Technology is the small investor's enemy. High-frequency traders move millions of shares in a few seconds. Using powerful computers, they can overwhelm human buyers and sellers and collapse values in single companies, even entire markets.
One company, Knight Capital, that lives by the HFT sword was almost destroyed last week when its computers bought billions of dollars of stock more than its capital structure should have allowed. Knight was forced to liquidate its excess positions at a $200 million loss and seek emergency funding from other financial firms.
As a small investor I participate in this new, exciting, and dangerously volatile environment by not placing market, stop-loss, or any orders that execute trades at "market" prices that can rocket suddenly upward or downward.
I always use limit orders that execute at prices that I specify. I know that I will never sell at the daily high or buy at the daily low; the high-frequency traders will snatch those up before price information travels from eye to brain. As was true before computers, there are no guarantees that limit orders will execute, so this policy can't be followed by someone who absolutely has to get out that day.
I hope that you, dear reader, or I are never in that position.
[Update - 8/10/12, the consequence to small investors if Knight went under:
The bigger risk to small investors might be if "market makers" like Knight, which play a huge role in executing retail trades, were to disappear altogether. In that case, small investors could be forced to pay higher prices for stocks and funds they buy and get lower prices for ones they sell, at least temporarily, say market experts.[Update - 8/11/12: the dangers to financial markets have led to calls for more regulation of HFT: "these high-frequency trades are not regulated and have begun to destroy the market."] © 2012 Stephen Yuen
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