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High-Frequency Trading Costs You $5 Per Trade

Dan Newman
December 5, 2012

Turn on, boot up, and jack in -- if you want to save your $5, that is. While the computers behind high-frequency trading might have many benefits, one economist puts the cost to retail investors at $5 per futures contract. What does this mean for small investors without their own algorithms and supercomputers? How can the little guy compete with Stock-o-tron 3000?

Simple: Limit your potential interactions with the machines.

The study
As The New York Times reports, chief economist Andrei Kirilenko at the Commodity Futures Trading Commission found the $5 figure in his yet-to-be-peer-reviewed study. He looked at futures contracts based on the S&P 500 (INDEX: ^GSPC) and determined:

The most aggressive [traders] scored an average profit of $1.92 for every futures contract they traded with big institutional investors, and made an average $3.49 with a smaller, retail investor. Passive traders, on the other hand, saw a small loss on each contract traded with institutional investors, but they made a bigger profit against retail investors, of $5.05 a contract.

The average aggressive high-speed trader made a daily profit of $45,267 in a month in 2010 analyzed by the study.

So on average, in each trade with a machine (at least in the futures realm), you lose out on a Subway Five-Dollar Footlong. How do they do it?

The internals of HFT
Again, the Times has an excellent primer on the subject. Basically, computers can ping for quotes and send in millions of orders per second while canceling them virtually simultaneously. This can provide the firms with information more rapidly than human traders can, and the computers can execute the trades to book profits. And along with the money made from bid and ask prices, the exchanges themselves pay fractions of a cent to the firms for each share traded.

Of course, sometimes the computers get a bit feisty, or the humans that programmed them slip up, which