Stop High Frequency Trading: It’s Time For Ordinary Investors To Reclaim The Market

| August 22, 2011 | 0 Comments

The past five years have seen a monumental surge in market volatility. Daily swings of 5% or more in stocks have become the new normal on Wall Street.  And it’s scaring many ordinary investors right out of the market… for good.

We got our first real taste of the new normal in late 2008 when the financial crisis swept the globe.  The markets dropped more than 50% in value from May 2008 through March 2009.  And daily swings of 5%, 8%, and 10% were all too common.

These harrowing market swings sent many investors running for the perceived safety of the bond market.

In fact, the damage done to investor psyches was severe and long-lasting.  Many investors were so shell-shocked from the daily ups and downs, they refused to buy stocks even after the market bottomed in March 2009.

According to Strategic Insight, a mutual fund consulting firm, stock mutual funds took in around $85 billion in 2009 as the markets began moving higher.  That may sound like a lot of money, but it’s a far cry from the $425 billion investors piled into bond funds over that same time.

The result… many ordinary investors missed out on a rare opportunity to make back the losses they incurred on the market’s way down.

What’s behind the surge in stock market volatility?

G. Andrew Karolyi, a finance professor at Cornell University Johnson Graduate School of Management has a theory.  He believes the market rollercoaster rides are the result of what he calls “liquidity black holes”.

Sounds ominous… and it is!

A liquidity black hole occurs when selling pressure in large-cap stocks becomes so intense it sucks the air out of the market, causing stock prices to plunge.  If you were watching the market on August 8th, you had a front row seat to the last one.

You may remember that was the first day of trading after Standard & Poor’s eliminated the US government’s AAA credit rating.  The market plunged nearly 7%.  But the really scary part was every single stock in the S&P 500 posted a loss that day.

What’s more, the CBOE Volatility Index (VIX) recorded the biggest one-day surge in four years.  The fear-gauge, as it’s widely known, soared by more than 50%!

Now, don’t get me wrong, volatility isn’t always a bad thing.  Without it, the market wouldn’t be able to move higher.  And investors wouldn’t be able to build wealth over the long run.

But the kind of crazy volatility we’re seeing in recent years goes well beyond what’s reasonable.  And the worst part is this gut-busting volatility is destroying many investors’ will to invest in stocks at all.

This is a dangerous problem for all of us.

If ordinary investors are too scared to invest in stocks, how are they going to build enough wealth for retirement?  Bond funds just don’t provide enough growth to build the kind of wealth needed to fund 20 to 30 years in retirement.

So, what can we do about it?

The time has come to let your elected representatives know you’re fed up with steroid-induced volatility.  You can easily contact them by email here.

Tell them they must do something about High-Frequency Trading (HFT) before it’s too late.

HFT involves using super-fast computer programs to make thousands of trades per day.  The idea is to consistently capture small gains (fractions of a penny) on positions often held for just a few seconds at a time.

The problem is HFT is dominating market action.

According to a survey conducted by Aite Group, HFT accounts for 73% of all daily stock trading volume in the US.  However, HFT firms make up just 2% of the more than 20,000 trading firms.

In other words, a very small group of traders is exerting tremendous pressure on the market.  Especially, on down days.

We saw this most vividly on May 6, 2010.  You may remember this was the day of the infamous “Flash Crash”.  The Dow plunged about 900 points – or about 9% – and then recovered the losses within minutes.

The bottom line…

Ordinary investors need a stock market that moves up and down on fundamentals.  It’s the only way we can make reasonable decisions for managing our money.

HFT, on the other hand, has nothing to do with long-term fundamentals.

These programs are trading huge blocks of shares over and over based on short-term market action.  And in the process, they’re transforming the market from a wealth-building mechanism for ordinary investors into their own personal casino.

It’s time to take the market back!

Let your Congressman know you’re fed up with a small number of traders dominating market action.  And more importantly, remind them the market should be a place for ordinary people to invest their money and build long-term wealth.

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Category: Stocks

About the Author ()

Robert Morris is the editor of Penny Stock All-Stars, an investment advisory focused on discovering small-cap and micro-cap stocks that are destined to become the market’s next Blue Chips. The Wall Street veteran and small-cap stock specialist is also a regular contributor to Penny Stock Research. Every week, Robert shares his thoughts with our readers on a variety of penny stock-related topics. In addition to Penny Stock Research, Robert also writes frequently for two other free financial e-letters, ETF Trading Research and the Dynamic Wealth Report. He’s also the editor of two highly successful and popular investment advisories, Biotech SuperTrader and China Stock Insider.

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