Question: Please explain high-frequency trading (HFT) and what this means to individual investors?
Answer: Simply stated, high-frequency trading describes computer-based stock market activity. The practice relies on mathematical technology and trading systems known as algorithms which allow traders to buy and sell securities within nanoseconds.
The notion of high-speed stock market trading isn’t new. What’s new is Michael Lewis’ book “Flash Boys: A Wall Street Revolt.” While promoting his book that explores the world of high-speed fiber optics trading, Lewis has brought media attention back to this concept. The implication is that HFT is predatory because it may give pricing advantages to certain traders at high-speed electronic trading firms.
In 1898, the Chicago Mercantile Exchange (CME) was known as The Chicago Butter and Egg Board, an exchange for agricultural commodities. Traders conducted business using an open outcry method, placing and confirming trades verbally on the floor of the exchange.
Fast-forward 89 years to Black Monday — Monday, October 19, 1987 — when computerized program trading was blamed, in part, for a one-day market decline of more than 22 percent when trading systems couldn’t adequately handle the large number of sell orders. Markets, advisors and investors felt helpless and overwhelmed. On these high volume days, transaction reporting delay was deadly, contributing to confusion, chaos and ultimately prompting panic.
To some extent, computerized electronictrading began in 1982, and was partially in place prior to Black Monday during 1987. The Chicago Mercantile Exchange (CME) electronic trading platforms weren’t fully launched until 1992. Fortunately, the 1987 crash did inspire upgrades to systems and their capabilities.
When I started in the financial services industry in 1983, the procedure for entering orders was both time consuming and cumbersome. The entire process could take up to 15 minutes as compared to today’s instantaneous reporting. Client orders were hand-written on green (buy) or red (sell) tri-copy tickets with the stock symbol, number of shares, client name and account number. We’d tear off a copy for ourselves and drop the ticket in a basket for the wire operator to enter. He or she was clearly an important person on those busy days. Typing skills were essential as information was transmitted to a floor broker who negotiated the price and filled the order. Then the entire exercise was repeated in reverse, communicating results to our wire clerk who would in turn relay the information to advisors. Speed and accuracy were critical.
The manner in which trades are handled today has evolved due to necessity and advanced because of technology. Growing pains and unintended consequences are often the result of such progress and call for adaptation. High-frequency trading, which came about due to improvements in fiber optic (fibo) cable transmission speeds, is no exception. Industry groups, exchanges and regulators have ongoing investigations into high-frequency computerized stock trading to makesure that investors are being treated fairly and equally.
It’s important to point out that financial markets are critical drivers of the global economy contributing to personal wealth and well-being. High-frequency trading has brought positive advancements to markets such as lower transactions costs, increased market access, improved liquidity and instantaneous order execution
To answer your question on how high-frequency trading affects individual investors, the answer hinges on the difference between trading and investing. High-frequency trading primarily influences those who are purely in the business of trading rather than investing. The current debate and attention concerns a particularly narrow segment of traders who leverage the use of high-speed techniques. Abuse and misuse of technology is an unfortunate reality in many industries. History does show that when advantages are distorted and then identified by market participants, a combination of market forces, investor sentiment and regulation will intervene to level the playing field and promote greater efficiency.
Investing in the markets, with the assistance of a trusted advisor to help you identify and obtain long-term goals, is vastly different from high-frequency trading. Stay focused and invest accordingly.
This article provided by Darcie Guerin, CFP®, Associate Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. She may be reached at 239-389-1041,email@example.com or www.raymondjames.com/Darcie. Please contact Darcie with any questions you would like to have answered in this column.