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High Frequency Trading & Your 401(k)
A slow moving Category 3 hurricane comes ashore and ravages your community. The power will be out for days. You find a way to scramble over to a Home Depot to buy a generator for your family. You wait patiently with other storm victims who are lined up in front of the last pallet of generators available. They are $500 apiece, but you need one, so you wait.
There is only one generator left as you step forward to take your turn, but before you can hand the clerk your money, some rude dude (who doesn’t even live in the affected area) breaks in line ahead of you and pays the clerk $501 for that last generator. He then turns to you, smiles, and says he’ll gladly sell that generator to you for $521. You need it, so you grudgingly pull another 21 bucks out of your wallet and pay him.
So rude dude has just made a quick $20 profit on something he didn’t need - something he had no intention of using! - and caused you to pay more for something you and your family did need. You have just become a victim of “front running,” a tactic high frequency traders use in the stock market thousands of times a day.
Since Monday’s release of Michael Lewis’ new book, “Flash Boys: A Wall Street Revolt” (click to our Amazon affiliate link), high frequency trading (HFT) has been the topic of conversation in the investment community. While much of the debate this week has centered on HFT’s affects on active traders/investors, less has been said of its affects on us long term investors (we’ve got a couple of articles in our “News” and Views” columns over to the right). Should we be worried?
If we were to go out and buy 100 shares of IBM with the intentions of holding those shares for 20 years, the fact that an HFT front runner caused us to pay a penny or two more per share is really no big deal. It won’t have an impact on our bottom line. But what if a mutual fund that we own decides to go out and buy 50,000 shares of IBM? Front running on large purchases like that (which are really the types of orders these guys focus on) increases costs for that fund, thereby affecting its bottom line…and ours! Multiply that out by the huge number of buys and sells (yes, they do it on the “sell side,” too!) that funds make in a given period of time and you can see how this practice can have an impact.
Out of all the stuff we heard this week, there was one other point that made sense to us: it came from Mark Cuban - yeah, the crazy Dallas Mavericks owner, that Mark Cuban. He’s actually pretty sharp when it comes to the stock market. His point was this: the highly sophisticated HFT trading software that performs these trades at such astounding speeds is, when you get right down to it, just software. And software, as all of us computer users know, can sometimes get glitches, bugs and or just flat out crash. Cuban’s concern was that as more and more of these types of software programs are developed and used, the more likely some kind of major glitch could occur that would wreak havoc on the markets in general (think “Flash Crash” back in 2010).
What can us little guys do? Not much, except maybe holler at our elected officials and get them to light a fire under the SEC. They are supposed to be our watchdogs and enforcers! It’s pretty frustrating, but there is little else we can do.
However, as far as rude dude is concerned, if we could just catch him in the parking lot…
NEWS YOU CAN USE
"High Frequency Trading:
How Does it Work?"
from CNBC (video)
"Speed Trading in a Rigged Market"
"Obama's Budget Plans Bad for 401(k) Savers"
"One-third of Americans Have Only $1000
Saved for Retirement"
"How target Date Funds Work - and Don't Work"
from Bankrate, Inc.
VIEWS YOU CAN USE
"New Report Looks at High Frequency Trading"
"Should You Worry About
High Frequency Trading?"
from The Daily Intelligencer
"Are You Paying Too Much for Mutual Funds?"
from US News & World Report
"How to be an Index Investor"
"You Get What You Pay For"