10 milliseconds: too slow
[from Merrill Lynch chief investment strategist Richard Berntstein]
10 milliseconds is way too slow
Financial historians often point out that one common characteristic
of speculative periods in financial markets is the desire to trade
more frequently. In other words, market participants can’t get
enough of a good thing. A recent example is the popularity of day
trading during the Technology bubble.
Even with that sense of history, a recent article in the Financial
Times still came as a shock to us. The article, entitled
“Millisecond trading arrives” (3/19/07) points out that a new trading
system being put in place will “reduce transaction times to just 1
millisecond from about 10 milliseconds”. The article further points
out how such speeds are critical to “market participants using
advanced trading strategies”.
Some short-term traders are indeed successful. However, our research
has consistently shown that the probability of losing money increases
significantly as one shortens one’s investment time horizon. We have
examined periods as long as 10 years and as short as 1 day. Short-
term trading is roughly a 50/50 proposition, i.e. success is likely
to be luck.
The economic rationale behind our results is simply that fundamentals
do not actually change in very short time periods, and that short-
term trading is often largely based on meaningless noise.
Nonetheless, 10 milliseconds is now considered too slow for
“advanced” trading, and our preference for taking a long-term and
fundamentally-based approach to investing is increasingly becoming a
starkly contrarian strategy.