Are Your Investments Losing to High-Speed Traders?

Gabrielle Karol

How High-Frequency Trading Can Hurt the Average Investor

The race for greater and greater speed has caused concern for the fate of the normal investor, as well as the integrity of the stock market as a whole.

Integrity isn’t a trait that usually comes to mind when thinking of the stock market. But critics of high-frequency trading cite the true purpose of the market when pointing out the dangers of high-speed trading. The market, they say, exists so that companies and investors can discover how much an ownership stake (or a share) in a company is worth. When that stock goes up, it tells other investors to put their money in that company and similar ones

Get All the Latest Economic News

Sign up for The Market, LearnVest’s new weekly newsletter

High-frequency trading, however, isn’t designed with this original intent in mind. Rather than trying to determine whether a share of Apple is worth more or less since the release of the iPhone 5, high-frequency trading operates through the manipulation of tiny price discrepancies. And since computers process at such a rapid pace and can execute millions of trades in seconds, the stock price of well-established corporations could fluctuate wildly–without rhyme or reason in the eyes of a human trader.

RELATED: What You Need to Know About Black Swan Funds

Critics of H.F.T. also worry that high-frequency trading forces ordinary investors to pay higher prices for stocks because:

  • The computers pick up information about orders and push prices before they can be filled.
  • Other investors can be confused by market fluctuations caused by high-frequency traders, which can issue and cancel orders almost simultaneously.
  • There are worries that the crashes initiated by high-frequency trading–including the Knight Capital incident and the flash crash of 2010, in which the Dow lost almost 1,000 points in 20 minutes before bouncing back–destabilize the market. The 2010 crash caused several companies to lose nearly $1 trillion of market value due to a crash initiated by a single high-frequency trading firm. Greater volatility of this kind could mean less stable long-term investments for investors.

The head of U.S. Equity Trading at T. Rowe Price, Andrew M. Brooks, told The New York Times, “You want to encourage innovation … but we’re moving toward a two-tiered marketplace of the high frequency arbitrage guys, and everyone else. People want to know they have a legitimate shot at getting a fair deal. Otherwise, the markets lose their integrity.”

RELATED: Quiz: What’s Your Risk Tolerance?