Some parts that stood out to me...
TCR: It sounds like the average investor is seriously outgunned. But what about a retail investor with a longer timeframe who only makes 1-2 trades a month? Does he need to worry about high-frequency trading?
GARRETT: HFT affects all investors to an extent, because stocks are now priced differently than in the past. The market used to consist mostly of investors analyzing cash flows and balance sheets, trying to calculate a company’s fair value. HFTs, on the other hand, react to movements in stock prices alone. That is not necessarily a bad thing, but since HFTs are responsible for two-thirds of the trading volume, we have the strange situation where they can set the price based on what they perceive others’ perceptions to be.
GARRETT: Exactly. Fundamental investors used to dominate the market. They would buy and sell based on companies’ results.
Today, HFTs outnumber humans in trade volume and thus are a stronger force on prices. HFTs buy and sell based on what they perceive others’ perceptions to be, as quirky as that sounds. So instead of analyzing revenue and expenses, computers analyze how other market participants act, and trade accordingly.
TCR: It seems that normal investors can counteract this by investing for the long term. HFTs create a lot of noise, trying to guess what other traders will do. But ultimately, if a company is profiting, its stock will do well.
GARRETT: Precisely. You don’t want to get into a trading battle with them. But if you have a long-time horizon, fundamental investing can still work.
Just waiting for Knight Capital redux. To speculators: stop using hard stops. They're dead.