Is Algorithmic trading good for the markets?

By: ispeculatornew
Date posted: 07.15.2009 (5:00 am) | Write a Comment  (2 Comments)

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electronic-trading-1Over the past few weeks, there has been a lot of talks about Algorithmic trading. It is basically trading that is done electronically through programmed rules. These high powered machines will trade over and over the same stocks when specific technical events happen to profit from very small mispricings between securities, to profit from momentum and even in some cases (although few would admit to this), to manipulate markets. The recent arrest of an ex-Goldman employee as long as many reports about how Goldman has mastered this form of trading had placed very high expectations on today’s earning report. And even with such high expectations, Goldman Sachs (GS) crushes estimates coming in with earnings of 3.44$B for the last quarter.

If electronic trading does account for such a high proportion of Goldman’s trading, it is certainly worth looking into as many in and outside of the markets consider this to be a potential danger. To be sure, electronic trading is now the norm and in fact now represents over 70% of trading done on us exchanges by many estimates. Many of the recent critics have said that in such a high tech game, it is now impossible for small or retail investors to compete. And yes, I agree that any small investor trying to arbitrage two markets has pretty much no chance to make it happen on his own. He would need high tech equipment, programmers and good real estate (yes, location does matter when you are talking about hundreds of a second).

But let’s be real. How many small investors are actually investing for a few seconds at a time? Very few in fact. Most investors will buy and hold, at least for a few hours or longer. And in that case, liquidity is important and I don’t think anyone would argue that these electronic traders bring lots of liquidity in the market. Having a bid-ask spread that is less than a cent will be to the advantage of most investors and that will traditionally happen a lot more on stocks that trade electronically. So yes, I do believe that these traders actually do help small investors do well, and certainly would not be the one criticising…at least not because of liquidity!

Personally, I consider the more valid criticism to be about what happens in a crash, as all these electronic programs could decide to sell at once and it would send the market down very very quickly. It might be something to be looked into but considering how the markets were “fairly” calm during the past few months, which were a very good test I would say…do you agree?

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2 Comments

  1. Comment by Frank — July 15, 2009 @ 7:57 am

    Interesting subject!! I agree that program trading is increasing liquidity. But big institutions are doing big money (i.e. GS). If there’s a winner, there has to be a loser, individual investors like us?!?

  2. Comment by IS — July 15, 2009 @ 8:57 pm

    Interesting way to look at it, I agree… But I would say that for individual investors, it really is about liquidity.

    Another point.. as strange as it sounds, a lot of firms trade high volumes barely breaking even and even losing money and they don’t mind because their main objective is to appear as being very active

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