August 14, 2012
The NYT had an interesting article on the growth of high-speed trading on U.S. stock exchanges. While the piece notes the risks that these trading system can pose to long-term investor by taking profitable opportunities ahead of them, it reports the industry’s claim that it benefits long-term investors:
“The new trading sites and high-speed trading firms have managed to fend off critics by pointing to benefits that long-term investors have derived from the sophisticated markets.
One of the most popular ways to gauge how investors are doing is the difference between the price at which a stock can be bought and sold at a given moment — the so-called bid-ask spread. When this goes down, day traders, mutual funds and other institutional investors pay less to move in and out of stocks.”
While long-term investors in principle benefit from lower transactions costs, if these costs are offset by increased trading then there may be little or no gain to the investor. For example, if the average price of selling a share of stock falls by 50 percent, but fund managers respond to the price decline by doubling the amount of trading they do, total trading costs to investors will be unchanged.
There is research on the response of trading volume to prices that suggests the ratio is close to 1, meaning that trading volume will typically rise by an amount that will roughly offset any decline in the cost of trading. This means that ordinary investors are likely to see little benefit from any decline in trading costs associated with high-speed trading.
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