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Volatility- Courtesy Of HFT's And Algorithms

On Thursday May 6, 2010 the Dow Jones Industrial Average plunged about 1000 points (about 9%) only to recover those losses within minutes. It was the second largest point swing, 1,010.14 points, and the biggest one-day point decline, 998.5 points, on an intraday basis in Dow Jones Industrial Average history. Traders refer to it as the Flash Crash. The cause of the 'Flash crash' was High Frequency Trading (HFT) a type of algorithmic trading, specifically the use of sophisticated technological tools and computer algorithms to rapidly trade securities. Think of it as number crunching on a grand scale at supersonic speeds. Firms employing this strategy (hedge funds and managed accounts) have racked up great profits over the years and have increased exchange volume 50%. The problem with HFT is it simply creates more and more volatility. HFT programs exploit minute movements in the markets, buying a stock at $1.00 and selling it at $1.0001, for example. Do this 10,000 times a second and the proceeds add up. Constantly moving into and out of securities for those tiny slivers of profit-and ending the day owning nothing. This rapid churning has reduced the average holding period of a stock. 50 years ago it was eight years; today it is around five days.

The 'Flash Crash' was a canary in the coal mine, unfortunately the market watchdogs will never be able to catch up and rein in the funds and small firms employing this tactic. Even worse the strategy has started to trickle down to mom and pop investors. Firms like Interactive Brokers will be more than happy to get you into the game for just $10,000.

With the rise of high-frequency trading and it's volume-multiplier effect a whole new industry in chart and trend analysis has popped up and in some areas, supplanted fundamental stock analysis.

Companies like Sterling Global are using ETF's and algorithmic programs to enable their investors to ride the wave the big boys and their HFT programs are creating. You don't have to be on a surfboard waiting for it to come and you don't have to ride it to a crest or crash. Sterling Global is simply following the flow of money from one basic ETF category to another and using algorithmic number crunching to pick the proper entry and exit points.

As a long time fundamental analysis investor I cringe at this brave new world created by the "Quants" (people who specialize in the application of mathematical and statistical methods - such as numerical or quantitative techniques - to financial problems). To me it is just day trading on Steroids. The problem is day trading only hurt the fool trying to get rich by jumping in and out of stocks within a trading day. The

Firms using algorithmic and HFT programs have the ability to take all of us along for the ride.