What is high frequency trading?

Moving on to our topic this week with a collective head shake, what is this thing called “high frequency trading”, IROs and executives?

Well, it would be a good name for a rock band, but high frequency trading is an indication of money behavior and a measure of market risk. It currently accounts for 20-30% or more of volume. In practice, it’s a continuous, high-volume buy and sell, using real-time data to control risk while generating returns from minute changes. It comes from all sorts of sources of capital, but don’t blame hedge funds alone. All investment advisers need to put money to work…and if they can’t invest it, they will put it to good use in other ways. This is the best way at the moment. (NOTE: Speaking of which, look for money to exit stocks to pursue the Treasury Department’s ridiculous lending facility for high-risk lending assets as the options expire next week. This won’t be good for stock prices.)

Both Nasdaq OMX and NYSE Euronext announced recent fee changes aimed at attracting “high frequency traders”. If they’re trying to attract it, it’s because a lot of it is happening, except it’s happening somewhere else. Here’s the revealing trait: These two exchanges have changed the cost of CONSUMPTING liquidity or buying it, while offering “rebates” or incentives to provide liquidity (another way of saying “putting stocks for sale which attracts buyers”) ) were held high.

This means that changes are at work across the broader markets. Where “discount” trading, or the provision of liquidity, is necessary to help conventional institutional investors such as pension funds buy and sell large volumes of stocks efficiently, high-frequency trading depends on buying and selling in very small increments, nearly be equalized and balanced. This is the type of activity that is currently dominating volumes (and why volumes are broadly declining too).

What does this mean for Investor Relations? We’ve always had a fairly arcane profession, populated with terms like Consulting, Reg FD, and Earnings Call. Our ability to understand concepts that often sweeten the eyes of others is a hallmark of the investor relations professional. Guess what? It’s happening again.

All of this high-frequency trading means that much of the money moving your price and volume is high stock risk and studies stock market behavior, not business fundamentals. It’s been like this for a while, but it’s only getting worse and it’s not going to get better anytime soon. So, IR folks, it’s time to add this knowledge to your repertoire. After all, someone has to know what’s going on out there – since the SEC obviously doesn’t – and it might as well be us.

Look, we’re purposely trying to make you laugh here. But I hope you’ll remember: well over 80% of American companies (and about the same number of European companies) conduct earnings calls. However, fundamental investments account for about 15% of the volume at best. Shouldn’t we have understood the rest better? We believe that knowing the market structure is now as important to IR as the odds.

And it shouldn’t cost you much more than your earnings, either. If so, you are paying too much. IR departments don’t need expensive, outdated tools that don’t work in modern markets.