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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Why The Stock Market Is Not In A Bubble

The big news in the financial sector these days is, of course, the stock market.  With year to date returns already over 15% (and counting), many out there are jumping in and proclaiming that the stock market is in a bubble and proclaiming that the bubble will burst.

I’m not buying it.

Or selling it, I guess would be the right term 🙂

Many of those who think we’re in a bubble use some combination of the following arguments to state their case:

  • The big run in the stock market has taken all opportunity away
  • Unemployment is not falling fast enough
  • Corporate profits are leveling off
  • Europe and Japan are in a recession
  • Our mounting national debt

Here’s my take on each of these

  • Opportunity is not fully priced in –  When the economy and the market tanked in 2008-09, many people left the market altogether.  While many have returned, there’s still a lot of money sitting on the sidelines.  Some of those jaded investors may never return to the market, but I still think there are many investors who would consider re-entering the market.  There is upside
  • Unemployment is fine – One of the things that’s separated this recession from many others is that unemployment did not fall at the end of the recession.  Many argue that’s a bad thing, but I argue that it’s a good thing.  Companies aren’t just hiring en masse, but only hiring when they need positions.  I’d feel comfortable saying that the jobs being created today are more likely to stay in the event of a slowdown.  I think the job market is building a much more solid foundation, so while there are less jobs, I think they’re a sign of long term stability.
  • Profits are only one piece of the puzzle – Many companies are making record profits, but the rate of profitability is slowing.  First, this is to be expected as many companies are returning to profitability after suffering losses, so the first jumps are always the strongest.  Second, and more important, is even if profit growth does slow, many companies are continuing to strengthen their balance sheet.  They’re adding more cash reserves.  They are paying off debt.  They’re investing in new technology.  These are all things that will provide profitability way down the line, something that investors will pay a premium for.
  • Europe and Japan are less important – The crisis in Europe probably isn’t done and we’ll here more bad news along the way, but it seems to me, that compared to 18-24 months ago, Europe has leveled off.  If investors believe that the worst is behind, they will not discount stocks whose companies are exposed to Europe.  If the economies of those countries start actually showing signs of recovery, investors will be rewarded further.  As far as Japan, they’ve been in such a rut that I’m not sure they factor in much either way.
  • The Fed has the debt covered for now – Eventually the debt will catch up to us, but for the time being, I think the debt is a non-factor.  The Fed is keeping interest rates down, and there are signs that the national deficits will actually start falling, meaning that we’ll be adding less to the debt than we have in years past.  I fully expect this to be something that hits us hard down the line, but for now, I believe the risk is minimal.

These are simply my thoughts (I’m no investment professional) and I’m hoping that this leads to continued upward momentum in the stock market as I’d like to see some additional gains in my 401(k) and personal portfolio.

How about you, what do you think about the stock market and its chances for continued success in the short and long term?

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Will The Stock Market Impact The Election?

The stock market hasn’t done very well at all, and is down roughly 5% from it’s highs just in the last month with another day in the red shaping up for today (the S&P is trading around 1400, having fallen from roughly 1470 earlier this month).

I think another 4-5% before the election could be devastating to President Obama, and given how quickly we’ve shed the amount we have, a drop of that amount (or close to it) could definitely happen, especially with the way that the market has been trending down.  It only takes a few tenths of a percentage points a day to add up to a pretty big drop.

Such a large drop would be roughly a double digit drop and would signify a pretty big warning sign about the economy.  Since the stock market is forward looking (meaning the movement is largely centered upon what investors believe is going to happen down the line), this would be a very bad sign.

Plus, people don’t like to lose money and if they’ve just witnessed 10% of their 401(k) and investment savings go down the drain, this could make people pretty cranky.  Generally, when people are cranky and go out to vote, they tend to take out some of their crankiness on the incumbents.

I’ll be curious to see what the stock market does between now and the election.  So far it hasn’t shown any encouraging signs, and if the bears continue to chip away, I believe it could have an impact on the election.  If the president has any aces up his sleeve regarding the economy, he would be wise to play them.

What are your thoughts?  Could a bad October translate to a bad November day at the polls for the president?

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