INTERVIEW - How Does High Frequency Trading Affect Individual Investors?

INTERVIEW - How Does High Frequency Trading Affect Individual Investors?

20 August 2014, 15:11
Mike Dennis
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Why You Should Support High-Frequency Trading

RICK FERRI : High-frequency trading provides market liquidity, and that's good for individual investors. Some say it's unfair because a few very smart people are making money doing it. I disagree. Competition will take care of that.
Rick Ferri is founder of Portfolio Solutions LLC and the author of six books on low-cost index fund and ETF investing.

For Most Investors, High-Frequency Trading Is Irrelevant

TED JENKIN : The scuttlebutt surrounding "high-frequency" trading has come to the forefront from the Flash Crash to the recent statements about the market being rigged. High-frequency trading should not affect normal investors at all because the regular investor has no business sitting around and trying to day trade their stock portfolio. Equity investments should only be considered if you have a long-term time frame to hold your investments. The majority of investors who get burned do so because of their own lack of judgment or over emotional decisions generally resulting out of fear or greed.
Ted Jenkin s the co-CEO and founder of oXYGen Financial, a financial advisory firm focused on the X & Y generations.

How Individuals Should Think About High-Frequency Trading

LARRY ZIMPLEMAN : The release of the latest Michael Lewis book, "Flash Boys," and the subsequent report on "60 Minutes" has reignited the debate over the purpose and value of high-frequency trading (HFT).

Like many innovations, HFT had some noble objectives when it first started (to improve both the cost and timing of trades) but the concept has morphed and changed well beyond its original intent. The original purpose of HFT began to change, in my view, when the exchanges began to focus on HFT firms and began to recruit and incent them to set up shop on or near their exchange location so that they could gain milliseconds over other trading firms, which gave them a trading advantage. As is often the case, the regulatory agencies tend to be slow to react to these new innovations.

I believe that the most accurate characterization of HFT is to call it "structured front running." It is seeking to consistently gain an information advantage to the disadvantage of those whose orders come behind the high-frequency trader.

As to its impact on the individual investor, the answer depends on the investment horizon of the individual investor. I believe it is fair to say that most individual investors have a time frame in mind that is measured at least in months, if not several years. On that basis, HFT tends to have a negative impact on the individual investor because HFT tends to reward those investors with the shortest investment time horizon.

To be fair, however, it must also be said that electronic trading (which is what gave rise to HFT) has substantially reducing the overall cost of trading, so the negative impact to the individual investor is lessened.
Larry D. Zimpleman is chairman, president and chief executive of Principal Financial Group.

Don't Lose Sleep Over High-Frequency Trading

GEORGE PAPADOPOULOS : In general, high-frequency trading mostly affects institutional investors. More specifically, it affects professional traders and short-term investors the most. For long-term investors who utilize broad-based index funds and ETFs and practice low-frequency trades, this issue of high-frequency trading that was brought recently into the spotlight by Michael Lewis's "Flash Boys" book is not a big concern in our day-to-day lives.

But, looking at the bigger picture, we should all be concerned, as it sure sounds like a form of "front-running," which has been around for a long time, giving ammunition to consumers to say that the market is rigged. Well, in a way, this has always been true in some form or another ever since the birth of the stock market. But it has not stopped investors from continuing to make money in stock investing. So, I welcome the sudden decision by regulators and the FBI to launch investigations that may bring criminal charges against some high-frequency traders. I just don't lose sleep over high-frequency trading and neither should you or any other long-term investors. Leave that to the speculators.
George Papadopoulos is a fee-only wealth manager in Novi, Mich., serving affluent individuals and families.

Why Individuals Should Care About High-Frequency Trading

SHERYL GARRETT : High-frequency trading may affect individual investors in ways that aren't initially considered. Traders with lots of money have access to gaining a fraction of a cent or more on every share in a high-frequency trade. Individual investors aren't trading a sufficient volume and won't feel the financial impact of not having access to this type of trading. They don't know what they've missed. Isn't it supposed to be a level playing field?

Michael Lewis' new book, "Flash Boys," and the press exposure of this inequity do have an effect on individual investors. Many people lost faith in the financial system after the 2008 fallout and may be just starting to recover. Now they're learning about high-frequency trading. Losing faith in the capital markets could have a very damaging effect on individual investors' ability to achieve their financial goals.
Sheryl Garrett is founder of the Garrett Planning Network Inc.

Investors, Use Your Advantages Over High-Frequency Traders
CHARLES ROTBLUT : Instead of worrying about high-frequency traders, individual investors should focus on exploiting the advantages they have over these traders. Those advantages are:

1. Opting not to play their game. Day trading was a loser's game for the majority of those who tried it before the advent of high-frequency trading. Now the odds are even more stacked against individual investors who attempt to day trade. The arms race favors ultra-high-speed connections and servers as close to the exchanges as possible. The only way you can beat high-frequency traders is to circumvent them.

2. Limiting the number of transactions. The less you trade, the less chance high-frequency traders have to jump in front of your orders.

3. Buying funds with less portfolio turnover. The average large-cap mutual fund covered by our mutual-fund guide had a portfolio turnover ratio of 64% last year. In comparison, the Vanguard 500 Index fund (VFINX) had a turnover ratio of 3%. Even if high-frequency trading does drive up costs, buying funds with low turnover ratios will limit the impact on your wealth.

4. Investing where the professionals aren't looking. Many pension funds, mutual funds and other institutional investors have restrictions on what they can and cannot invest in. It only makes sense for high-frequency traders to focus on the stocks most likely to be bought and sold by institutional investors. You, as an individual investor, are not encumbered by the restrictions placed on institutional investors. So do what we do at the American Association of Individual Investors, which is to go into the shadows of the market and seek out small, profitable companies with attractive valuations. By investing where others aren't, our Model Shadow Stock Portfolio has realized a five-year annualized return of 44.5% (through Feb. 28, 2013)—a performance number that includes all transaction costs.

Charles Rotblut is a vice president with the American Association of Individual Investors.





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