#4: High-Frequency Trading Targets
Unlike low-volume penny stocks that can be juiced by unscrupulous traders, equally troublesome are mega-volume companies that are the playground of Wall Street computers.
For those unfamiliar with the practice of “high-frequency trading,” it involves stocks that trade almost instantaneously when a sophisticated algorithm is identified by supercomputers. Some HFT positions are held for only a matter of seconds, and often there’s no net investment at the end of a given trading day. A report by the Tabb Group estimates that as many as 98% of orders placed by these computers are canceled before they become trades.
Worst of all, many think it was high-frequency trading algorithms that resulted in the May 2010 “Flash Crash” that caused a nearly 1,000 plunge in the Dow for a brief period.
HFT is legal, though an article earlier this year in The Wall Street Journal says the Securities & Exchange Commission is looking to take on the practice. Until more regulations are in place, however, you need to understand the risks to your portfolio to prevent getting your pocket picked.
For starters, be aware that HFT tactics work best on low-priced stocks with high volume. That would be companies like Bank of America (NYSE:BAC), which some estimate makes up 5% to 10% of total U.S. stock market volume while the computers run wild with shares. Headlines and financial reform will play into how BAC performs, to be sure. But you can bet the HFT algorithms will have their say — even on a day with no news.
Secondly, be aware of the risks of placing stop-losses in HFT targets. Volatility can be par for the course despite the big size of these picks, and you easily could be stopped out of a position one day and see it bounce back the next.