Did anyone catch 60 Minutes last Sunday? There was an interesting story about how high-frequency traders have an unfair advantage in the stock market over mom-and-pop investors. High-frequency trading is the use of high powered computers and computer algorithms to give certain investors a split-second advantage over other traders in the stock market. These programs look at a variety of factors, including economic reports and news headlines, to make split-second determinations and then place trades faster than a human could. There were some eye-popping numbers in the story such as how one firm spent $300 million to shave three milliseconds off its trade execution.
The first time many people heard of high-frequency trading was in May 2010, when the Dow dropped more than 1,000 points (and regained them) in less than twenty minutes. This “flash crash” was largely attributed to high-frequency trading, especially with stock options.
The real question is:
Does high-frequency trading doom the retail investor to below-average returns because there is not a level playing field?
Is the stock market rigged? I would say, “No.” High-frequency traders are trying to get an advantage of a penny or two per share. Pennies make a big difference when you are trading tens of millions of shares a day. But it is not a game-changer for an individual investor who is buying a few hundred shares of a given stock.
The most recent Dalbar study showed that retail investors have under-performed market indexes by almost 4% per year over the past 20 years. The reason retail investors under-perform is not because there is not a level playing field. It is because of psychological biases that lead to poor investor behavior.
The stock Market is more transparent and efficient than ever before:
The high-frequency trading story is an excuse some investors may use to justify avoiding the stock market. However, at the end of the day, it is just noise. The stock market arguably offers a more level playing field than ever before, with lower trading costs, better transparency, and access to more asset classes and investment vehicles. Now, you just need to know what to buy and when to sell. 🙂