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High-Frequency Trading: Just a Lot of Noise

Earlier this month, fellow Fool Matt Koppenheffer showed how the phenomenon of high-frequency trading, or HFT, has grown over the past five years. In short, HFT is carried out by computers programmed to eke out as many pennies of profit from stock movements as they can -- sometimes holding the stocks for only fractions of a second.

Take a look at how HFT quotes grew from 2008 to 2011:

Source: Nanex, LLC.

Source: Nanex, LLC.

Matt pointedly observes that while several market pundits think this is a disastrous sign for our financial markets, this graphic does not "show anything about how HFTs are harming individual investors, institutional investors, or any other investors in between." Nor, he points out, does it show how HFT leads to an unstable market.

There's bound to be more information to come about the rise of HFT, but I'm writing to tell you this about HFT: It's either a positive or a complete non-factor for individual, buy-to-hold investors.

Back to the basics
For starters, let's remember why there's a stock market in the first place. When companies are getting started, they might need extra cash to carry out their stated mission. By selling the company to public investors, management gets the infusion of cash that's needed.

When you buy a stock, you hypothetically have a right to a portion of the free cash that company generates. In reality, though, the most direct path you have to prove you're an owner of a company -- other than voting on your proxy -- is through the dividends you receive or money you're paid if a company gets bought out.

We at the Fool have repeatedly tried to show that buying companies that you're proud to own for the long haul is the best way to share in the financial benefits of the world economy. Checking your portfolio on a regular basis can be hazardous to your health -- and wealth -- and could cause you to miss the more important things in life.

Put simply, getting overly hyped about HFT doesn't make sense for the long-term investor, and it isn't going to do anything but get you all worked up and stressed out.

But if you want to get technical ...
Of course, it's important to check and see whether your reasons for investing in a company are still holding true -- but rarely should a company's stock price be the sole variable that matters.

For instance, I bought National Oilwell Varco (NYSE: NOV  ) more than a year ago because I believed the company's products would continue to serve the world's desire for fossil fuels. As it turns out, the stock is down since I bought, but the best I can tell, the thesis is still well intact. Certainly, when a thesis plays out, I'd like to see the stock price go up, but I'm way too small of an investor to have a real impact on the markets -- so I focus on what I can control.

HFT takes a completely different approach to the market

In reality, these machines really function as the maggots and worms of the natural world that help decompose the waste that others wouldn't use. They focus on the minute inefficiencies of the market and make a living off them.

Just as humans benefit from decomposers that put nutrients back into the soil that feeds us, HFT can also be beneficial -- it narrows the spread that companies are trading for. This makes the market more liquid and allows us to easily buy and sell stocks on those rare occasions when we are trading.

Sure, there are odd occasions of flash-crashes. Recently, Knight Capital (NYSE: KCG  ) lost millions on a trading glitch. But the people affected most by these events were high-frequency traders. For buy-to-hold investors who only periodically check their portfolios, there was no reason to be concerned about such events.

In the end, we're here to help you invest better. We've prepared a special free report to accomplish that aim: "3 Dow Stocks Dividend Investors Need." Inside, you'll get the full scoop on why buying these stalwarts, holding them for decades, and collecting dividends along the way, and forgetting all about high-frequency trading is a great idea. Get your copy of the report today, absolutely free!

Fool contributor Brian Stoffel owns shares of National Oilwell Varco. Motley Fool newsletter services have recommended buying shares of National Oilwell Varco. We Fools don't 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. The Motley Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (2)

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 29, 2012, at 12:01 PM, EricHunsader wrote:

    Suggesting investors don't need to worry about HFT because of infrequent encounter is a bit like advising homeowners to skip insurance. Sure, fires are expensive when they happen to you, but they are infrequent so let's not worry about them. The savings will be worth it for the vast majority of homeowners.

  • Report this Comment On August 29, 2012, at 12:28 PM, TMFCheesehead wrote:


    Investors don't have to worry about HFT b/c the effects are short-term. A "fire" would be akin to a Great Depression, and probably caused by valuation or socio-economic shifts, not HFT.

    Brian Stoffel

  • Report this Comment On August 29, 2012, at 1:18 PM, EricHunsader wrote:

    Brian -

    Your "fire" is now our great depression? That's one small fire for a man, one great depression for mankind. (Apologies to the late Neil Armstrong)

    What about the investor who decided to sell a significant stake at the very moment HFT was "affecting" the market?

    Why haven't electronic markets brought transparency? Shouldn't I know more about how my $20K stock order was executed than I do about my $20 order from Amazon?

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