Does the profit made from high frequency trading (HFT) reduce profit from long-term investments?
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No, except the the extent that it can cause problems with the transparency of the exchange... but these are inherently not long term problems.– MatthewCommented Sep 24, 2014 at 23:24
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For anyone who is wondering, HFT stands for High-frequency trading.– Ben MillerCommented Nov 28, 2014 at 17:42
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3 Answers
No, at least not noticeably so. The majority of what HFT does is to take advantage of the fact that there is a spread between buy and sell orders on the exchange, and to instantly fill both orders, gaining relatively risk-free profit from some inherent inefficiencies in how the market prices stocks. The end result is that intraday trading of the non-HFT nature, as well as speculative short-term trading will be less profitable, since HFT will cause the buy/sell spread to be closer than it would otherwise be. Buying and holding will be (largely) unaffected since the spread that HFT takes advantage of is miniscule compared to the gains a stock will experience over time.
For example, when you go to buy shares intending to hold them for a long time, the HFT might cost you say, 1 to 2 cents per share. When you go to sell the share, HFT might cost you the same again. But, if you held it for a long time, the share might have doubled or tripled in value over the time you held it, so the overall effect of that 2-4 cents per share lost from HFT is negligible. However, since the HFT is doing this millions of times per day, that 1 cent (or more commonly a fraction of a cent) adds up to HFTs making millions. Individually it doesn't affect anyone that much, but collectively it represents a huge loss of value, and whether this is acceptable or not is still a subject of much debate!
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1Is it not the case that, by closing up the buy/sell spread, it actually reduces the costs, not increases them, for people holding long-term? With smaller buy/sell spreads, the buy will be priced lower and the sell will be priced higher? Commented Sep 25, 2014 at 14:28
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1@ChrisInEdmonton: Can be argued either way. In theory, any market-making activity helps to close the spread; that is, any participant who enters limit orders to buy and/or sell. But to the extent that an HFT "knows" that new best-price orders will be entering the market and is positioned to pick them off in a very short time interval, then that could widen spreads. As serakfalcon points out, however, for the long term investor this impact is negligible.– user14446Commented Sep 25, 2014 at 18:40
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@JohnPirie, thank you very much for your explanation. Commented Sep 25, 2014 at 18:56
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The last paragraph was especially informative. My idea of HFT was that it predicted the future price of stocks like a normal trader but just acted within a much shorter timeframe, in which case I assume that if there was sufficient HFT activity, it could take a significant amount of money from long-term traders profits which would discourage long-term investments.– raindropCommented Sep 25, 2014 at 22:41
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3If you use only limit orders (as everyone should do), then another trader cannot possibly "cost you" any money, because you're not crossing the spread. If you do (unwisely) fire a market order, then without HFT the spreads in US equities would still be on the order of $0.10 - $0.25, and your counterparty would be "costing you" $0.09 - $0.24. So, step 1: Don't fire market orders. Step 2: If you fire a market order, be happy that you're paying $0.01 to an HFT instead of 9-24 times that much to an institutional investor. (Step 3: Profit.)– dg99Commented Sep 26, 2014 at 14:59
Not really. High frequency traders affect mainly short term investors. If everyone invested long-term and traded infrequently, there would be no high frequency trading.
For a long term investor, you by at X, hold for several years, and sell at Y. At worst, high frequency trading may affect "X" and "Y" by a few pennies (and the changes may cancel out). For a long term trader that doesn't amount to a "hill of beans" It is other frequent traders that will feel the loss of those "pennies."
I disagree strongly with the other two answers posted thus far. HFT are not just liquidity providers (in fact that claim is completely bogus, considering liquidity evaporates whenever the market is falling). HFT are not just scalping for pennies, they are also trading based on trends and news releases. So you end up having imperfect algorithms, not humans, deciding the price of almost every security being traded. These algorithms data mine for news releases or they look for and make correlations, even when none exist.
The result is that every asset traded using HFT is mispriced. This happens in a variety of ways. Algos will react to the same news event if it has multiple sources (Ive seen stocks soar when week old news was re-released), algos will react to fake news posted on Twitter, and algos will correlate S&P to other indexes such as VIX or currencies. About 2 years ago the S&P was strongly correlated with EURJPY. In other words, the American stock market was completely dependent on the exchange rate of two currencies on completely different continents. In other words, no one knows the true value of stocks anymore because the free market hasnt existed in over 5 years.
