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How High Frequency Trading Affects Individual Investors

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Understanding High Frequency Trading

High Frequency TradingWall Street insiders have been profiting from high frequency trading for years, which has garnered a lot of criticism from stock market observers regarding how high frequency trading impacts individual investors. Unfortunately, for individual investors, access to high frequency trading is for the most part out of their reach and avenues to profit from high frequency trading are limited to investors that can afford to invest money in hedge funds that engage in high frequency trading. Since most individual investors cannot join the high frequency trading party, it is important that they understand how high frequency trading affects them.

An important thing to understand about high frequency trading is that it is not the same thing as what has been traditionally come to be known as “day trading”. Unlike day trading, which requires human input to enter and exit trades, high frequency trading is done by computer software that is programmed to trade into and out of stocks in milliseconds.

The Negative Consequences of High Frequency Trading

Individual investors can be negatively affected by high frequency trading in a number of ways. Individual investors might not even realize how high frequency trading affects them since it is done by computers in milliseconds; however, the consequences of high frequency trading are quite real.

First off, when an individual investor enters an order to buy or sell stock, a high frequency trading computer program with access to nearly real time stock market data, may “front run” the individual investor’s stock order and cause it to execute at a price that is less favorable to the individual investor. Front running is a practice in which those with greater access to data in the stock market take advantage of stock orders by jumping ahead of the orders and scalping a small profit, leaving the person who placed the order with a less profitable execution price.

Secondly, while high frequency trading can be highly profitable for those who have successfully programmed computers to engage in the hyper-trading practice, it has increased stock market volatility and has played a big role in stock market flash crashes and other mayhem. This has reduced individual investor confidence in the soundness of the stock market and is one of the reasons why individual investors have shied away from the stock market in recent years.

Stock market regulators are just starting to grasp the negative implications of high frequency trading. While regulation of high frequency trading has been slow to evolve, due to industry arguments that high frequency trading benefits the stock market by providing additional liquidity, it is likely that high frequency trading will come under increasing scrutiny and regulation in coming years. Individual investors should make sure they are aware of pending regulatory changes involving high frequency trading, since they are impacted by this fast paced but nearly invisible form of stock trading.

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