Trades in a Flash: The High Frequency Trading Debate

 Imagine making a trade in less than the blink of an eye. That’s called High Frequency Trading (HFT) and it has generated a lot of buzz lately. HFT trades are executed between 2 and 7 milliseconds … we’re talking one thousandth of a second (1/1000).  There are as many milliseconds in one second as there are as many seconds in 16.67 minutes.   

High Frequency Trading Changing the Spreads?

There is a pretty lively debate going on right now between proponents of HFT and some outspoken critics.   Proponents of HFT claim that it’s good for the markets because it creates a lot of liquidity and volume for exchanges so the spreads aren’t as wide for different types of securities. For instance, if you wanted to buy Ford stock back in the 90’s the bid (what someone was willing to buy it for) and the ask (what someone was willing to sell it for) may have been as much as .125 or .25.  However, nowadays, if you look at the bid/ask spread for most heavily traded stocks (such as Ford) it’s usually as little as one penny.  The proponents of HFT claim that these “tight” spreads are because of all the activity and volume their computers bring to the markets.

Is High Frequency Trading Essentially Front Running?

The critics of HFT say that these computers and algorithms are engaging in front running.  That’s an illegal practice involving having prior knowledge that a large trade is going to take place, and just before that trade happens you go in and buy the stock yourself.  When the large trade is placed, it will naturally eat up all of the available shares at that price point, and push price slightly higher allowing the front runner an opportunity to exit with a few pennies profit.   

So why should we care?  If you are a long term investor, the simple answer is that paying a few extra pennies for your Google or Apple stock probably doesn’t matter. However, if you are a day trader, then I hate to break it to you, but the deck may be strongly stacked against you.

Matthew Trujillo is a Registered Support Associate at Center for Financial Planning, Inc. Matt currently assists Center planners and clients, and is a contributor to Money Centered.

In reality, this practice mostly impacts those who are in the actual business of trading stocks. And more narrowly, the debate concerns a particular segment of traders who leverage speed to gain an advantage. Raymond James has long held that investing in the markets, with the assistance of an advisor, can help clients best meet their long-term goals through strategic, customized financial planning. We encourage our clients to buy and sell in context of those long-term plans, rather than make quick trades. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any opinions are those of Center for Financial Planning, Inc. and not necessarily those of RJFS or Raymond James. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. C14-009411