Do Not Be Fooled Again: The Markets are Gamed

What does it mean to say the “markets are gamed”?  It means in the past stocks were traded on the basis of what the underlying company was worth.  The idea was to buy the stock of a good company and HOLD it for perhaps years.  The company grew and the stock appreciated.  This is called fundamental investing.  Today a stock has value only in that it can be used as a “chip” in a high speed trade strategy that requires holding a stock often for less than six seconds.  This is called speculation.

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Why has this change occurred in the investment markets?

1.  The Nature of the Investor has Changed – It is no longer the individual investing their life savings and simply trying to keep up with inflation, which is all the markets were ever really designed to do.  Today the markets are designed for the ultra-wealthy class which has been created within approximately the last ten to twenty years.  These are individuals who have made vast fortunes in high-tech corporations, CEOs receiving multi-million dollar salaries, extremely wealthy real estate investors, owners of oil and gas corporations, and hedge fund managers.  These individuals are not content making a return of 5, 6, or 7 percent.  If they cannot make a return of 25 to 50 percent, it is not worth their time or effort to even be involved.  The new industry of hedge fund and private equity managers has evolved to cater to these wealthy investors and their trades are placed through a few very powerful trading firms who have their computers on the floor of the exchanges.  These firms have negotiated a favored status with the different exchanges and they are allowed to actually do business on the exchange floor.  This provides them a significant advantage over the typical investor.

 

Increasingly, it is clear, the stock market caters to the interests of a few – large trading concerns and large investment banks – while undermining the interests of small public companies, small broker dealers, fundamental investors, the US economy and jobs. Sound familiar?

–David Weild IV, Former Vice Chairman of NASDAQ1

 

2.  Computerization – This is not simply a matter of trades being placed through the computer, which anyone can do these days, I am referring to is the advent of the computer algorithm.  Algorithms are proprietary formulas developed by trading corporations, that sift through an exorbitant amount of trading data over a courses of weeks, months, and years in an attempt to find trading patterns that can be used as an advantage.  Today, 70% of the trades on the NYSE are placed by computer algorithms.  The unfortunate reality however, is that these algorithms are not always right; they do not always result in a profit which has made the markets more volatile.  Also they have caused some major crashes, the” flash crashes”  that we have seen in recent years because these algorithms unwind out of control and create havoc in the market because trades are being made that are completely senseless.  One of the biggest problems with the development of the computer algorithm is that it is nearly impossible to regulate.  Our regulators, the SEC, are for the most part, unable to understand the techniques being used, let alone able to monitor the fairness or the legality of this kind of activity.

Indian Shares Suffer $60bn ‘Flash Crash’
–Financial Times, October 9, 2012

SEC No Match for High-Tech Traders
–Financial Times, September 19, 2012

Mini-Flash Crashes Continue to Fly Under the Radar
–Wall Street Journal, November 20, 2012

Other developments that have occurred are something called “dark pools”, these are groups organized completely separate from a legitimate exchanges and trade among themselves and the results are not reported to the exchanges until the end of the day.  So an investor going the traditional route through an exchange might be paying much more for a stock than it is actually being traded in the dark pool.  Again the average investor is no longer privy to very important information by which prices are determined.

New Report from CFA Institute Warns About Growth of Dark Pools
–Wall Street Journal, November 22, 2012

Shadows Fall Over Dark Pool Trading Practices
–Financial Times, December 18, 2011

Another technique that has been developed is something called “front running”.  This is where one of the trading firms floods the markets with trade orders consisting of millions of shares being bought or sold at one time.  They then immediately cancel the order, but in the meantime the price of the stock has been manipulated either up or down to their benefit and can then complete their order at a much more advantageous price.

As you can see, none of this has anything to do with investing.  It is basically legalized gambling.

The small investor cannot afford to lose their principal again and again.  They do not belong in the market with those who can.

 

 

 

 

 

 

 

 

 

 

 

 

1  Financial Times; Tuesday, August 30, 2010, “Equity Market Structure Caters to the Interests of a Few” by David Weild IV

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