Michael Lewis focused investors’ attentions to the practice of high frequency trading this past week with the release of his new book, “Flash Boys,” and his interview on 60 Minutes. The premise is people with high speed computers, with close proximity to the trading location possibly gain privileged information. A computer sees trades being placed and “front-runs” the trades by buying up as much of the inventory on that stock that is available in the market (on other exchanges) before the original trade can be fully executed.
It takes a computer system a fraction of a second to beat the original order to the available inventory. Computer speed and geographic location means everything to the high frequency trader. The practice earns the high frequency trader pennies, even fractions of pennies, per trade, but this happens so often, the pennies add up to real money.
High frequency trading like this is not illegal, but it is still front-running and costs traders collectively millions to billions of dollars each year. Regulators have not made significant attempts to make the practice illegal. However, there is a new trading exchange, Investor’s Exchange (IEX), which is giving traditional exchanges competition after having created a “fair exchange” that slows down trades, making all trades take at least 350 milliseconds.
Are the markets rigged?
In our opinion, no, the markets are not rigged. Smart people have figured out a way to beat the system. After figuring out how this works, others are now working to combat the front-runners. Those who buy stock based on fundamentals and hold for long periods are not being significantly affected by the loss of a penny on the purchase and a penny on the sell. Although this shouldn’t happen, it is not fraudulent or illegal, and there is no sinister plot to steal your money.
It is easy to get tied up with someone taking a cut of your stock trades, but consider how low commissions are today relative to historical fees. Placing a full broker trade over the phone during the early 1990s cost of $125 per trade. Today, Internet trades cost $8.95 or less. People made money in the stock market in the early 90s and have even more opportunity to make money in the stock market today!
At Henssler Financial we believe you should Live Ready, and that includes understanding the how market behavior may or may not affect your long-term investments. If you have questions regarding your financial situation the experts at Henssler Financial will be glad to help. You may call us at 770-429-9166 or email at experts@henssler.com.
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