Learn The Stock Market And How to Trade

High frequency trading can be a hugely profitable activity for the firms who are set up to do it. But in order to make those profits, firms have to trade incredibly high volume, because the profit margin on a per transaction basis is very low, in the region of a tenth of a cent per share.

It is for this reason that the high frequency trading firms on Wall Street are now worried about the latest proposals being put forward in US Congress for a new securities transaction tax. The tax rate proposed by Rep. Peter DeFazio (D-OR) is seven and a half cents per share, or 75 times their current profit margin!

This bill is gaining significant support. A similar bill has been put forward in the Senate by Sen Tom Harkin (D-IA). if passed, will force Wall Street to completely re-think its strategy around high frequency trading. Which is not necessarily a bad thing, but it will cause a sea change in the financial markets. Whether it will benefit the wider population of investors remains to be seen.

So far (late February 2009), 28 congressmen have signed on to support the DeFazio bill. Sen Harkin’s bill is also starting to pick up support.

If these bills are passed, in order for them to work, they will need to be highly detailed and well structured. It seems to be generally agreed amongst both supporters and detractors of these bills that they could result in a massive reduction in the volume of stock traded on US exchanges. Because high frequency trading firms account for around 70% of the volume on US equities exchanges, taking that volume out of the equation will result in a dramatic fall in volumes.

Will this benefit investors or the US economy in general? That of course is the big question. There is nothing to stop the big Wall Street firms setting up shop on other markets in other countries, so some argue that there is a danger that the bill will end up being detrimental to the US economy but nothing more than an inconvenience to the high frequency trading firms themselves.

Because less volume equals less liquidity. And less liquidity equals wider bid/ask spreads, which ends up hurting all investors. So it’s worth keeping an eye on these bills. The devil, as always, will be in the details.

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