Last week, media reports and a new book by author Michael Lewis have focused on a form of high-frequency stock trading where professional traders use sophisticated computers and complex programming to see stock orders coming in and position themselves ahead of the orders as middlemen between existing buyers and sellers.
All of this is done very rapidly, over and over again, often netting the high-frequency trader a few pennies on the stock price. While short-term traders fight it out at lightning speeds over these pennies, long-term investors are generally above the fray. If you are an investor focused on the longer term fundamentals of an investment, generally speaking, you have little to fear over the very small price moves caused by high-frequency trading.
High-frequency trading has been gathering headlines for 15 years. But, in recent years, this trading has shown some signs of stressing the fabric of the markets, for example, with the May 6, 2010 “flash crash,” when the Dow Jones Industrial Average dropped 1,000 points in just minutes, then rebounded by the end of the day. Investors should bear the risk of their investment; they should not have to bear the risk of whether the markets are functioning fairly or effectively. In response, regulators have taken some action.
The Dodd-Frank legislation, passed in 2010, effectively restricted high-frequency trading by the big banks. Yet, not everyone sees high-frequency trading as a negative; some mutual fund companies have publically noted that using such strategies reduces transaction costs and benefits the investors in their funds.
In short, high-frequency trading may create small inefficiencies over the short run, but for long-term investors it has little impact on achieving their financial goals.
As always, if you have questions, I encourage you to contact me at firstname.lastname@example.org or at (925) 301-4086.