Investors have plenty to worry about these days: slow economic growth, lackluster corporate earnings and negative interest rates, to name just a few.

But some claim that a practice that actually benefits investors – high-frequency trading – is another grave threat. Michael Lewis promoted this notion in his best-seller Flash Boys.

[ad#Google Adsense 336×280-IA]In response, the SEC just approved a new alternative Investors Exchange (or the IEX), where trades are purposefully slowed down.

They needn’t have bothered.

Lewis is a fine writer, and Flash Boys – like his other books – is an entertaining read. But he is way off the mark when he claims that “the stock market is rigged.”

That is simply not the case. And – besides – with two simple actions, you can guarantee that high-frequency trading never costs you a thing.

If you’re skeptical, let’s start with the facts.

Super-fast high-frequency traders have built their own telecommunications networks to gain an advantage of a few microseconds over ordinary investors. Their trades now make up the majority of daily volume on U.S. stock exchanges.

Because their speed allows them to race ahead of large orders – and snap up shares – it does seem inherently unfair at first blush, especially since many of these traders are making millions.

But these folks are really doing nothing more than using the latest and most expensive technology to vacuum up pennies all day. This is profitable for them, yes, but they are also saving you a great deal of money.

To explain how, let me take you back 30 years to when I was a lowly stockbroker at a firm in Central Florida. At the time, the typical large cap stock had a bid/ask spread of an eighth of a point (or 12.5 cents). The typical small cap stock had a spread of a quarter of a point (or 25 cents).

What that meant is if you bought a thousand shares of a large cap, your investment was instantly worth $125 less, the difference between the bid and ask. If you bought 1,000 shares of a small cap, it was worth $250 less. (And, of course, if you bought 5,000 shares of a small cap, it was immediately worth $1,250 less.)

This is hardly small potatoes. Yet investors ate these costs day in and day out – and Wall Street’s dealers and investment banks profited hugely.

That is no longer the case. The typical bid/ask spread is one cent.

Part of this favorable change happened when trading switched from fractions of a point to pennies several years ago. But spreads have tightened further because technology and high-frequency traders have dramatically increased daily volume.

But – the Chicken Littles persist – what if there is another flash crash, like the one on May 6, 2010, when a computer glitch caused the market to suddenly plunge before recovering 36 minutes later?

This event was unsettling to investors everywhere. But, thanks in part to new trading restrictions, there has not been another flash crash in six years. But even if by some chance there were another, you needn’t be hurt by it.

Consider this analogy…

Imagine that traders were constantly bidding electronically on your house – recently appraised for $300,000 – during market hours each day. Imagine further that you could accept any of these bids if you so desired.

Sometimes traders might be optimistic and bid $305,000 for your house. Other days they might be pessimistic and bid just $196,000.

But then on one day there is a computer glitch and the highest bid for your house is just $45,000. Does that mean your house is now worth only $45,000? Of course not. You don’t have to accept such a bid and you wouldn’t.

The same is true in the stock market, where prices fluctuate more than underlying values – especially in a crash.

That means you can avoid financial damage in the future by a) never panicking and b) following The Oxford Club’s system of using protective stops without actual stop orders. (Our sell decisions are based on closing prices, not intra-day prices.) That makes it impossible for you to get knocked out of your stocks on a technical trading glitch.

Likewise, you can avoid front running by high-frequency traders by using a limit order on every buy or sell. If a stock you want to own is trading at $15.25, for instance, put in a limit order at $15.25. (Otherwise you may get a fill at $15.26 or $15.27.) If you don’t get an immediate fill because the market is moving, cancel your order and enter a new limit.

Do the same thing on the sell side.

This prevents high-frequency traders from making a dime off your transactions, even though you already benefit from the razor-thin spreads they create.

In short, there are always plenty of things for investors to worry about. High-frequency trading isn’t one of them.

Good investing,



Source: Investment U