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Why Warren Buffett is Wrong about High-Frequency Trading

Daily Ticker

High-frequency trading (HFT) is once again making headlines. State securities regulators Tuesday urged Congress to investigate the practice, saying in a report it can put retail investors at a disadvantage, since they don’t have access to the same information and buy and sell at less favorable prices.

HFT refers to the trading that happens at the millisecond and cannot be conducted manually by a human, requiring electronic algorithmic trading.

Earlier this week in a CNBC interview, the Oracle of Omaha weighed in on the issue when asked if HFT hurts the main street investor. According to Barron’s, he said it doesn’t make a difference if you own stocks long-term, and that while real-time quotes are good, people have made them a bad thing by being swayed by what the market tells them at any moment.

Eric Hunsader, founder of Nanex which monitors whole market data and watches HFT shenanigans go down in real time, tells The Daily Ticker Buffett is dead wrong.

Hunsader compares HFT to pick-pocketing. You may not be worried about it when you’re walking around the streets of New York, until you’re a victim.

For example, if you had to sell or you panicked the day market-maker Knight Capital (KCG) had a glitch caused by its HFT software, when 150 stocks that trade on the New York Stock Exchange (NYX) experienced extreme price swings and unusually high volume due to the firm's computerized trades, you had your pocket-picked 10% according to Hunsader.

And Facebook (FB), a "story stock" that captured the minds and money of retail investors, had a botched IPO traced in part to a technical trading snafu linked by Nanex, in part, to HFT.

Related: Is Facebook Losing Its cool?

And while you could argue if you buy and hold a stock, it won’t matter to retail investors if they get cheated out of a penny, it matters to everyone in the markets when it causes a crisis like the flash crash.

Many stood by in shock on May 6, 2010 when the Dow Jones Industrial Average (DJIA) plunged 9% in minutes.

Related: ‘Flash Crash’ Was a Warm-Up: Computerized Trading Threatens Global Financial System

Make no mistake, there are those who advocate the market’s transition to electronic trading at faster and faster paces as something that has helped to cut down costs for investors. That’s a good thing for your average Joe now able to trade stocks on his cell phone, or for the mutual fund he is putting faith in to invest his money. There’s also an argument that it provides liquidity.

Where it’s bad is when traders don’t follow the rules or when they get unfair advantages, which Hunsader sees happen regularly.

The SEC is now monitoring market data with it’s new program called Midas, which Hunsader says is a reassuring big step. It's not, however, without blind spots. For instance, Hunsader says Midas can’t see options and futures.

Related: SEC Message for Insider Traders: We’re Watching You, Says Jason Scharfman

In just one example of why this matters, it was a large and quick sale of futures contracts U.S. regulators named as a trigger to the Flash Crash.

Lauren Lyster is the host of The Daily Ticker and Hot Stock Minute. You can follow her on Twitter at @LaurenLyster.

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