Are Investors Being Terrorized by Stock-Trading Robots?

There's an implicit assumption in the media that high-frequency trading is scaring investors out of the stock market. In the wake of the debacle at Knight Capital (NYSE: KCG  ) , the volume on this argument has been cranked up to 11.

In Monday's  New York Times article looking at the impact of high frequency trading, Nathaniel Popper showed just how ingrained this belief has become with the drive-by one-liner: "These perils [of high-frequency trading] have been one factor scaring investors away from American stocks."

No further explanation, no numbers, studies, or anything else to back it up. The implication is that it's so obvious that it doesn't need any further fleshing out. Individual investors are scared of high-frequency trading, so they're not investing in stocks. Period.

To be fair to Popper, he does add: "They have also been put off by a market that has delivered almost no returns over the last decade because of asset bubbles and instability in the global economy." But "[t]hey have also" suggests that the high-frequency trading concern and the "almost no returns over the last decade" are somehow on the same level, or same playing field, or even in the same universe.

To say that investors are anywhere near as concerned with high-frequency trading as they are with their historical returns is just plain nuts. No, past performance does not guarantee future results. And, no, basing views of current asset allocation on the trailing performance of a period that included one of the biggest stock bubbles in history does not make sense. But, alas, that's the way all too many investors set their investing views. If investors are abandoning stocks -- which isn't as clear as it seems either -- the reason is far more likely to be lackluster past returns than stock-trading algorithms.

Five better reasons
But it's not just poor past performance that's gotten investors fed up. Here are five more reasons (there are plenty more) that easily outrank high-frequency trading in terms of affecting individual investors:

  1. A generational financial-market meltdown that was driven in large part by ultra-wealthy Wall Streeters that don't appear to have been held accountable.
  2. The entire continent of Europe teetering on financial collapse as major Eurozone countries struggle with massive debt burdens.
  3. The lack of a free ride on Facebook (Nasdaq: FB  ) stock. Nope, nobody should have expected that, but they did. And they're mad that it didn't work out.
  4. A U.S. legislative body that is split by two sides that would rather flip each other the bird rather than do any collaborative work on legislation.
  5. A 24/7 news media that feels like a failure if it hasn't labeled at least three things a "crisis" in any given 12-hour period.

If somebody conducted an open-ended survey that asked investors why they're concerned about the markets, I'd be surprised if high-frequency trading breached 1%. Make it a multiple-choice survey with just three options and a view of the scary animated GIF that's been making rounds, perhaps it'd get up a slightly higher.

A problem that isn't there?
Of course, all of this assumes that there is this pervasive fear among U.S. investors that's causing them to flee stocks. But it's not entirely clear that that's the case. The Investment Company Institute showed a cumulative $30 billion flowing out of equity mutual funds through the first half of 2012. However, nearly $28 billion flowed into hybrid funds, which are a mix of stocks and bonds.

If we zoom into June, ICI shows $6.3 billion in equity mutual fund outflows, versus just $510 million going into those hybrid funds. Meanwhile though, ETF-focused website Index Universe shows a combined $6.2 billion flowing into U.S. and international-equity ETFs.

For market-watchers that focus only on traditional equity mutual funds, the picture may indeed seem like a stampede out of stocks. A broader view, though, suggests that investors may be reallocating to different products as they find options that are cheaper, more flexible, or just plain better than mutual funds.

Be afraid, be very afraid... or don't
While I'm not sold on the idea that there is a massive exodus out of stocks by individual investors, it's obvious that they're not excited about the asset class. And though I'm skeptical that the source of their angst is high-frequency trading, the fact that they're skittish at all inevitably brings up the classic (cliched?) Buffett quote: "Be fearful when others are greedy, and greedy when others are fearful."

Investors that are looking to get long-term greedy in the face of this fear will definitely want to check out The Motley Fool's latest special report: "The 3 Dow Stocks Dividend Investors Need." To score a free copy of this report, just click here.

The Motley Fool owns shares of Facebook. Motley Fool newsletter services have recommended buying shares of Facebook. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Matt Koppenheffer does not have a financial interest in any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.


Read/Post Comments (8) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 15, 2012, at 6:00 PM, JadedFoolalex wrote:

    Or change the way you think about investing! Anyone bailing out of the market now is a trader, plain and simple! You investing timeline should be the rest of your life!!! When you think like this, noise such as high frequency trading, politics, Global hiccups, etc. become meaningless! Who cares about someone using a computer to make pennies on thousands of trades? Who cares if governments don't get along? All this crap will have fallen by the wayside 20-30 years from now!

    Buy great companies at good prices. Never sell unless the company is in danger of losing it's business model. When the economy tanks, this is a major buying opportunity! Load up on those great, dividend paying companies! Hold them for years, ignore all the noise and you will become wealthy over time!!

  • Report this Comment On August 15, 2012, at 6:05 PM, dennyinusa wrote:

    My take is any money that high frequency traders take is directly stealing from the people who put money into companies as a true investment.

    Without the real money that people, 401K, pensions, etc put into the market that stays in the market over years or decades that companies can count on to make improvements and upgrades these companies could not survive.

    We are allowing a small group of people to skim off profits that should be going to real investors. Holding a stock for milliseconds does not help companies or society.

    What if everybody held stock for milliseconds, could a company make any long term investments. Every couple of seconds their value would change.

  • Report this Comment On August 15, 2012, at 6:43 PM, TMFKopp wrote:

    @dennyinusa

    "What if everybody held stock for milliseconds, could a company make any long term investments. Every couple of seconds their value would change."

    The only time this would potentially directly impact a company is when they're first selling the stock into the public markets. And in that situation, the investment bankers they hire to do the deal are putting the stock in the hands of institutional and (in some cases) individual investors.

    The length of time that investors are holding stocks doesn't impact the day-to-day balance sheet of publicly-held companies.

    Matt

  • Report this Comment On August 15, 2012, at 10:41 PM, bobbyk1 wrote:

    I could care less about the robots.If anything I get an oppuortunity to buy dips.Vol is down because people think the market is rigged.At the end of the day its about the numbers.

  • Report this Comment On August 16, 2012, at 11:21 AM, scottydeez wrote:

    Yes, it is true that the only time companies gain or lose on their balance sheets is because of ipo's or issuance or additional stock offerings. Nevertheless changes in stock value do affect management decisions for obvious reasons. I believe these supercomputer trades should simply be banned. They are gaming the system and operate in a fashion that undermines the entire process. Automatic weapons are banned in this country because they can cause great harm in a short time and have no rational value to society or an individual. (Don't get me started on semi automatics with big clips) Allowing supercomputers to trade in milliseconds making fractions of a penny on millions of transactions is just plain nuts. We have rules in society for good reason. Freedom isn't the right to dominate just because we can. Anyone want to debate campaign finance reform? Make the system equitable for We the People.

  • Report this Comment On August 16, 2012, at 2:37 PM, TMFKopp wrote:

    @scottydeez

    Your point is taken, but don't you think it's just a bit alarmist to compare computers that trade stocks quickly with weapons that kill people quickly?

    Matt

  • Report this Comment On August 16, 2012, at 6:46 PM, scottydeez wrote:

    Hyperbole is the mustard on the pastrami sandwich of debate. They called Paul Revere an alarmist too. Don't ask me to produce my three cornered hat. I think it's packed away with my collection of divining rods.

  • Report this Comment On August 21, 2012, at 8:57 PM, ayalara wrote:

    Day traders are poker players that are successful in proportion to their skill, the efficacy of their algorithms, and the size of their bankroll. It you can't compete on any of those three levels, find a different game.

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