Similar to this question, but with new information concerning High Frequency Trading [HFT], see articles on HPCwire and the NY Times citing that HFT accounts for 73 percent of all equity trading volume in the US and their effect on the small individual investor.
Is it, currently, wise to place money in the US stock market? Or should we look elsewhere until the SEC changes the laws to prevent HFT practices? Is this a real threat to my current investments?
There's a lot of hype about HFT. It involves computers doing things that people don't really understand and making a bunch of rich guys a bunch of money, and there was a crisis and so we hate rich wall street guys this year, and so it's a hot-button issue. Meh. There's some reason for concern about the safety of the markets, but I think there's also a lot more of people trying to sell you a newspaper.
Remember that while HFT may mean there are a lot of trades, the buying and the selling add up to the same thing. Meanwhile, people who buy stock to hold on to it for significant periods of time will still affect the quantity of stock out there on the market, applying pressure to the price, buying and selling at the prices that they think the security is worth.
As a result, it's unlikely that high-frequency trading moves the stock price very far from the price that the rest of the market would determine for very long; if it did, the lower-frequency traders could take advantage of it, buying if it's too low and selling if it's too high.
How long do you plan to hold a stock? If you're trying to do day-trading, you might have some trouble; these people are competing with you to do the same thing, and have significant resources at their disposal. If you're holding onto your stock for years on end (like you probably should be doing with most stock) then a trivial premium or discount on the price probably isn't going to be a big deal for you.
I don't think that HFT is a game-changer for retail investors. It does mean that amateur daytraders need to pack it up and go home, because the HFT guys are smarter, faster and have more money than you.
I'm no Warren Buffet, but I've done better in the market over the last 4 years than I ever have, and I've been actively investing since 1995. You need to do your research and understand what you're investing in. Barring outliers like the "Flash Crash", nothing has changed.
You have a great opportunity to buy quality companies with long track records of generous dividends right now for the "safe" part of your portfolio. You have great value stock opportunities. You have great opportunities to take risks on good companies the will benefit from economic recovery.
What has changed is that the "set it and forget it" advice that people blindly followed from magazines doesn't work anymore. If you expect to park your money in Index funds and don't manage your money, you're going to lose.
Remember that saying "Buy low, sell high"? You buy low when everyone is freaked out and you hear Gold commercials 24x7 on the radio.
Obviously there are good answers about the alternatives to the stock market in the referenced question.
HFT has been debated heavily over the past couple of years, and the Flash crash of May 6, 2010, has spurred regulators to rein in heavy automated trading. HFT takes advantage of churn and split second reactions to changing market trends, news and rumors. It is not wise for individual investors to fight the big boys in these games and you will likely lose money in day trading as a result.
HFT's defender's may be right when they claim that it makes the market more liquid for you to get the listed price for a security, but the article points out that their actions more closely resemble the currently illegal practice of front-running than a negotiated trade where both parties feel that they've received a fair value. There are many factors including supply and demand which affect stock prices more than volume does. While market makers are generating the majority of volume with their HFT practices, volume is merely the number of shares bought and sold in a day. Volume shows how many shares people are interested in trading, not the actual underlying value of the security and its long term prospects. Extra volume doesn't affect most long term investments, so your long term investments aren't in any extra danger due to HFT.
That said, the stock market is a risky place whether panicked people or poorly written programs are trading out of control. Most people are better off investing rather than merely trading. Long term investors don't need to get the absolute lowest price or the highest sell. They move into and out of positions based on overall value and long term prospects. They're diversified so bad apples like Enron, etc. won't destroy their portfolio. Investors long term view allows them to ignore the effects of churn, while working like the tortoise to win the race while the hare eventually gets swallowed by a bad bet.
There are a lot of worrying and stressful uncertainties in the global economy. If it's a question of wisdom, focus on sound investments and work politically (as a citizen and shareholder) to fix problems you see in the system.
In some senses, any answer to this question is going to be opinion based - nobody outside of HFT firms really know what they do, as they tend to be highly secretive due to the competitive nature of the activity they're engaged in. What's more, people working at HFT firms are bound by confidentiality agreements, so even those in the industry have no idea how other firms operate. And finally, there tend to be very, very few people at each firm who have any kind of overall picture of how things work. The hardware and software that is used to implement HFT is 'modular', and a developer will work on a single component, having no idea how it fits into a bigger machine (a programmer, for instance, might right routines to perform a function for variable 'k', but have absolutely no idea for what 'k' stands!)
Keeping this in mind and returning to the question . . . The one thing that is well known about HFT is that it is done at incredibly high speeds, making very small profits many thousands of times per day. Activities are typically associated with market making and 'scalping' which profits from or within the bid-ask spread.
Where does all this leave us?
At worst, the average investor might get clipped for a few cents per round trip in a stock. Given that investing buy its very nature involves long holding periods and (hopefully) large gains, the dangers associated with the activities of HFT are negligible for the average trader, and can be considered no more than a slight markup in execution costs.
A whole other area not really touched upon in the answers above is the endemic instability that HFT can bring to entire financial markets. HFT is associated with the provision of liquidity, and yet this liquidity can vanish very suddenly at times of market stress as the HFT remove themselves from the market; the possibility of lack of liquidity is probably the biggest market-wide danger that may arise from HFT operations.
