> If you are a "long term" investor you don't sell stocks to capture a few pennies here and there.
Yes, but I'm still certain that high frequency traders are siphoning value off long term traders when the latter have to transact.
Yes, but I'm still certain that high frequency traders are siphoning value off long term traders when the latter have to transact.
It seems like most people are "certain" about the impact of high frequency trading on an a priori basis as well. If facts wouldn't be inconvenient, however, run a Google Scholar search on the impact of high frequency trading or look at Chris Stucchio's discourse on the matter [1].
Consider two markets, one with high-frequency and human market making and one with only human specialists against whom you trade. Run similar value-style strategies on both; if the former outperforms the latter portfolio you pay up $10 000 (or whatever number keeps this interesting for you), else I pay you.
Fact is you'd be silly to take that bet, as would I. We don't understand the impact of HFT enough for either of us to be "certain" of anything.
And its the market makers who provide the liquidity (with limit orders) for the long-term traders when they do decide to trade, not the short-term traders (who take liquidity with market orders).
If someone trades with a HFT market maker its because
a) they are un-informed about the current true price
b) they choose to optimize execution time over best price
Its the same market game that`s been played for decades, just with different players and tools.
By definition, HFT jump into liquid market and count on exiting illiquid markets faster than anyone else. That means that they don't actually bring a greater assurance that a trade will happen, in contrast to the traditional "market makers" of NYSE. The "flash crash" can be seen as a simple illustration of this but so could be the greater volatility we have seen in the last few years.
Which "flash crash"? The one about a year ago or the one in the mid-60s?
Whether these are exacerbated by hft is hard to tell, but I can't see how it would help damp volatility. Probably they have more to do with momentum investors and algorithmic trading, though they can easily happen with only human trade too, just at a slower pace. Would be interesting to see stats on volatility going back decades, but it's probably quite a complex subject for a layperson.
Here are some examples: http://www.usatoday.com/money/markets/2011-05-16-mini-flash-...
You place a limit order to buy FOO at $32
Someone else offers FOO at $31.90
A HFT algorithm buys FOO at $31.90 and immediately offers it at $32
You buy FOO at $32 from the HFT algo
So you have lost potential profit on the transaction even though you technically hit your limit price.
Someone else offers FOO at $31.90
At this stage, the matching engine observes that you want to buy at $32, and someone is willing to sell at less than $32. You trade directly with that person at $32.
It's actually illegal for any matching engine to match the $31.90 bid, they must cross trades at the NBBO.
You place a limit order to buy FOO at $32
Someone else offers FOO at $31.90
A HFT algorithm buys FOO at $31.90
So, in the interest of disclosure, do you do HFT? You seem to have an interest in defending the notion that high frequency traders have no overall effect.
To respond to your comment though,
"The aggregate effect of HFT might change the amount people decide to put on orders, resulting in their buying higher and selling lower."
I'm trying to figure out the linkage. What mechanism would connect the order pricing from a long term investor with the activities of an HFT trader? HFT works in the first and second derivative space of values and long term traders seem solidly in the linear space. Can you construct and example where the activities of an HFT trader are both visible too, and influential on, the pricing targets of a long term investor?
Oh I do have some Bank of America stock (one of the stocks called out in the article) which I bought in 2009 when they were pummeled by the Countrywide fiasco and their inability to get another CEO, sold half of it for a 100% gain, (net 50% gain on the total investment) and have watched the remainder go up and down. I got my 50% return (and that cash is working elsewhere) and I've got some extra shares that I could sell for anything over $0 to add to that gain (although if you want to do the annualized computation it gets lower if I holder it longer etc etc) but holding that since 2009 pretty much defines a 'long' holding.
Now add some HFTs, these make a profit (there is empirical evidence for this claim). Now money is leaving the market without going to long term investors. Thus the long term investors are making less profit.
Now the big unsubstantiated assumption I have used above is that HFT adds no value to the market. I do not feel I am in any position to argue about whether this assumption is good or not. The above argument is presented in the hope that it makes things clearer and points towards what I think is the fundamental point which needs to be discussed: "Do HFT traders add value of a market?"