Some people are still not sure what exactly high frequency trading is and if it is good or bad. Explaining what high frequency trading is creates less controversy than deciding if it is good or bad for traders and for the economy as a whole.
First, to understand what high speed trading is you should understand that there are two parts to the process.
1. Traders us an algorithm to determine when there is a price mismatch for a stock or a sector of stocks.
2. Trades are made in just thousands of second, or even faster when that algorithm is triggered.
When high speed trading is implemented, some of the things that will occur include trades will be made with great speed, there are more trades possible and people hope that they can make some money off of each of those trades, and trades are short-term. Traders rarely keep many stocks overnight.
Traditionally, or at least as traditionally as possible for a process that has not been a part of the stock market for very long, most high frequency traders (HFT) are small investors, although there are some large investors participating more and more often. What traders look for is a stock or part of the market that drops below its expected performance level. Then, traders will sell after a stock goes above its performance level. That is what the algorithm determines.
Trades can occur faster than a human can see that a stock is below its performance expectation, let alone try to make a trade to benefit from that stock when it turns around. HFT traders are not buying stock and keeping it for months or years until it is retirement time. They are selling for smaller but sure profits.
Some Reasons Why High Frequency Trading Might Be Bad
Those who have access to high speed internet have an advantage over a person who does not have similar access. Location is also important. People with really high speed internet who are located closer to where the trades will occur also have an advantage. These stocks are being trading in thousandth of seconds. Some people find the disparity of those who don’t have access to any high speed internet for stock trading, or those who live away from the stock market are at a disadvantage, if not legally, then in the eyes of some, morally.
Another reason some people are concerned about HFT is it seems to fly in the face of what has been the traditional and conventional wisdom of traditional market watchers. People engaged in HFT are not as interested in staying in the market and allowing their portfolio to grow. HFT traders are waiting for their algorithm to buy when a particular stock or sector drops, then sell when it goes back up.
Some Reasons High Frequency Trading May Be a Good Thing
Many people believe that only large traders are able to influence a stock or market sector. When Warren Buffet makes a trade more people watch him and mimic him than people watch Joe Schmoe. This allows Warren Buffet to make the market move, but poor Joe Schmoe, not so much. That means Joe has to stay in the market for the long haul to see profit. Mr. Buffet does not.
With HFT, Joe doesn’t have to influence the market, but he can take advantage when other people do and by when a solid stock goes down, and sell when that stock goes up enough to trigger the algorithm. Joe is still at the mercy of the big guns, but he can now make more money and see faster profits.
As with all things, there are pros and cons to HFT. Right now though, there are probably more advantages, especially for the smaller investor than in the past thanks to HFT. The little guy probably needs to celebrate his small victories while he can.