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What is High-Frequency Trading?
Moving with a shake of the collective head to our topic this week, what is this thing called “high frequency trading,” IROs and execs?
Well, it would be a good name for a rock band, but high frequency trading is an indication of the behavior of money and a measure of market risk. It is responsible for 20-30% or more of volume currently. Practically speaking, it’s continual, tick-by-tick, high-turnover buying and selling with real-time data to control risk while generating returns from minute change. It’s coming from all sorts of capital sources, but don’t blame hedge funds alone. All investment advisors must put money to work…and if they can’t invest it, they’re going to deploy it in other ways. This is the best way right now. (NOTE: Speaking of which, look for money to leave equities in pursuit of the Treasury Department’s ridiculous lending facility for high-risk credit assets as options expire next week. This will not be good for equity prices.)
Both Nasdaq OMX and NYSE Euronext announced recent fee changes designed to draw “high frequency traders.” If they’re trying to attract it, it’s because there’s a lot of it going on, except it’s happening elsewhere. Here’s the telling feature: both these exchanges made changes to the cost of CONSUMING liquidity, or buying, while keeping “rebates,” or incentives to provide liquidity (another way to say ‘offering shares for sale, which attracts buyers’) high.
This means there are changes at work in the broad markets. Where “rebate” trading, or furnishing liquidity, is necessary to helping conventional institutional investors like pension funds efficiently buy and sell large quantities of shares, high frequency trading depends on nearly equal and offsetting buying and selling in very small increments. That’s the kind of activity currently dominating volumes (and why volumes are on the whole down, too).
What does this mean for investor relations? We’ve always had a rather arcane profession populated with terms like guidance, and Reg FD and earnings call. Our ability to grasp concepts that often make other peoples’ eyes glaze over is a defining mark of the investor-relations professional. Well, guess what? It’s happening again.
All this high-frequency trading means that much of the money moving your price and volume sees high equity risk and studies equity-markets behavior, not business fundamentals. This has been going on for some time but it’s getting worse and worse, and it’s not going to get better anytime soon. Therefore, IR folks, it’s time to add this knowledge to your repertoire. After all, somebody’s gotta know what’s going on out there – since the SEC apparently doesn’t – and it might as well be us.
Look, we’re purposely aiming to make you chuckle here. But I hope you’ll remember this: well more than 80% of American companies (and roughly an equal number of European firms) hold earnings calls. Yet fundamental investment is accounting for about 15% of volume at best. Hadn’t we better understand the rest? We think knowing market structure is as crucial to IR now as earnings calls.
And it shouldn’t cost you much more than your earnings calls, either. If it is, you’re paying too much. IR departments don’t need expensive, outdated tools that don’t work in modern markets.
