Move over traders, there’s a new shark in town. Well, maybe not THAT new, but it sure is at the forefront of controversy today. Who’s the shark? It’s called High Frequency Trading. What is it? It is basically black box or algorithmic trading using speed so fast that it picks up market discrepancies that a human can not catch alone. This type of trading can manipulate prices so ferociously in a blink and picks pockets clean so quickly it leaves some scratching their heads and others in financial ruin.

Supposedly it costs anywhere from $10,000 – $25,000 plus per month to have your computer tweaked with cranked up connectivity that gives you this kind of speed. It is being blamed for the “Flash Crash” in May which was supposedly started by a huge mutual fund dump that the High Frequency systems picked up on quicker than any trader did and whip-sawed the market to take instant profit. It caused the Dow to drop over 1,000 points and snap back 750 points in about 5 minutes. Price movement at this pace doesn’t surprise us these days, which is why we set ourselves up with our fingers on the pulse of the action and real-time access to the markets.

Well, the old school, regulated firms are taking notice and fighting back. The industry governing bodies are looking into this type of trading and debating on what should be allowed and what shouldn’t. Some of the biggest, best and oldest “market maker” firms are crying very loudly wanting high frequency trading to be placed under the same scrutiny and ground rules as they are. Firms like Introducing Brokers (IBKR) have to make markets under industry guidelines and are threatening to pull out unless the playing field gets leveled. Under government regulations “market makers” are required to supply bids and offers across multiple markets to provide liquidity at all times no matter what the conditions. High frequency traders are not required to make markets across the board, so they can hit and run with lightning speed to produce enormous, quick profits. Since steroid injected computers and greed have no conscience, now not only can a firm be wiped clean, an entire market or economy can be left destroyed.

The high frequency traders (or should we call them high frequency programmers) are claiming they are providing more liquidity to the markets. Who to believe? Hardly any of these high frequency trading firms are willing to comment publicly on their data connections or anything for that matter. They are super secretive and they can be right now because they are not highly regulated. Believe us, we are not complaining, because we know and understand the risks involved, but we do think the industry needs some regulation in this area. We often times debate why competitive advantages are given to some and not to others like we are now seeing with the Dodd-Frank ruling. Before the ruling Forex had the advantage and after the ruling Futures has the advantage. Why not level it for all and let the best product win or let them co-exist side by side?

In our opinion market makers like IBKR are needed to help new and emerging markets grow and become mainstream. This is how great products like the 30 yr. Bonds and the S&P 500 futures markets were built and the reason why they thrive today. On the other hand regulated high frequency trading could be a new and innovative way to capitalize on the markets and provide a healthy competition for the market makers. It doesn’t seem right to have one team abide by regulations and another to do whatever they please. It’s like the debate about the proper valuation of the Hong Kong Dollar. The world feels China artificially pegs its currency and holds it at attractive levels to benefit themselves with no regard to its trading partners around the globe. China argues that the US does the same. Let the war of the machines rage on.

Big money players are going to have to “duke it out” and our only real thought about the whole thing is this: we have been in the business since 1989 and we have seen massive trading firms collapse only to open doors to the next big one. And, then when that one collapsed another firm came on, and so on. We have seen (and traded with) the biggest and the best traders in the S&P500 futures and 30 Yr. Bond pits only to see them taken over by the next biggest and best traders ever. We have seen the entire way trading has been conducted for over 100 years be overtaken by computers (the next best thing) causing a mass exodus from the trading floors. Many open-outcry exchanges have closed down and the CME is holding on by a thread. So, our point is that we are ever changing and evolving in this industry. Some will make it and others will not. High frequency trading may be the next biggest and best thing, but something else will come along.

Where does all of this leave the individual investor? We wholeheartedly believe that the small investor still can win with a decent computer and an internet connection. We just need to know who we are playing against and when and how a specific style works best. The markets are so large and we must respect that, as we said above in our “greetings” message. Risk management is everything and we are grateful that we are disciplined enough to assign stops to every trade we take. If that whipsaw market returns as a result of these black box trades we will be stopped out and forced to take profits or lumps within our risk parameters. But, who knows? Maybe it might become a place where there is no room for the small trader. That’s when we open our hotdog stand. Plan B.

In the meantime, it will surely be interesting to see what our regulators decide to do about this wild shark swimming in our waters. Might I remind you, though, sharks are not the only fish that survive in the sea.

Whatever you decide to trade or try; you can’t win, if you don’t play!! Prosperity is at your fingertips! All you have to do is grab it!!