In our monthly Investment Committee meeting this week, Ken brought up High Frequency Trading (HFT) as a topic of discussion (using the very witty title I have borrowed for this post). For those of you who do not know about HFT, it is a combination of trading strategies using computer algorithms to make profits on small but very quick trades which usually last for mere seconds. They have become so dominant in the trading game today that it is estimated that they are responsible for over 70% of trading volume on any given day. Is this a good thing? Well, that is the question currently being debated.
HFT firms will argue that they provide three major benefits to the marketplace. They provide added liquidity to the market, they narrow the bid-ask spread (price difference between selling and buying a security), and improve market efficiency by reducing price inconsistencies. However, critics are quick to point out that these trading strategies are essentially front-running trades as they can see large orders and execute faster, while in the process trimming profits from individual investors. Additionally, the firms are engaging in questionable activity including multiple order cancellations which might be viewed as market manipulation.
Whatever side of the argument you fall on, I think we need to concentrate on one important area. These trading strategies are implicated, rightly or wrongly, in the flash crash that occurred in May. Every week since the flash crash we have seen equity outflows by retail investors as they are increasingly concerned with volatility. This creates instability and a lack of confidence in the marketplace which is very worrisome since our recovery is standing on a very thin edge. It might be time to restore that confidence and encourage capital investment as the exchanges were built to do.
