Wednesday, 29 July 2009

High-Frequency Trading: MUST READ!

Congrats to Mike, who is using his considerable economics training to good ends now over at the Atlantic's business blog section. He has an introduction to high-frequency trading that may be a bit of a slog for the novice, but it is a VERY IMPORTANT read for any stock market investor.

I've been watching the attention focused on high-frequency trading bloom rapidly over the last month or two -- sort of like a slow-motion explosion -- from Zero Hedge's initial ominous entries on the subject, to a New York Times piece that followed surprisingly quickly, to Mike now ... and I think this will be the next scandal in the stock markets, assuming enough people are bright enough to understand what's going on. They certainly should care.

What's happening: there is the market for the big boys with the high-powered computer algorithms, the Goldman Sachses and all ... and there is the market for the rest of us. My naked assessment so far, based on admittedly limited information: the rest of us are getting screwed. Or should I say, any little guy who trades stocks, is invested in a retirement fund that trades in and out of stocks, or has a 401(k) that's making buys and sells, is getting screwed.

It seems that ultra-fast computers can do a number of bad, manipulative things to stock prices. They can scrape a few pennies, or fractions of pennies, off lots of trades (those pennies are coming out of your, or your mutual fund's, pocket). Pretty soon we're talking real money.

But please, read what Mike has to say. He has a very smart, incisive, well-reasoned posting on this. He shreds the argument that the computers are simply providing liquidity. He also highlights the real issue, beyond the fact that we're getting ripped off: this is distorting how the market is supposed to work. Prices on stocks are supposed to move based on perceptions of the underlying value of the company, not because of smokes and mirrors and rotten ruses.

I gotta be honest. For a long time I used to preach that the smartest investment was the stock market, where you just put your money in an index fund and left it alone. No hassle! Returns were, what, ten percent on average a year? But I've really soured on the market. Stocks have performed absymally over the last 10 years. I've personally lost thousands of dollars.

Now someone might argue: Well, just stick with it. They'll bounce back. But I'm starting to smell rot in the system itself. Companies juice immediate profits to pad bonus checks. The historical returns ain't looking so hot either: what are they now, about 8 percent? Hell, you can get a good 5 percent in a safe bond fund. And now we have this high-frequency trading revelation: if the stock market didn't resemble a casino before, it sure as hell does now. And the guy next to you at the table, whether you know it or not, may have an edge at the game of chance -- at your expense.

I'm very discouraged about fairness in markets right now. I'm starting to edge toward the belief that the United States is a deeply corrupt country. I use the word "deeply" not in the sense of arrant corruption -- I don't believe that is the case. Rather, I think we have a system that is profoundly corrupt in that it appears to be democratic and free, but is increasingly controlled by special interests and powerful entities that do their worst behind the cloak of a free market ideology.