The Independent Market Observer

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

Posted by Brad McMillan, CFA®, CFP®

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

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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.

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