Flash Trading

 

On my way back to the US from a diving trip in the Philippines with my husband, I passed a few book stores that were selling a book regarding aware high frequency trading.  I did not purchase the book as it was not something that interested me.

However when I arrived home the author of the book was being interviewed on TV and as it would happen I had brought home a section of the Strait Times from Singapore and lo and behold there was an article on the subject there too.

So while I was still not interested in the book I became interested in the subject.

The reason is that the interview on TV raised some disconcerting questions regarding whether the stock market is rigged against the retail investor or not.

To determine whether this is the case let’s first define what is meant by high frequency trading (“HFT”).

There are individuals who possess computers that are programmed to “see” stocks trades as they are getting ready to be processed. For example a person wants to purchase 100 shares of IBM and the computer quickly purchases those shares and then instantly (in milliseconds) makes them available for that order.

“A controversial computerized trading practice offered by some stock exchanges. Flash trading uses highly sophisticated high-speed computer technology to allow traders to view orders from other market participants fractions of a second before others in the marketplace. This gives flash traders the advantage of being able to gauge supply and demand and recognize movements in market sentiment before other traders.” – Investopedia

The owners of these HFT computers pay an average of US$30,000+ per month for the ability to participate in this type of trading. You can see how they need to extract thousands of dollars just to get to the point of paying for that seat on the exchange. The key is to get in ahead of the investors.

This is called “front running” a trade.

While this is illegal if done by an individual (I want to know how that would even be possible) it is not illegal if it is done by a computer.

Why is this not good for the investor? Because the investor is paying slightly more for the stock than they would normally be paying.

Because of this environment the news in the US has jumped all over the stock market indicating that it was known all along that the markets are stacked against investor.

How can this be? The computer is not concerned with whether the investor is buying or selling a stock.

They are not causing the stock market to either go up or down! They are simply front running the trades which is far different from the rigging of the stock market.  I do not believe, therefore, that the stock market as a whole is rigged.

However can some stocks be rigged?

I believe that stocks that are lower priced, small volume stocks can be rigged.

The SEC has in the past and currently continues to crack down on this type of activity.

If anyone is interested there was a really good movie with the actor Ben Affleck called “Boiler Room” that clearly drives the point home regarding the dangers of investing in these types of stocks.

As Smart Traders how do we make sure that we are protected?

We would want to avoid participating in stocks that have 500,000 shares or less traded per day.

In addition how can I make sure to always get the best possible price when we get ready to purchase a stock?

The key is to always use a Limit order.

The limit order does just that – limit how much I am going to pay so that when my trade goes to the floor I can’t pay more than it was being offered at my time of entry.

How cool is that!