High frequency trading has been in the news more, thanks in part to Michael Lewis’ new book, Flash Boys. This article presents a simple explanation of how and why high frequency trading works, and why it is good for small investors.
We will begin by imagining a market with lots of small individual traders. Then we will look at how large institutional investors change the market. Next we will look at high frequency trading. Finally, we’ll explain how small investors are impacted.
Start by imagining a stock with no particular news about it. The price is stable, but there are lot of small trades. Some investors have enjoyed gains but now think the stock is overpriced. Other investors have seen gains and have decided to jump on the bandwagon. Some investors have been watching it, and now have money to invest. Others have owned it and are happy with the stock but need some cash. So lots of orders are coming in, pretty evenly mixed between buy and sell orders. The price trend for the stock looks perfectly steady.
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