A combination of high frequency trading, computer programing, and exchange traded fund momentum buying and selling have made the daily action in the stock market simply a joke. As far as I’m concerned the market is a broken gambling hall.
The make-up of those participating in the market has changed in the last four to five years. Gone are most human investors buying and selling stocks and in come high frequency, quants, and computer programs.
High frequency trading has dramatically changed the market, and not for the better. This is trading done by computer program that trades stocks every second or minute trying to grab pennies here in there ahead of buyers and sellers. The high frequency trading gives investors the illusion of liquidity, but I believe this is mostly front running of legitimate orders through the use of technology and privileged access to the markets ahead of other participants.
A great example is that of Dell Inc. (NASDAQ: DELL) on August 25th, which saw 10,000 different quotes in one second at 3:45:48 pm with some changes in the size of what was offered. Let’s stop for a second. What possible use is there to blast 10,000 quotes of DELL in single second? I believe that this is computers and high frequency trading gone amok and that they are trying to front run legitimate buyers. What you get are momentum traders with technology advantages and the ability to see orders and “bait” orders before others see them and ride ahead of them.
Have you noticed that the market is suddenly a lot more volatile? Notice how the market will go up suddenly by hundreds of points or down by hundreds of points? It is because the market is much “thinner” than investors realize. There aren’t as many real investors out there like there have been in the past and a lot of what we are seeing is computers trading with themselves trying to get you to respond to the volatility to take advantage of your orders.
There have been reports that in the August upheavals, computerized trading represented more than 70% of some day’s volume? When there are real orders this momentum trading piggybacks on top of the buys or the sells making it harder to fill your order and makes stocks move around much more than they used to.
In the past, I would argue that volatility is your friend, as most value investors would say. 2008 changed my opinion. Many investors cannot stand the volatility no matter what they say. And I believe most people are abandoning the stock market in droves for this reason. Long term this should make for fantastic opportunity, but you have to be able to endure a lot of volatility to get there.
So what is an investor to do? Give up? No, I think the way you fight this volatility is to find high dividend paying stocks like Telular (NASDAQ: WRLS) and stocks “off the grid” that don’t have much computerized trading such as microcaps like Transgaming. I also think that more than ever you have to focus on management teams that are shareholder friendly and will actively buyback stock and pay dividends. In the long term you will be rewarded. In the mean time get used to more volatility.