By Arnaud Houdmont, Chief Communications Officer
European Union lawmakers plan to significantly restrict high-frequency trading with new rules that would rein in high-frequency trading (HFT) and tighten up rules related to the use of so-called dark pools.
High-frequency traders use software that allows trading at lightning speed. Whereas large firms have access to such technology, critics claim that smaller private investors find themselves at a disadvantage and that HFT can be destabilising.
The envisioned limits to HFT are part of a larger EU legislative effort dealing with issues ranging from commodity derivatives speculation to investor protection. “With these rules the EU is putting in place one of the strictest set of regulations for high-frequency trading in the world”, said EU Commissioner for Internal Market and Services Michel Barnier. “While HFT trading might bring some benefits, we need to make sure that it doesn’t cause instability, and isn’t a source of market abuse”.
In the United States the American Association of Individual Investors (AAII) recently published recommendations for retail investors to beat high frequency traders. Whereas these might not be exactly applicable to the European context, they provide an interesting insight for investors across the world.
Charles Rotblut, AAII Journal Editor and author of the article, believes “it’s hard to discuss this subject without igniting emotions. It’s even more difficult to separate the facts from the hyperbole. What’s lost in the conversation is a focus on the market’s complexity. The digital structure underlying the market has become so complex, there isn’t a clear answer as what actual impact high-frequency traders are having on all other investors. […] What we do know is that complexity not only can lead to problems such as the flash crash, but it can create anomalies and opportunities for malfeasance (legal, ethical or perceived).
As an individual investor you can fret about this or you can exploit your advantages. Those advantages are:
- Opting not to play their game. Day trading was a loser’s game for the majority of those who tried it before the advent of high-frequency trading. Now the odds are even more stacked against individual investors who attempt to day trade. The arms race favours ultra-high-speed connections and servers as close to the exchanges as possible. The only way you can beat high-frequency traders is to circumvent them.
- Limiting the number of transactions. The less you trade, the less chance high-frequency traders have to jump in front of your orders.
- Buying funds with less portfolio turnover. The average large-cap mutual fund covered by our mutual fund guide had a portfolio turnover ratio of 64% last year. In comparison, the Vanguard 500 Index fund (VFINX) had a turnover ratio of 3%. Even if high-frequency trading does drive up costs, buying funds with low turnover ratios will limit the impact on your wealth.
- Investing where the professionals aren’t looking. Many pension funds, mutual funds and other institutional investors have restrictions on what they can and cannot invest in. It only makes sense for high-frequency traders to focus on the stocks most likely to be bought and sold by institutional investors. You, as an individual investor, are not encumbered by the restrictions placed on institutional investors. So do what we do at AAII, which is to go into the shadows of the market and seek out small, profitable companies with attractive valuations.
Please read here the full article.