Contrarian investor David Dreman say high-frequency trading is a “dark vulture” hovering over markets. And in his latest Forbes column, he offers a few tips on how individual investors can elude the beast.
“In my forthcoming book, Contrarian Investment Strategies: The Psychological Edge … I detail the dangers of HFT firms that accentuate market movements by shorting heavily when the Dow or S&P 500 rapidly drops about 2%, or buying if it suddenly rises the same amount,” Dreman writes. High-frequency traders were a big factor in the 2010 “Flash Crash”, he says, and they were also a big factor in the market’s wild swings last summer. “From July 8 to Aug. 8 the Dow fell 17.3% — 13.4% in the first six trading days of August alone,” Dreman says. “The CBOE Volatility Index (VIX), dubbed the ‘fear index,’ traded at 16 in early July but moved up to 48 by Aug. 8. Panic was everywhere. HFT did not initiate — but certainly accentuated — the size of the drop and the enormous increase in volatility.”
“Investors thrive on low volatility and a stable environment,” Dreman says. “Flash traders thrive on instability. The volatility they require to make major profits is what drives many tens of thousands of investors out of the marketplace.” His advice: Don’t use stop loss or sell at the market orders. “Instead, put limits on your orders either to buy or to sell,” he says. Dreman also offers a few stock and exchange-traded fund picks, including mining firm Rio Tinto PLC.