News traders who are close to the action and can react to news rapidly are crowding out traditional investors who patiently research the fundamental value of stocks.
Surprisingly, the stock market benefits from this: market liquidity improves and price efficiency remains intact. Moreover, the traditional investor still comes out on top financially, earning a net profit almost three times higher than the fast news trader. This is the conclusion of Professor of Finance Albert J. Menkveld and researcher Ion Lucas Saru from Vrije Universiteit Amsterdam, based on unique trading data.
A fundamental shift is taking place on the trading floor. On the one side, there are the traditional 'value traders'. These are investors who spend a great deal of time researching the long-term value of a company, after which they trade strategically and patiently to slowly close the gap between the actual value and the market price. On the other side are the 'news traders'. These are traders equipped with fast computer systems and algorithms that react instantly to small snippets of news or changes, even before the rest of the market can adapt.
The new VU research shows that these fast news traders are indeed taking the place of traditional investors. Because news traders react so quickly to price changes, they chip away at some of the profits of slower investors. Contrary to expectations, however, this does not appear to harm the stock market. In fact, it makes the market more liquid (easier to trade in). This is because fast news traders can only use their information advantage very briefly, for a single moment. As soon as they make a purchase or sale, the "dealer" (the intermediary facilitating the trades) immediately sees this news and adjusts the prices. Because this intermediary is thus informed more quickly and runs less financial risk than when trading with a patient, unpredictable traditional investor, they can afford to charge lower trading costs. This has a positive effect on the liquidity of the entire market, and furthermore, the market remains exactly as efficient at determining the right prices.
Despite the aggressive competition from algorithms, traditional trading remains the most profitable approach at the bottom line. The VU researchers were able to demonstrate this thanks to exclusive access to a proprietary dataset from the Deutsche Börse. In it, they analyzed all transactions in EURO STOXX 50 Index Futures from 2013 through 2023. The daily amounts circulating in this market are massive. For example, fast news traders earn an average gross profit of 670,000 euros per day. After deducting 120,000 euros in daily transaction costs, a net amount of 550,000 euros remains. Traditional value traders, on the other hand, achieve a gross profit of no less than 1.7 million euros per day. Because their total transaction costs are significantly lower at 60,000 euros per day, they are left with a net profit of 1.64 million euros per day.
Net, the traditional, thoughtful approach is therefore almost three times as profitable as fast news trading. The explanation for this is simple: the slow investor can repeatedly book profits throughout the entire day based on their thorough research, whereas the news trader's advantage is virtually exhausted immediately after their one quick action on a news item.
Read the full publication by Menkveld and Saru here.