NY Times: High Speed Trading

One criticism I've heard that would affect a buy & hold mutual fund investor, even one sticking to broad-market index funds, is that the existence of HFT firms has brought down the size of orders and made it more difficult to fill larger blocks vs. in the pre-HFT market. That wouldn't affect individual investors buying small lots of individual securities, but could act as a sort of drain on their mutual fund holdings.

I don't know if that's actually true, but if it is, the mutual fund would see larger execution costs (not from commissions, but from market impact and spread costs). That should show up in index funds as tracking error, meaning deviation from the return of the index, resulting from the additional trade costs. So far I'm not aware that it has shown up in the larger index funds. Front-running and market impact from big orders was a part of the old market as well, so the cost may have already been there, just in a different form (a guy on the phone, not a computer sniffing out the existence of a large order).

I think you're right that certain aspects of HFT look little different from other short-term speculation, which in aggregate should be zero-sum minus costs (i.e. a losing strategy unless you're the house). It seems a bigger piece, though, is more like being the house - meaning traditional market-making and arbitrage trading, where the participants manage an inventory of securities and earn market-maker profits. There are more warehouses and they flip their inventories much more often, but that is still a valid business; somebody has to make markets in securities and can expect to be compensated for that.

-Tad

I now think the article I cited above misses the boat. Elsewhere in the last few years the Times has reported that these "high speed traders" see orders before others can, due to a loophole in the laws and/or superior technology. This allegedly include being physically closer to the exchanges, so the time of transmission allegedly is shorter and a computer-run algorithm can pounce when it sees orders piling on and take advantage of movement on a stock on a milli-second (or whatever) timescale. If this is all true, then the profits won't balance out with losses.

I am not sure why they have so much access to orders. I sure don't.

Thanks for posting your interesting insights.

The high speed traders have access to a broader bandwidth connection to the exchange and so can receive the data faster. (Not sure if the exchange has different size pipes and/or the high speed traders just use a broader bandwidth). The exchange gets a higher fee for broad band data than narrow band data. The high speed traders have also invested in algorithms and high speed computers.

What bothers me is that I believe that the higher speed traders cause more market volatility and I either as a buy and more or less hold investor or my mutual fund is at a disadvantage in working in a highly volatile market.

In addition, the high speed traders pay extra $$ to co-locate their computers in the exchange. That way the speed of light (and/or speed of electricity) delays are smaller (remember, at light speed,

1 foot equals 1 nanosecond of delay) and so they are seeing the action literally before those who have computers off-exchange.

In addition, the high speed traders pay extra $$ to co-locate their computers in the exchange. That way the speed of light (and/or speed of electricity) delays are smaller (remember, at light speed,

1 foot equals 1 nanosecond of delay) and so they are seeing the action literally before those who have computers off-exchange.

nanosecond-by-nanosecond momentum) care about high speed traders?

Sure, the buy-and-hold strategy is affected by high speed trading because stock prices might go higher than one's target price.

"technique" of trading stocks needs government regulation.

It needs government regulation because some of the sales create naked shorts.