Wednesday, September 14, 2011

High Frequency Trading

I was reading the other day where high frequency trading (HFT) accounts for 60% of the volume on the New York Stock Exchange on any given day.

This is an astonishing number.

What this really means, among other things, that the wide swings in volatility that the market has experienced over the last few months have probably been exacerbated by computer-driven trading.

The Europeans are trying to crack down on HFT, according to Bloomberg:

The European Union is considering listing “specific examples of strategies using algorithmic trading and high-frequency trading” that should be banned and punished by regulators as market manipulation.

The measures to increase investor protection and reduce volatility are part of plans to clamp down on market abuse in the region, according to a draft of the proposals obtained by Bloomberg News.

HFT also has driven correlations of stock price movements to extremely high levels. As a recent newsletter from the firm ConvergEx wrote earlier this week (tip of the hat to loyal reader Bob Quinn):

Disparate markets – stocks, bonds, currencies, and the like – have a lot in common lately. Whether they want to or not. Average correlations between the 10 major sectors of the S&P 500 have reached 97.2%, from 82.1% just three months ago. That’s the highest level of such common price action since the Financial Crisis....

The difference between investing in Emerging Markets equities, Developed Markets equities, and High Yield bonds is now effectively zero. We think these high correlations will plague markets through the end of the year, since they are fundamentally caused by worries over European financial market solvency. Those aren’t going away any times soon.

What this means to me, then, is that it will be nearly impossible to try to "time" the market. When markets are rising, the lower priced, more volatile stocks will outperform. When markets are falling, the opposite will be true.

But if you truly have a longer term time horizon - which I certainly do - you can only focus on value, which in my opinion is mostly found in dividend-paying, large cap stocks.