How Trading Would Have Changed Forever In 2021 – Can It Still Be Resolved?
How 2021 May Have Changed Trading Forever
Last week, Bloomberg published a story about tech companies, like Amazon, Apple and Microsoft, using high frequency trading (HFT) to influence stock prices.
Some consider the practice to be unfair to the average investor, and numerous lawsuits have been filed against various HFTs and banks. At the center of the controversy, though, is High Frequency Trading (HFT) in America.
Bloomberg has shown that HFT companies consistently charge the highest fees to execute trades. And these fees typically cost about 2.5% or more of the transaction, which is an extremely high charge for the average trader.
And when regulators take notice, the trouble is on. All the proposed new laws and rulings on HFT have been in effect for the past six months, and they do not include caps for HFT fees.
In theory, the Federal Open Market Committee (FOMC) has already implemented regulations in a way that would limit HFT abuse. But as the Bloomberg report shows, the regulations, like most of the regulations, have not been well-publicized.
The secret meetings and rules are only mentioned in blog posts and on individual financial websites. This leaves the average trader with the burden of figuring out the new rules.
This level of secrecy could have large ramifications for the average trader, but these ramifications are largely out of control.
Who will get caught next?
Before we dive into that question, I want to show you an incredibly simple illustration of HFT.
Imagine a market that sells every day at 2:30pm. When a buyer wants to sell, he searches for a seller who agrees to take $50 for each share he’s selling.
As the market gets hotter, he finds one seller who accepts the trade. Now, the seller puts out an ad to his friends or family asking for a trade. These orders don’t have to be executed that day, but the seller needs to get a “pull” to complete the trade.
A “pull” means that the seller will pay the buyer for the order if and only if the buyer gets executed the next day. The other part of the puzzle is the “spread.”
This is the extra fee that HFT companies charge for the fees of a “pull.” The buyer pays $25 and the seller pays $25 for each $50 trade.
These trades must be executed by 4pm. The problem is that the market moves too fast for a one-hour window to hold all orders.
In today’s market, HFTs have developed a strategy to game the system. The HFT companies track the marketplace for days and weeks before the day of the trade.
These companies know exactly who is willing to sell at what price. If they know that the best prices have already been paid, they adjust their spreads to buy at the better prices.
These programs drive up the total cost to complete trades, forcing the traders to pass on the fee to the buyer and making it impossible for the end-user to know the true cost of the trade.
This approach may have begun as a way to catch the abusive practices of those who had gotten greedy. But in its current state, HFT is a way to exploit the naïve players of the market. And there are no signs of HFTs slowing down.
So, can regulators stop HFT abuse?
As Bloomberg’s Chris DiCenzo reports, “regulators appear unable to agree on how to crack down on the problem.” Even if they were to crack down, how would they know what to do? The Fed has met with traders and industry representatives, but their suggestions have all fallen short of reform.
At the same time, stock markets in New York, London, Frankfurt and the Chicago Mercantile Exchange have passed laws limiting HFT. It remains to be seen whether these new laws have any effect on the big banks that make up HFTs.
But the question still remains: Can the average investor play with the big boys?
Do you still use brokers for your trades?
If you are a customer of a brokerage firm, you could look into using what are called “DRIP” programs.
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