Wednesday, July 29, 2009

Small Investors Beware

High frequency (or algorithmic) trading was one of the major investment innovations to emerge in the late 20th century. Given the effectiveness and profit potential of such methods, it comes as no surprise to learn that 46 percent of daily volume originates through high frequency strategies.
Powerful computers, some housed right next to the machines that drive marketplaces like the New York Stock Exchange, enable high frequency traders to transmit millions of orders at lightning speed and, their detractors contend, reap billions at everyone else’s expense… High-frequency specialists clearly have an edge over typical traders, let alone ordinary investors… Powerful algorithms — “algos,” in industry parlance — execute millions of orders a second and scan dozens of public and private marketplaces simultaneously. They can spot trends before other investors can blink, changing orders and strategies within milliseconds… These systems are so fast they can outsmart or outrun other investors, humans and computers alike. (Duhigg, “Stock Traders Find Speed Pays, in Milliseconds,” NYT, 23 Jul 2009)
Unfortunately, the methods of high frequency trading are neither available nor assessable to the average investor. My advice to most investors is to invest in public companies only with funds that you can afford to lose. My recommended investment strategy of choice for serious investors is to target companies in which you are an active owner, partner, or director in order to ensure you have full access to the fundamental information you need to monitor your investments wisely (which incidentally is the same strategy apparently used by Warren Buffet, George Soros, and Carl Icahn).

Institutional investors and other major players dominate modern day investing with sophisticated methods and technologies that the average investor cannot hope to match. Unless regulators can find a way to level the playing field, small investors should beware of the markets.

1 comment:

Josh said...

I disagree.

As a former institutional equity trader, I’m all too familiar with the algos you are referring too. I’ve used most of them currently dominating the market; from Goldman Sach’s REDI Plus system and Barclay’s RealTick to Liquidnet’s H2O and Credit Suisse’s algo suite. I agree, they are fast and can give an institutional investor the edge. But that edge is only as powerful as the trader is lucky in putting in the correct perimeters. I agree that the average Joe should not try day trading versus a quant...they will loose more often then they win. However, for long term traders, these algos fail as often as they make money. Just think, if it was that easy, all of the algos on the street would be doing the same thing and nullify their respective effectiveness.

And lastly, I wouldn’t push your readers, “to target companies in which you are an active owner, partner, or director in order to ensure you have full access to the fundamental information.” If you trading on anything other then fully public information, you can plan on spending time in jail with Madoff.

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