Last Sunday following the NCAA Men’s Basketball tournament games the high profile news magazine show "60 Minutes" aired a segment proclaiming the “stock market is a rigged game.”
The piece was based on a new book, “Flash Boys,” by Michael Lewis. The book is an expose on the nature of modern technology centered stock exchanges, and more specifically the high frequency computer based trading activity interacting with legitimate stock trading activity in way described as parasitical.
The subject of high frequency trading is extremely difficult to understand, so we won’t explore it here. But we will answer the charge the stock market is a rigged game to lend some perspective.
Is the stock market a rigged game? Well first, the stock market is not a game. It’s an extremely effective tool for capital formation and wealth creation. For those who consider the stock market a game then the answer is yes, it’s absolutely rigged and always has been.
Using the market to day trade or speculate is not investing; it’s gambling. And the high frequency trading computers are only the most recent and effective version of a class of professional speculators who have always beat smaller speculators at their own “game.” The high frequency trading computers are now using tools that while legal, certainly seem like cheating. But how do these nefarious techniques really impact investors using common stock as a tool to store capital and grow wealth over time?
I submit investing in stocks correctly, with a reasonable level of patience and appreciation for investment fundamentals, might be the best way to beat high frequency traders at their own game. After all, trading computers thrive on the movement of money throughout the markets, attempting to latch onto or get in front of legitimate trades in order to squeeze out repeated levels of ill-gotten micro profits for themselves.
When a stock is held by a confident investor intending to benefit from the fundamental growth of a company and perhaps collect a dividend over time, the high frequency trader is denied the movement of money needed to scrounge out a micro profit. In effect this is beating the rigged game by not playing it.
I believe high frequency trading is a serious issue and challenge for professional asset managers and the agencies regulating the stock market. For those who invest in mutual funds or have pension benefits, these trading computers can cause investment management expenses to rise and hence returns to be lower over time.
But funds and pensions will learn ways to adapt, and over time regulators will catch up too. I think it would be a shame for these “market is rigged” headlines to scare individual investors away from using the stock market properly as a tool to grow wealth over time.
Oh, and for the disgruntled speculators out there, one of the primary sources of the ill-gotten data needed for high frequency traders to build their parasitic strategies is your very own online trading firms. If you find the practice of your online broker letting these computers in on your trading data distasteful, you might want to reach out and let your firm know.