I read an article recently caught my attention as something worthy of sharing with others. The article addressed the issue of high frequency trading. If you follow the market much at all, you’re likely familiar with the term and the increasingly relevant role it is playing in the stock market. The article discusses the increase in political donations made by high frequency trading firms to numerous officials in Washington. The article cited a study comparing the 2008 to 2012 presidential campaigns which found that there was an increase of 637% in donations to politicians over that time span.
Truth be told, these firms were only donating $2.1 Million during the 2008 election, but the stark increase opens our eyes a little more to the relevancy of high frequency traders and their role within the larger scope of the stock market.
High Frequency Trading is Here to Stay
While opponents of high speed traders won’t like to hear it, I think the practice is here to stay. As each year passes, there are more and more high frequency trading firms starting up. A sign that these firms aren’t going anywhere is the fact that they have begun to form their own trade associations. Sure, you could say that the pragmatism behind that belief is a little off, but I am convinced that there is too much money involved in the game of high frequency trading to see its growth slow down or taper off now.
As it stands now, high frequency trading is largely unregulated and unless Congress passes sweeping legislation, which is unlikely to happen given its performance during past opportunities to enact regulation upon the stock market or financial dealings, there is nothing impeding the growth of high frequency trading. The drastic increase in political donations points to the fact that high frequency traders are growing in number and are concerned over possible legislative efforts to mitigate their algorithmic trading.
Do We Benefit From High Frequency Trading?
As with any controversial issue there are multiple sides to it. The high frequency trading firms will argue that they are bringing liquidity to the market that benefits the mom and pop investor. They will also argue that this increased liquidity brings about lower pricing for the retail investor that we all get to benefit from.
The critics, on the other hand, will argue that these firms are harming the common investor through their practices. These firms use their algorithms to take advantage of very small price movements within the stock market that are not readily available to investors like you and me. I don’t know that I would say that one side is entirely wrong or entirely right, but this issue is one that does warrant measured consideration.
That said, we have already seen impact, on some level, with high frequency trading from the Facebook IPO debacle, to the Knight Capital fiasco, to the April 22 Fake Tweet Flash Crash, to the Flash Crash several years ago. All those events were related to high frequency trading at some level and had the potential to trigger a much bigger black swan event. With this knowledge of how high speed traders have impacted the stock market as a whole one has to question if they do benefit us and I would say it’s not really at the level the high frequency trading firms would necessarily say.
Is More Regulation the Answer?
The knee jerk reaction to seeing how these firms have increased in number, in addition to the number of problematic events, has led some to believe that regulation is the answer to the problem. I am not one to typically champion increased regulation, though the events of the past do make me wonder if they are called for here.
While there are circuit breakers in place in the event of a quick and massive sell off, there still is a lack of new regulations in place to police the practices of high frequency trading firms. As one who tends to think that getting the government involved generally makes problems worse, I do believe we need to have a national conversation about this topic. We do not want to restrict a free market, but we also do not want to allow things to run roughshod without a certain amount of restraint. The fact that numerous westernized countries have certain regulations in place or are at the very least seriously looking at them does cause me to wonder if we should be doing the same in relation to our high frequency trading issue here in the States.
Should We All Just Throw Up Our Hands?
Now that I have gone on ad nauseam about the issue of high frequency trading, one has to ask what should we do now. Should we throw our hands in the air, take our ball home and stop investing in the stock market? Not at all!
I understand the hesitancy to be comfortable with the market in light of something like this, but I ask you where else will you go to build your wealth? Where else will you go to help further your retirement planning? You could take your money and run and put it into something “safer” like CD’s or certain bonds, but how will that help you reach your goal of accumulating and building wealth as most are earning very little interest overall?
What this issue causes me to see is the increased importance of being mindful of what is going on in the stock market and avoiding an extreme version of setting and forgetting and hoping that your investments will do well. While the growth and expansion of these trading tactics can cause many to fret their financial investment opportunities away, the more concerning thing to me is giving up on investing in the stock market altogether and risk missing out on potential solid gains that would be a boon to your portfolio as a whole. In my opinion, we investors are often a bigger threat to the performance of our investment portfolios than any market force, such as high frequency trading, could ever be.
What’s your take on high frequency trading? Do you think it is here to stay and are you taking actions in your portfolio because of it?
John Schmoll is the founder of Frugal Rules, a Dad, husband and veteran of the financial services industry. He’s passionate about helping people learn how to make wise investing decisions so they can prepare for their futures and avoid the mistakes that he and so many others have made.