High Fidelity

What is high-frequency trading?

High frequency trading is a computer-driven strategy whereby firms take positions in stocks and options and hold them for seconds, or even fractions of seconds. It’s behind the tremendous increase in volume on stock exchanges around the world. Indeed, last year high frequency trading accounted for as much as 70% of the equity trades done in the US.

Some studies show that such activity benefits the market—higher volume means larger trades can be accommodated, and prices are more consistent across markets. But when things get chancy, these same traders tend to step away from the market. As a result, the liquidity that folks planned on having may not be there. Hence, you can see phenomena like the “Flash Crash” a year ago, where the Dow fell a thousand points and recovered within minutes.

In essence, high frequency trading is computers day-trading with each other. Of course, trading is not investing: someone has to win and somebody else loses. Some are concerned that if all the day-traders are winning, then long-term investors have to be paying more. But it seems more likely to me that the day-trading computers will just try to outsmart each other and pick each other’s pockets.

In the end, day-traders (and computers) supply liquidity to a system that needs it. But investors need to be careful about how markets behave. This innovation gives credence to the old investors’ saw: be long term, but watch the ticks.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

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By | 2014-09-11T11:15:49+00:00 June 1st, 2011|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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