No, small investors, Wall Street robots are not front-running your trades or picking your pocket.
In fact, it’s becoming increasingly clear that high frequency electronic trading firms are a boon to individual stock investors, who get better prices because the automated middlemen are fiercely jockeying to handle their orders.
Almost a year after Michael Lewis’s book “Flash Boys” stoked public outrage by playing up the predatory reputation of HFT players, Barron’s this weekend crunched the raw trading data produced by brokerage firms and market makers to determine that the little guy makes out nicely in this high-speed game.
As the financial weekly points out: “The competition for retail traders’ orders actually yields a price that’s better than the published quote, on average, when small investors go to buy or sell at the market price.”
The Barron’s report ranked the big online brokers such as Fidelity Brokerage and Charles Schwab Corp. (SCHW), and the wholesale market makers including KCG Holdings Inc. (KCG) and Citadel Securities, by how well they do for investors in terms of "price improvement" per trade. Their conclusions are in line with a recent Bank of England study that HFT enhances market efficiency and helps the small trader.
As I discuss with Yahoo Finance’s Jen Rogers in the attached video, trading for small investors has never been faster, cheaper or more certain.
Most of the regulatory changes that have produced our complex and opaque high-tech equity-trading system have been geared toward encouraging competition for order flow and compressing the “spread” between the prices at which the public buys and sells shares. It has largely worked.
Of course, many of these same changes have led to headaches for large, institutional traders as they try to execute large orders. It has never been easy to get big trades done without affecting the stock price.
But the move toward automated platforms from exchange floors and phone-based human brokers has meant that large orders are sliced into bits and executed over time, a process that leaves fund managers feeling exposed to electronic opportunists jumping ahead to skim pennies.
While this can also be a concern for Mom and Pop, given that they are often the end investors in large funds, even at this level the frictional cost of trading has greatly diminished. The peak year for high-frequency trading industry profits was 2009, according to Rosenblatt Securities, and by 2012 they had fallen by some 80%.
There are still abuses that arise from the tangled multitude of execution rules and order types, for sure. The practice of “spoofing,” or sending out fake quotes in order to trick other investors into making a trade, has reportedly persisted despite being prohibited by the Dodd-Frank financial regulation law.
But for the small do-it-yourself trader, or the individual who uses ultra-low-cost index exchange-traded funds, the electronification of trading has been a boon.
What remains interesting is how durable is the idea among small investors that the market is rigged and they are victimized by high-tech sharpies stealing their money one millisecond and fraction of a penny at a time.
This seemingly comes from an abiding mistrust of Wall Street, generalized techno-phobia and a misplaced sense among little investors that their orders are even worth front-running in the first place.
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