Is The Stock Market Really Rigged?

Apr 1 2014, 4:04pm CDT | by

In case you missed it, CNBC aired an interview between Brian Katsuyama and William O’Brien about High Frequency Trading.  The conversation started as a result of Michael Lewis’s new book, Flash Boys, in conjunction with a 60 Minutes story that aired this previous Sunday.  The big hubbub is all about Katsuyama’s quote, “The market is rigged.”

As an advisor, I received a few calls from clients after the 60 Minutes story aired and now, as the story catches fire, I anticipate even more questions.  A comment such as, “The stock market is rigged” is no joking matter.  It can potentially shake the very foundations of investor/client trust … and in my opinion is exactly what we need more of.  Investing, after all, isn’t a free, zero sum game.  But HFT (High Frequency Trading) is a problem that affects more than just wealthy Wall Street hedge fund players.

In a nutshell, the evidence offered in the book and the 60 Minutes story suggests some financial firms are investing billions of dollars in computerized systems and fiber optic cables in order to trade faster than everyone else.  The sixty minutes piece does an excellent job of explaining the details and technology used to profit from this approach.  For a more simplified perspective, investors can think of it like purchasing golf clubs through an online auction.  Let’s say you find the perfect set and send in a bid of $1,000 for both the woods and irons.  However, just as your order for the woods is confirmed, an HFT sees it and sends its own faster bid to buy the irons ahead of you.  Then,  before the online auction company even knows it, the HFT turns around and resells it to you at a higher price, which you inevitably pay because you don’t want a mismatched set of clubs.

On the surface, High Frequency Trading would appear to be a Wall Street or institutional problem, not a Main Street concern.  However, I have to side with Katsuyama who notes that many of the institutional traders being forced to pay-up are some of the people who control your future.  We’re talking about pension fund and mutual fund managers who may be generating lower returns as a result of increased fees.

Right now, no one knows if this is costing Middle Americans millions of dollars, or if its shaving years off of their retirement dreams.  But what we do know is that it is a problem more and more investors need to be aware of.  After all, individual investors control nearly $19 trillion in retirement savings alone.

Our firm works through two different trading platforms, which I have contacted to request a statement from them about  High Frequency Trading, trade routing, and if options are available to work with the likes of IEX, which has developed a potential solution.  I would encourage readers to do the same with the companies they work with.

As far as the question whether the stock market is really rigged, the answer is absolutely YES! It’s rigged with risks and opportunities that investors take each and every day.  The reality is, HFC is not illegal (yet) and we do live in a capitalistic society.  News and information like this can shake markets, and when it does,  investors and advisors have to be prepared to respond by investing their money is the place they feel is most suitable.  Do you want to support firms and platforms that foster HFC?  Do you want your pension or fund manager to  have a policy against it or method to prevent it? Ultimately, the markets can only stayed rigged as long as investors allow it to take place.

P.S. Let me know what you think of High Frequency Trading by leaving a comment… and thanks for following me at Forbes.com and on Twitter @robertlaura

Source: Forbes Business

 
 
 

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