Are Machines Terminating Your Stocks?

In my research into high-frequency trading, or HFT, I've come across a lot of great information on what it is, what it does in the market, and how regulators are trying to cope with its growth. But beyond momentary abnormalities, there wasn't much information on which stocks were most affected by HFT -- until I found a report that laid out all the stocks that the machines most love to trade. The results are surprising, and they might give you pause as you look for blue-chip companies to invest in. Are your favorite stocks in the hands of the machines?

Queens in the HFT hive
The research, by electronic-trading pioneer and broker Instinet, attempted to pin down both companies and industries that have fallen under HFT's sway. It doesn't quite break out exactly how much HFT contributed to each stock's trading volume, but it offers a good view of what might be happening. In examining industries in the S&P 500, the study found that the banking sector, more than any other, is dominated by HFT. Technology stocks are close behind, with insurance and retail lagging fairly far behind the leading two.

That doesn't mean there aren't companies in other sectors that get a lot of HFT action. The study breaks out the top 15 HFT-heavy stocks traded on the NYSE, the Nasdaq, and the BATS exchanges. Most made only one or two lists, but these stocks showed up on all three:

Company

Avg. Daily Volume

Beta

5-Year Total Return

Bank of America (NYSE: BAC  ) 304.5 million 2.76 (84%)
General Electric (NYSE: GE  ) 81.6 million 1.88 (40%)
Ford (NYSE: F  ) 77.1 million 2.64 46%
Sprint Nextel (NYSE: S  ) 80.7 million 0.96 (86%)
Alcoa (NYSE: AA  ) 34.3 million 2.27 (56%)
Citigroup (NYSE: C  ) 58.2 million 2.89 (92%)
Wells Fargo (NYSE: WFC  ) 46.9 million 1.78 (16%)

Sources: Yahoo! Finance and Google Finance.

Reading the e-leaves
All of these stocks have huge floats, all but Sprint have extremely high betas, and all but Ford have fallen on hard times over the last five years. Blame the 2007 market crash, bad business models, tough economic times, or whatever else you'd like. I've written on beta before, and I've found that lower-beta stocks are better able to persevere through difficult markets. Ford's price appreciation makes it an exception here, but it has gained market share since the crash and has been consistently profitable while doing so.

What does this all mean? Well, for one thing, it hardly engenders any more trust in bank stocks. The industry has more than its fair share of problems. Despite wild daily bobbing, the rebound is still a long way off. Try watching Bank of America's stock one day -- it's like a roller-coaster with none of the excitement and double the nausea. While you've been waiting for your favorite banks to rise again, HFT has probably been picking at their corpses. GE should be partly counted among the banking stocks because of the problems its financial arm ran into during the recession.

For another thing, HFT systems sure seem to like kicking 'em when they're down. Although it wouldn't be fair to blame HFT on these companies' declines, it may be possible that the depth of their drops has been exaggerated by frequent computer trading. If you've been eyeing a company that's well off its pre-crash highs, it never hurts to look for extreme volume paired with a dizzyingly high beta, indicators of a HFT feeding frenzy. If your assessment of the company's fundamentals doesn't bring up any truly compelling reason why it might start growing again, you might just want to let the machines have it.

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Fool contributor Alex Planes holds no financial stake in any company mentioned here. Add him on Google+ for more insights and random ruminations.

The Motley Fool owns shares of Ford, Citigroup, Bank of America, and Wells Fargo. Motley Fool newsletter services have recommended buying shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On November 01, 2011, at 11:18 AM, DJDynamicNC wrote:

    Good article, thanks for posting this. People need to be aware of the danger that HFT poses to the market - and consequently to our portfolios.

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