-Euronext-US-Liquidity-Center.pdf
PS: Bill - I was disappointed in you today. This and the similarly unbelievable report from John Challenger on the job outlook makes me wonder if you've been doing some heavy reporting on the CA initiative to legalize marijuana! <g> How about Marketplace include some other points of view than the consultants and lobbyists who got us in this mess?
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