Should You Worry About High Frequency Trading

A March 30th segment on “60 Minutes” examined high-frequency trading and whether insiders are increasing the cost of stock trading for investors. Here are points to keep in mind as it relates to high-frequency trading:

1)      While there certainly is some questionable activity in the high-frequency trading community on Wall Street, the general belief within the industry is that trading costs have gone down – not up – as a result of high-frequency trading. This is because high-frequency trading can provide liquidity to the stock market at costs cheaper than what traditional market makers charge. Further, it appears that most high-frequency traders are in the business of market making (i.e., providing bid-and-ask quotes on stocks) as opposed to other activities.

2)      While it’s thought that investors have generally benefited from high-frequency trading through lower market bid-ask spreads, it appears that investment managers who have continued to trade using old methods (i.e., resisted electronic trading technology) or who have continued to try and push large blocks of stock through the market are more exposed to being taken advantage of than other investors. So, individual investors or those who use mutual funds with relatively low turnover (like the funds we use) are likely better off with high-frequency trading compared with the more costly approach of traditional market making.

3)      The idea that markets are rigged isn’t new, of course. Yet, the huge downward swing in markets that we saw in 2008 wasn’t caused by high-frequency trading. Further, to the extent that market making has been detrimental to some investors, which is still very much an open question, it is no more than a secondary concern compared with other factors within your control, like asset allocation, that drive investment returns.

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