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On this week’s Mullooly Asset Management podcast Tom and Brendan discuss high frequency trading. This topic has been getting tons of coverage this week because of the 60 Minutes episode many people saw on Sunday night (March 30, 2014). The episode featured an interview with Michael Lewis about his new book. The book is based on high frequency traders. The concept to take away from Lewis’s book is that high frequency traders can see your buy orders moments before they’re executed. With this knowledge, they buy the security for their own accounts and then re-sell it to you. In turn, they make money (cents) off the trades. We’ll see how the information continues to unfold regarding this situation. If you follow this link (http://www.cbsnews.com/news/is-the-us-stock-market-rigged/) it’ll take you to a text version of Michael Lewis’ interview.
In light of this situation, it’s interesting to look at where we’ve come from in regards to trading.
In the 1980s when an investor wanted to buy 100 shares of a stock, the average spread they could expect was .25 per share. By spread we mean the difference between the bid price and the ask price. That 1/4 point spread often went to the market maker or the brokerage firm. Plus investors could expect a commission in the realm of $100 to place a trade.
As we moved into the 1990s, the spreads got tighter. Instead of a 1/4 point spread it became more like a 1/8 point spread. So the spread got better for investors, but the commissions remained high.
In the late 1990s and early 2000s we saw spreads tighten to a penny. This is where we see them today in most instances. We also saw the development of online discount brokerage firms. These discount brokerage firms significantly lowered commissions for investors. Many trades can be executed today for as little as $10. A big difference from the rates seen in the 1980s.
Tune into this week’s Mullooly Asset Management podcast to hear more about high frequency trading, the development of trading spreads, and liquidity. We’ll see what happens as more details come out regarding high frequency traders, but we do know that liquidity has never been better and costs to buy/sell have never been lower.