Since Michael Lewis appeared on CBS' 60 Minutes last Sunday talking about his book “Flash Boys,” the issue of “high frequency trading” (HFT) has been on the tip of every tongue on Wall Street. It has gotten its fair share of attention in the mainstream media as well.
What is HFT and does it affect you? Let's answer the second question first. Unless you are an institutional investor, buying a million shares at a time, probably not.
HFTs use their proprietary computer algorithm to see others' stock purchase orders a split second before they are executed, allowing them to jump in front and buy the shares first, at a lower price. A split second later, they sell them to the original buyer.
Pennies can add up
The HFT, however, may only be making a penny or two profit per share – sometimes even less than a penny – on the transaction. But the transaction may be for one million or more shares, providing a hefty profit for a transaction that took less than a second to complete.
For the average consumer with a portfolio of stocks in a retirement account, this is hardly a blip. Most of these investors rarely buy or sell shares of stock, and a penny a share on 100 shares of IBM isn't going to make much difference in capital appreciation over the long haul.
But what about mutual funds, you may ask? If investors have their retirement accounts mostly in funds, the stocks in the funds are bought and sold in large blocks and trades are more frequent.
True enough, but that might be just another reason to avoid owning mutual funds in the first place. The fees charged by these funds may be a bigger detriment to your portfolio than HFT.
Lewis' book, and the charge that the market “is rigged,” may be of much more concern to the people who make vast fortunes on Wall Street than to the average consumer – or even the average day trader.
Tuesday, when CNBC interviewed Brad Katsuyama, who leveled the “market is rigged” charges in Lewis' book, he was joined on the set by William O'Brien, president of BATS Global market. The exchange was so heated and bitter it actually stopped trading on the floor of the New York Stock exchange.
The issue cuts deeply across the world of Wall Street. If you happen to be one of the HFTs, you see nothing wrong with it. If you aren't part of that world, however, you're likely to see it as grossly unfair.
Is it illegal or unethical? New York Attorney General Eric Schneiderman has shown interest in that question.
He recently announced an agreement with Marketwired, a news distribution and reporting firm, to stop selling to high-frequency traders direct feeds of the information that Marketwired distributes on behalf of clients, a move he says will end advantages to high-frequency traders.
“High-frequency traders who drain the value out of market-moving information in the milliseconds before it becomes widely available to other investors erode confidence in our markets and skim from the rest of the investing public, which hurts the entire market,” Schneiderman said.
Meanwhile, the Securities and Exchange Commission (SEC) is looking into the legality issue. SEC Chair Mary Jo White told a House Appropriations subcommittee this week the agency has several on-going probes involving market integrity, including a close look at HFT.