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Island Investing

Riffs, rants, and the upside of investing from way off Wall Street


“60 Minutes” on High Frequency Trading

In case you missed it Sunday night, a reasonably well-done intro to High Frequency Trading (or HFT):

And here’s more web-only video on HFT – this clip being of the COO of the New York Stock Exchange. If you play the video backwards you can hear him admit a huge conflict of interest:

Another web-extra from Sen. Ted Kaufman of Delaware on how high frequency trading grew:

And here is the principal of a high frequency trading firm attempting to demonstrate, ah-hem, how HFT actually benefits small investors. With a straight face. Thank you, Botox!

I think Steve Kroft nailed the relevant takeaway for individual investors in the intro to the first clip above:

“[These computers] are operating on highly secretive instructions programmed into them by math wizards who may or many not know anything about the values of the companies that are traded.”

Two points:

1 – If you can objectively identify the best of those companies with the widest discrepancies between share price and intrinsic value – whether or not HFT is involved – you will do well as an investor.

2 – Speed is not a durable competitive advantage. Thus, High Frequency Trading firms have no moat. And unless the machines become clairvoyant, there would seem to be a cap on the efficiencies in this business.

Because new competitors and increased public pressure will likely make the economics of running an HFT firm poor, I suspect this problem will ultimately fix itself. And then, 3.4 nanoseconds later, the S.E.C. will announce a preliminary investigation into it.

Here is one of my previous posts on HFT, and another pointing to some additional background reading. And here’s a good graphic from this NYT article.