What is High Frequency Trading (HFT) and should you be concerned? I’m sure you’ve recently seen some news reports about HFT and depending on your news sources’ political bias it may oppose or support HFT. The audience of this blog is primarily military members E1-O6 and knowing that, my personal opinion, is that High Frequency Trading should not concern you, from a threat to your financial goals perspective. HFT doesn’t prevent you from reaching your financial goals nor is it “stealing” from you as some articles suggest. It may impact your ideologies, in terms of right and wrong, fair or unfair, to tax or not to tax; but as far as your financial goals, HFT should be irrelevant to you.
High Frequency Trading (HFT) is a term used for computer programs that execute millions of trades within minutes. The HFT you are currently reading about is used by Stock Exchanges to match buyers of stocks will sellers of stocks and vice versa. For each trade, the HFT earns $.0015[1] or somewhere around there, but multiplied my millions of traders per day. Your first thought should be quoting the “Office Space” movie where the protagonist is explaining that he is “taking” a fraction of a penny, so it’s not really stealing and Jennifer Aniston rightly rebuts, saying it is “stealing.” The difference between the Office Space movie and the recent HFT articles is Accounting principles actually account for those fractions of pennies, so taking them is really stealing. The HFT you are reading about is actually part of the system, right or wrong, it is a necessary “evil” for our stock exchanges. For every buyer there has to be a seller and these HFT machines provide that service. The problem is now we have HFT machines placing buy and sell orders a million times a day and other HFT machines placing those purchases. If the market moves in a way different than the HFT is programmed to handle, the market could swing wildly, affecting our 401(k)s, TSPs, IRAs, and investment accounts. On May 6th, 2010 this scenario happened and the DOW Jones lost 1,000 points or 9% in less than an hour[2]; but, it was the same HFT computer programs that enabled the market to bounce back to normal. NOTE – I was at work when this “flash crash” occurred and would have loved to buy stocks during that hour and get some quick returns.
Should you be concerned? As of now, no, you shouldn’t be concerned. HFT trades makes up 50%[3] of the daily activity on the New York Stock Exchange and some articles use that number to scare you; however, the large investment banks still hold a majority of the stocks in mutual funds providing a balance to the market. So until something changes, HFT provides both a scary volatility and a scary balance to the stock markets. You should continue applying sound financial principles and HFT won’t affect you. 1) Establish an emergency fund 2) Eliminate or Reduce Debt 3) Max out tax-advantaged accounts TSP, IRAs, 401(k)s, 529 plans, 4) Save and invest everything else. HFT sounds scary, but for us normal investors, it doesn’t affect us. If another flash crash happens, it could provide an opportunity to buy. If a flash increase happens, it could provide a solid selling opportunity.
Final Thought: Values of anything have increased wildly in a massive bubble creating winners and then popped, leaving losers, even before computers were invented. One of the first examples of this is the prices of Tulips in the Netherlands in the 1600s and High Frequency Trading was not around then. Getting rid of HFT won’t stop bubbles from forming and won’t collapse the whole financial system. Until something changes, keep investing smartly by diversifying and avoiding fees and taxes.
Good post Brandon.
ReplyDeleteI think one of the main keys to investing successfully is learning to drown out all the noise like this and just focus on yourself and your investing. Don't worry about what the big shots are doing on Wall Street and instead focus on what you can control, starting with being responsible with your money and investing for the long-term.
Best wishes,
SFZ