4/2/14 – High-Frequency Trading and the Average Investor

Posted by Brad McMillan, CFA, CAIA, MAI

Find me on:

This entry was posted on Apr 2, 2014 1:30:00 PM

and tagged Ask Brad

Leave a comment

I got a good question from Matt Parsons about yesterday’s post—essentially, what does high-frequency trading (HFT) mean to the average investor? If you’re retired, living off your investments, do you need to worry? This is an excellent question—thanks, Matt!

The short answer is no, you don’t need to worry. Basically, HFT traders are playing in pennies or fractions of a cent per share. For average investors, even those directly affected, the downside (if it exists at all) is tiny. Offsetting any potential negative effect is the very positive one of more efficient pricing—which, in aggregate, means lower prices, to the benefit of the average investor. This is part of the trade-off I discussed yesterday, with the benefit of more efficient pricing accruing to everyone.

The costs are a little more subtle and generally wouldn’t accrue to the average investor but instead to institutional traders or other HFT firms. Make no mistake, this can have an indirect impact on average investors, through the funds they invest in. But for most types of products, the impact appears to be relatively minor—and, again, offset by the better pricing generated by HFT traders.

In all likelihood, somewhere in the new trading ecosystem, there are bad actors who are gaming the trading systems, which would be neither new nor unusual. The real issues here are complexity and adequate supervision and regulation, not fast traders. And, quite frankly, this is a completely normal situation for Wall Street. Technology and market practices have always and will always outrun regulation, which then has to catch up. This is the price of progress.

So, for the average investor, the benefits outweigh the costs. That’s also true for institutional investors, although some areas of the system are currently being investigated and will be corrected. HFT traders themselves will continue to battle it out with each other—soon within the context of a well-designed set of rules that’s now being prepared—which is as it should be.

Also keep in mind that, as is typical on Wall Street, many of those predicting disaster have a large vested interest in the outcome, limiting their objectivity. Overall, while there are things to worry about—complexity, as I note above, being a big one—HFT is not at the top of the list for you, me, or the average investor in general.

Upcoming Appearances

Tune in to Bloomberg Radio's Bloomberg Businessweek on Friday, February 28, at 3:45 P.M. ET to hear Brad talk about the market. Stream the show live at https://www.bloombergradio.com/, listen through SiriusXM 119, or download Bloomberg's app, Bloomberg Radio+.

Tune into Yahoo Finance's The Final Round on Thursday, March 12, between 2:50 and 4:00 P.M. ET to hear Brad talk about the market. Exact interview time will be updated once confirmed. Watch at finance.yahoo.com

Subscribe via E-mail

New call-to-action
Crash-Test Investing
Commonwealth Independent Advisor

Hot Topics

Have a Question?

New Call-to-action

Conversations

Archives

see all

Subscribe

Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly into an index.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.  

Third party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®