Monday, October 12, 2009

High Frequency Trading and the small investor

High frequency trading is the process of using powerful computers to exploit the smallest inefficiencies in stock prices. The Wall Street Journal has a good primer on the topic here.

One of the problems of HFT is that the little guy can get mowed down by the massive trades put on by HFT algorithms. Matthew Goldstein of Reuters discusses one such case.

As my undergrad students should know, a stop loss order is really just a market order to sell that is waiting to be triggered. The key risks with a stop loss is that it will either get triggered by a gyration in the stock or that it will trigger far below the original order price because the stock is moving so fast. This is precisely what happened in the case discussed by Goldstein, who says...

The lightening fast selling triggered a so-called stop-loss standing order Watson had with his broker to sell Dendreon shares if the stock fell into the low $20s. But the stock fell so fast that the broker didn’t actually sell Watson’s 1,500 shares until the price had hit $15

What to take away? If you are an individual investor trading stocks on your own, you are swimming with the sharks. Nothing good will come of it. You should be indexing.

HT: Felix Salmon