Savant’s Perspective on High-Frequency Trading

High-Frequency Trading, a term previously unknown to the general public, burst onto the national scene in a big way this past Sunday night. CBS’s 60 Minutes aired an interview with Michael Lewis, a former bond salesman turned financial journalist whose new book, Flash Boys, details high-frequency trading and its effects on the market. This is a fairly complicated issue, so we would like to share our perspective. Hopefully the attention from the media and Mr. Lewis’s book can spur regulators to analyze the current rules governing equity trading to ensure a fair and efficient market.

What is High-Frequency Trading?

  • High-frequency trading is the use of extremely powerful computers and sophisticated trading algorithms to buy and sell securities in fractions of a second.
  • Overall, the use of technology to execute faster trading is completely legal. Regulators have ruled that there is nothing inherently wrong with the faster execution of trades.
  • From telegraphs, telephones, email, smartphones, and now supercomputers, technology has long been a part of life on Wall Street, and traders have always tried to innovate.

Not All Bad

  • We believe the majority of high-frequency traders are not harmful.
  • Compared to the old days of traders on an exchange shouting at each other, computerized trading is more efficient and has greatly reduced trading costs for all market participants.
  • Faster trading makes a more efficient market overall – information is priced into the market extremely quickly.

The Ugly Side of High-Frequency Trading

  • There are some high-frequency traders who may be unfairly taking advantage of other investors – this was the focus of Michael Lewis’s book.
  • Some traders may be able to see trades that are about to be made and then jump in front of those trades to bid the price up and sell at a profit. This is referred to as “front-running,” and even if the profit is only a penny or two, we believe this is unfair and wrong.
  • This activity does not describe the majority of high-frequency traders, but hopefully regulators will investigate fully. 

How Does This Affect Savant Clients?

  • Savant does not trade individual stocks and does not try to time the market. Investors can be harmed most by high-frequency trading when they must execute very large trades of individual stocks at a certain time or a certain price. That is simply NOT how Savant operates.
  • Savant primarily invests through very large mutual fund companies such as Vanguard or Dimensional Fund Advisors (DFA), who also do not try to time the market. They have very sophisticated trading systems that pay close attention to the prices they receive. If they believe a price is not fair, they will not execute the trade.

In the long run, we believe (and studies have repeatedly shown) that markets are efficient. This means that investors get fair returns on their money by investing in stocks and bonds over the long run – regardless of high-frequency traders. It is in the very short run that traders (whom we would classify differently than “investors”) may gain an information advantage. In some cases that advantage is fair, and in others it is unfair. Hopefully regulators will investigate this issue fully to ensure the market is as fair as possible.

Key Takeaways

  • High-frequency trading is currently completely legal, and the majority is not harmful.
  • A small percentage of traders may be able to use technology to unfairly take advantage of other traders this is unfair and wrong.
  • Savant does not trade individual stocks and does not try to time the market. Our strategy is inherently less affected by high-frequency trading.
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