The topic of high-frequency trading has been a focus for many financial commentators in the U.S. and internationally. High-frequency trading is the rapid trading of stocks through the use of computer algorithms. Michael Lewis, an author known for his books such as "Moneyball" and "Liar’s Poker," alleges in his latest book, "Flash Boys," that the U.S. equity markets are rigged due to high-frequency trading.
Like most complicated topics, especially those dealing with capital markets, high-speed technology and the opportunity to make significant returns, high-frequency trading has both proponents and detractors. Some argue high-frequency trading generally benefits stock market participants, as markets are more efficient due to the increased volume of trading coming from the wide range of high-frequency traders. Others argue the high-frequency trading firms are front running legitimate orders placed on certain stock exchanges by other market participants.
Both of these statements are likely true to some degree.
Large asset managers can employ a variety of tactics to minimize and track the potential effects of high-frequency trading on their stock trading. A number of off-market, private exchanges have been developed where institutions can attempt to match up offsetting buy and sell orders so as not to incur the expected costs of executing these trades on the open market. Called “dark pools,” these off-market transactions had been executed outside of the influence of high-frequency traders, but this situation has changed. Certain high-frequency traders now transact in selected dark pools.
Institutional asset managers measure and track the effects of their order execution on the publicly reported prices of shares. One such measure tracked is the volume-weighted average price, or VWAP. VWAP, generally assessed over a day’s trading, looks at the average price of a stock being traded. Using such measures, asset managers and their trading desks can determine how effective and costly the order execution activities are in supporting the overall portfolio management capability.
Concerns about the fairness of high-frequency trading are not new to the stock markets. With ever faster computers and faster fiber optic lines, high-frequency trading will continue to be a point of contention among market participants.
Competition among high-frequency trading firms will inevitably weed out the less efficient participants and squeeze profitability levels. For the average retail stock investor, lower transactions costs resulting from more efficient markets may outweigh the possible costs of having high-frequency traders involved in the equity markets.
Kirby Brown is the CEO of Beneficial Financial Group, which is based in Salt Lake City.