Why to Shun Speedy Trading

As if you needed more proof that frequent trading is not for regular folks, the high-frequency trading bots recently sent stocks into a free fall for a moment after a fake tweet hit the newswires. This miniature flash crash underscores how institutional investors’ trading algorithms stack the deck against individual investors.

A group of hackers temporarily took control of the Associated Press’ Twitter account on April 24 and posted, "Breaking: Two Explosions in the White House and Barack Obama is injured," on the newswire’s feed.

This fake tweet caused a selling frenzy before anyone could figure out what was going on. The stock market dumped $134 billion in stocks in a matter of seconds and the Dow Jones Industrial Average dropped 1% of its value, or 143 points. \Users\Mark Lyons\Desktop\Capture.PNG

As the chart shows, the market recovered just as quickly after the AP announced that the tweet was a fake. But the hoax served as a frightening fire drill and exposed the dangers of high-speed trading.  If the White House explosions really happened, the algorithms that make decisions for high-speed traders would continue selling, leaving the average investor behind as stock values tumbled.

It shows how much the game is tilted against individual investors. The cacophonous floor trading that you see on television is passé. These days, high frequency trading algorithms initiate 70% of stock trades on U.S. exchanges. There is no way you can beat them.

Do you think you can come up with a good trade, log into your online brokerage and click sell? By the time the software debits your checking account and executes the trade, you missed the opportunity. During the Twitter Flitter, my own order entry screen was moving so quickly it was impossible for any human to react and make intelligent stock choices.

That’s why CNBC pundit Rick Santelli said high-frequency trading has turned the markets into “high-speed casinos.”

“I have an issue with high-frequency, high-speed anything that requires nano, nano, nanoseconds to provide the wonderful liquidity we all must have,” Santelli said.  “Is it any surprise that, you know, the average guy on Main Street looks at this and goes, ‘None of this is for me. You people are all crazy.’ ”

As consultant David Lauer of nonprofit advocacy group Better Markets said in his testimony before the Senate Banking Committee, “The sophistication of your trading strategy is no longer a defining characteristic of its success, rather the number of microseconds that it takes your software to react to a piece of market data has become one of the most important factors of success in the HFT industry.”

When trading success depends on the speed of your computer, rather than a trading strategy built on insights into market fundamentals, the average investor is in trouble.

For reasons besides the prevalence of trading algorithms, making frequent trades yourself has other drawbacks. The more you trade, the more you enrich your broker through transaction fees and surcharges. On top of that, short-term capital gains are taxed at an even higher rate than gains on securities held for over a year.

A trusted financial advisor can help design and manage a portfolio that mitigates risk. Active management of your portfolio lets you improve your diversification to smooth market volatility, take quick advantage of opportunities and improve performance. Trying to beat a machine does none of this.

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Brenda P. Wenning is president of Wenning Investments LLC in Newton, Mass.  
 
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