Apr 02, 2014 The Markets are "Rigged". So What?

by Canadian MoneySaver

Ryan ModestoWith recent coverage on 60 minutes and the release of the book Flash Boys by Michael Lewis, the high frequency trading (HFT) business has been getting a lot of scrutiny lately. In very general terms, HFT involves super-fast trading systems that are able to make fractions of a penny through buying and selling securities at a rapid pace. The main defenses for these systems are that they add liquidity to the markets and have helped to reduce bid-ask spreads. The primary criticisms seem to be that HFT essentially steals from investors and reduces investor confidence through events such as the flash crash. Like any hot button issue, the truth is usually somewhere in the middle.

 

Using the term rigged, as it was framed in the 60 minutes episode, is quite a strong and suggestive word that probably takes the whole argument out of context right from the start. It implies that there is no point in investing because someone else is pulling the strings. Claiming that markets are rigged after 20% gains on the S&P 500 over the last year makes the argument tougher to swallow and doesn’t seem like such a bad deal if the market is rigging things in your favour.

 

Some context is also required when looking at whom this is actually affecting. In all reality, retail investors would be experiencing negligible hardship by losing fractions of a penny on their trades. Most are likely more concerned with trying to shave $5 off of trading commissions from their broker or 1% of fees off of their funds than worrying about X% of a penny. It is more of an issue with large volume, institutional investors that, if you agree with the defense that HFT has created lower trading spreads, may also end up as a negligible net effect. For individual investors, HFT has no lasting effect on the companies that are publicly traded and fundamentals will still dictate performance over the long-term. I think the real concern with HFT is that of fairness and less about how much money is being ‘stolen’ from investors.

 

Conceptually, HFT simply seems to undermine the purpose of capital markets, which is to raise capital for companies for funding of operations and the pursuit of growth. Having trading algorithms working in the background, buying and selling securities with no concern of underlying value perpetuates the idea of stock markets being akin to gambling at a casino and that the market is rigged.

 

Overall, the real story is probably somewhere in-between the sensationalist rhetoric coming from both sides. While there are some arguments in defense of HFT, there are likely many instances where it is used irresponsibly and the damage it causes to confidence in markets could be huge.  A little more transparency and communication from the HFT industry could go a long way and benefit everyone. One thing is for sure though, scaring individuals into believing they have no chance in generating a return in the markets (whether intended or not) helps no one.

Ryan Modesto,

CanadianMoneySaver.ca 

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