What??! The Stock Market is Rigged???
You may
have heard about the 60 Minutes interview with author Michael Lewis, a former
Wall Street broker, author of "Liar's Poker" and "The Big
Short," who has just come out with a new book entitled "Flash
Boys." Lewis is an eloquent and
astute critic of Wall Street's creative and predatory practices, and in his new
book (and in the 60 Minutes interview March 30, 2014) he offers evidence that
the stock market is "rigged" by a cabal of high-frequency traders,
abetted by stock exchanges and Wall Street firms.
The charge
is entirely true. And it is also
completely irrelevant to you and anyone else who practices patient investing.
Lewis is
exposing a secret advantage that a surprisingly large number of professional
traders, employed by large brokerage firms, are able to get when they build
high-speed fiber optic cable feeds directly into the computers that match
buyers and sellers of securities. Some
of those traders actually have their trading computers located in the same room
as the New York Stock Exchange and Nasdaq servers. And some pay extra for access to more
information on who wants to buy and sell, more quickly, than would be available
to you if you were sitting down at your home computer looking to buy or sell
Apple Computer through a discount brokerage account.
All of this
is perfectly legal, but Lewis points out that it is also shady. Why should some buyers and sellers have
millisecond advantages over others? The
companies that see more of the market, more quickly, are able to jump in ahead
of you and me and buy stocks at lower intraday prices, and then jump ahead 15
seconds later and sell to the highest bidder before you and I would even see
that bid on our screen. They can buy the
stock you put in an order for and sell it to you at a fractionally higher price
through the normal market-matching mechanisms.
This way, they can squeeze out additional pennies and nickels on each
transaction, and if they do this thousands of times a day, it adds up to real
money--millions of dollars a year.
Why is this
irrelevant to you? Many of those lost
dollars are coming out of the pockets of day traders, ordinary people who are
foolish enough to think that they can outwit the markets by moving into and out
of individual stocks several times a day, or professional traders at hedge
funds who may not have access to the fastest server or a direct feed into the
Nasdaq servers. There are tens of
thousands of these investors, and many of them, watching the 60 Minutes report,
discovered for the first time that they are getting routinely fleeced by Wall
Street's money machine.
However, if
you're invested for the long term, it really doesn't matter how many times the
stocks you own inside of a mutual fund or ETF, or directly in your retirement
account, change hands or at what price every few minutes. It doesn't even matter whether your stocks
are up or down in any given month or year, so long as the underlying companies
are building their value steadily over time.
Your time frame is eons compared with the quick-twitch traders, who hope
to be in and out of your stock in minutes rather than decades. Your mutual fund that buys when a stock seems
cheap might, if it's careless or unsophisticated, give up fractions of a cent
on its purchases, but that likely isn't going to have a measurable impact on
your long-term investment returns.
Somehow,
this important fact was lost in the 60 Minutes interview. The interview also didn't mention that things
can go horribly wrong in the arcane and predatory world of rapid-fire
trading. The Hall of Fame of trading
losses includes $9 billion lost in credit default swaps by a single Morgan
Stanley trader from 2004 through 2006, or the $7.2 billion lost by Societe
Generale trader Jerome Kerviel over a few days in 2008, or the $2 billion
"London whale" losses in 2012.
They--and many others--used their milliseconds speed advantage to
generate staggering losses, proving that even the smartest operators aren't
always raking in the profits.
In the end,
the interview tells us several things.
First, it exposes, yet again, the fact that the Wall Street culture will
go to great lengths to grab money out of the hands of unwary investors. One wishes that the 60 Minutes interviewers
had asked a simple question: what economic purpose is served by fast-twitch
traders, trying to make money for their wirehouse employers by purchasing and
selling individual stocks multiple times a day ahead of other investors? Is this benefiting the economy in some way?
Second, the
interview makes plainly clear the folly of an average investor trying to
outsmart the markets with short-term trading activities.
And
finally, for those who can see the big picture that is never explained in the
60 Minutes interview, these revelations confirm the wisdom of having a
long-term investment horizon. When you
measure returns over three-to-ten year time horizons, the milliseconds don't
matter.
However, I have bought and am reading the book!
