Question

Do you know that approximately 70% of all trading activity in modern markets consists of computers trading against other computers? At the bottom of page 65 in your text, you will see the "NEW TRADING STRATEGIES" section of your chapter. The rise of algorithmic and high-frequency trading have raised all sorts of questions related to speed, fairness, and stability. For example, the Flash Crash, occurring on May 6, 2010, saw the market (i.e. DJIA) fall 1000 points only to partly recover minutes later. While this was an extremely volatile event, markets now routinely see mini crashes in individual securities (where the stock drops dramatically only to recover seconds later), all due to the presence of high-frequency traders. Overall, based on what you have read thus far, do you think high-frequency traders are beneficial to markets, or do they do more harm than good? Do you worry about placing an order to buy a stock in the midst of a mini crash? What type of order makes the most sense to avoid receiving an unfavorable execution price should you buy in the midst of a mini flash crash?

Answer 1

High frequency traders are beneficial to the market on an overall basis. These traders buy when the price is below the trend and they sell when the price is above the trend. Thus they, in a way, help to reduce the price fluctuations that may occur in the market. It is due to the high frequency traders that blips on price lines are smaller as well as short-lived. High frequency traders make the stock market more efficient and this helps small investors whose trades are spread at random times throughout the day.

No, I do not worry about placing an order to buy a stock in the midst of a mini crash. This is because crashes in the stock market are only short lived.

The type of order that makes the most sense to avoid receiving an unfavorable execution price should I buy in the midst of a mini flash crash is to make use of limit buy orders. When I make use of limit buy orders then I will be able to set a limit on what price the order will be exercised if the stock was tripped. I will always set the limit price a few basis points higher than the current bid so in case there is a crash I will be saved from paying a ridiculous amount.