Two Seconds And Why High Frequency Trading Always Wins

Two Seconds And Why High Frequency Trading Always Wins

Two seconds.  It probably took the average reader two seconds to read this.  Not much can happen in two seconds, right?

Wrong.

It turns out that two seconds can make all the difference in the world in the financial markets.  Enough to make (or lose) a fortune, as it turns out.

Economic Reports

OLYMPUS DIGITAL CAMERAOne of the big drivers of the stock market are economic reports that come out at various periodic times.  Weekly jobs reports, manufacturing data, consumer data, unemployment rates, and a whole host of other things are key drivers of the market.

Long story short, what will happen is that the market will guess at what the data will be.  Say they expect unemployment to go from 8.0% to 7.8%.  The actual number will often drive the market.  Though other factors are at play, if the number came in at 7.6%, it’s a good bet that the market will rally, whereas if it were to come in unchanged at 8.0%, the market would sell off.

Seems pretty straightforward, and at first glance it seems like you can trade with that data.  But, in many cases that assumption would be off.  It’d be off by two seconds, to be exact.

Early Access

See, some economic reports are now available for delivery in advance of the release to the general market.

Two seconds before the release, to be exact.

Yes, if the report is set to be released at 10:00 AM, you can pay to have it made available to you at 9:59 and 58 seconds.

Hardly seems like a big deal, does it?  But, as it turns out, two seconds can be a lifetime when it comes to computers and high frequency trading.

In two seconds, a computer can receive the report, open the report, scan the report, parse out any pre-determined words or phrases, determine if the report is favorable or unfavorable, put in orders, and have the orders executed.

This can and does take place all within the space of two seconds.

That means that anybody that doesn’t have that advantage (meaning every individual investor out there) is always going to be too late.  You can have an order at the go, hear ‘positive’ at 10:00 and 2 seconds, hit ‘Execute Trade’, and you’re still going to have missed out.  Not only will the computers have ‘heard’ the data already, they’ll already have acted on it.  You’ll be behind the eight ball.

Every single time.

I’ve long been critical of high frequency trading, and the impact that computers have had on the market.  Proponents of high frequency trading argue that the benefits are there for the market.  By making their trades quickly and trading even to make a penny per share, they are offering liquidity to the market, meaning that the exchanges can match up buyers and sellers very quickly.

That’s all fine, but when you consider that, on a basic level, every transaction has one winner and one loser, it becomes pretty apparent that the high frequency traders rarely lose.

Meaning someone else does.  And, guess who that someone often is?  You.  Me.  Whoever.

Expectations

I don’t think high frequency trading should drive individual investors away from the market.  There’s no reason for this practice to cause complete mistrust in the market, but it should set expectations.

Don’t expect to beat the market.  You can’t (at least not on a regular basis).  You can still grow your investments, just don’t think you can be the hotshot that beats the market.

Don’t expect to beat the computers.  Even without the two second head start, the computers can still generate trades based on real time data that will beat you.  They scan the newswires.  They process the data.  They make their trades, both buying and selling, all before you can finish reading the same headline that they’re using.  Meaning, if Ford announced that they doubled earning projections, go try to put in a trade, whether it be during market hours or during pre-market trading.  You’re going to find the price already reflects that.  The big money has already been made.

By the computers.

Readers, what are your thoughts on high frequency trading?  Is the two second advantage fair or should it be regulated away?  (Personally, I don’t think it would even make a difference)

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7 thoughts on “Two Seconds And Why High Frequency Trading Always Wins

  1. Let’s face it…this ain’t going away any time soon…the machines are rising and will continue to and there is little we can do about that. Is is fair? We certainly can kid ourselves…this country seems to be built on greed…from the gold-rush to the real-estate bubble, to the financial crisis…its greed,greed and more greed…so from our collective mindset its certainly fair…those with capital and resources to afford such technology rule…capitalism at its best, right?
    I don’t think one should be in the market to beat it…reality is, it almost always never happens…a better reason would be to grow your investment and own a piece of great American companies and I think one can do that whether the machines have a millisecond advantage or not 🙂
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