One of the speakers at the recent SIP event I attended was a senior trader.

He gave a very interesting talk – and quite a scary insight into trading on the markets at the moment.

He estimated that about 60% of daily volume on the UK stock markets comes from high frequency trading algorithms. These are computer programmes designed to trade according to pre-set criteria. Often they hold positions for micro-seconds.

This is speculation. It is the opposite of investing.

Equity investing is (should be): purchasing a share of a company for the long term; engaging with the management through your voting rights (or your fund manager should do that on your behalf); sticking with them through the ups and downs over a long period of time; and being rewarded through a share of the profits (dividends) and some capital growth if the company can consistently deliver.

It is (should be) an honourable activity that (in aggregate and over time) allocates capital to productive enterprises and takes capital away from failing ones. This is the ‘creative destruction’ of capitalism at work.

A computer, spotting and exploiting pricing anomalies for 10ths of a second has no interest in how a company is performing, how the real economy is doing, no engagement with company management and doesn’t do anything to add value in the real world. It is simply gaming the system. It can be dangerous too: it was algorithmic trading that led to the 2010 Flash_Crash

If 60% of the volume on the public markets comes from computers, are these markets the right place for retail investors to put their money?

One argument might be that computer trading provides liquidity to the markets or aids ‘price discovery’

However, the trader revealed another startling fact. About 60% of daily volume is from ‘dark liquidity’: large institutional participants who want to trade away from public exchanges. The advantage for these institutions is that they can buy or sell securities without revealing who they are or how much they are trading (if they do this on public exchanges, it can have a price impact).

This disadvantages everybody else: they do not have all of the market information to help them determine a fair price for an asset. It is a deliberate removal of market transparency to help larger players. Check this site for more information about the current and updated online stock trading.

Again, to my mind this goes against a fundamental capitalist principle: fair and transparent markets.

Again, is a rigged market driven by computer trading the best place for retail investor’s money?

Thanks

Dan