Michael Lewis, in his book Flash Boys, describes in detail how high-frequency traders scalp billions of dollars from unsuspecting investors.

High-frequency trading is performed by sophisticated traders who have access to superfast computers and data transmission lines that can process market information and orders in milliseconds.

They are able to exploit market intelligence gleaned from the trading activity of long-term investors by effectively placing orders before these investors.

So what hope do small investors have given Flash Boys’ edge? Plenty, as it turns out, especially in Canadian stocks. More on this later.

But to finish the Flash Boys story: Lewis estimated the extraordinary profitability of these strategies at between US$5 billion and $15 billion per year, based on information made public when the high-frequency-trading firm Virtu Financial filed its prospectus for an initial public offering in early 2014. In that prospectus Virtu said it had a loss one day out of the 1,238 trading days before  seeking the listing. If only mere mortal investors could score investment results like that.

Given the importance of fast data transmission for the high-frequency traders, it was no wonder that the company Spread Networks was prepared to spend US$300 million to install an 827-mile, high-speed-data cable between the financial markets in Chicago and New York City to cut the data-traveling time by 4 milliseconds to 13 milliseconds. A blink of an eye takes about 100 milliseconds.

Ironically, the trading speed achieved by this cable was later eclipsed by the installation of a microwave data link between the two cities, reducing the data-travel speed by another 4.5 milliseconds.

Of course, the overall economic value achieved by this exercise is zero. All that happens is that profits that should accrue to long-term investors are skimmed off and pocketed by high- frequency traders.

Flash Boys Canada

Although Flash Boys focused mainly on the U.S. markets, high-frequency trading isn’t exclusive to U.S. traders. According to Jos Schmitt, CEO of the newly established Canadian stock exchange Aequitas, high-frequency trading nets C$1 billion to C$2 billion annually in Canada.

Market conditions that create a fertile environment for high-frequency traders include the existence of  several stock exchanges  and many highly liquid stocks that trade on multiple exchanges. High-frequency traders can then use their superior trading speed to gather information and execute their trades.

Canadian equities, exchange-traded funds and other instruments can be traded on any of at least nine stock exchanges. The main Canadian equities market is the Toronto Stock Exchange, but trading of the highly liquid stocks can take place on most of the other exchanges as well.

In the Canadian marketplace, the most liquid stocks, fewer than 75 of them, trade more than 1 million shares per day. These are the main targets for high-frequency traders.

The most liquid stocks are also the companies that receive the most attention from analysts and the press; the stocks often appear in the portfolios of institutional investors.

So the more lucrative opportunities will not be found among the top 50 Canadian stocks. To find bargains, investors have to avoid the scalping of high-frequency traders and find stocks that aren’t of interest to the press, analysts or large investors.

Among the Dividend Champions, 14% of the portfolio (four out of 28 stocks) fall into the highly liquid category and are potential prey for high-frequency traders. Another 25% fall into the medium-liquidity category, while 61% are in the lower-liquidity category that high-frequency traders avoid. The graph indicates where our Dividend Champions fall on the trading scale.

Of course, the third group also faces far less intense scrutiny by the press and analysts, and is unlikely to appear in large institutional portfolios.

This is the region of undiscovered gems within easy reach of smart, smaller investors.

Although we can find perfectly good companies at reasonable prices and attractive dividend yields in the highly liquid group, we believe we can add the most value through in-depth research that unearths attractive opportunities in the less-liquid group.