4/2/2014 4:49 PM – Is the Stock Market Rigged?

Michael Lewis, an author whose past work I have appreciated has a new book out called Flash Boys that the news show 60 Minutes highlighted Sunday. The show called the segment,”The Stock Market is Rigged” because that is the assertion Michael Lewis makes.

Is he right? Yes. And, no.

Flash trading has been around for the roughly 10 years since an institutional trader noticed that most of the shares he was buying or selling were getting a different price than what the quote on his screen led him to expect. Now, a trader sees prices not in dollars and cents like we do, but in prices out 5 and 6 places to the right of the decimal point. It was out in that neighborhood that he noticed a price difference. What was going on?

Apparently, someone had figured out a way for ultra-high speed computers to see the trader’s order, buy shares in mere milliseconds at a lower price from another institution and sell those shares to the first trader at a very, very slightly higher price than what he expected. They were able to do this because they had found a faster electronic circuit across Manhattan for their trading than what he had. We’re talking a couple milliseconds, folks.

Now, yours’ and my stock orders are far, far too small for a flash trader to even consider. He’s looking for orders of thousands of shares. So, the “no” part of my answer is that flash trading does not affect your stock orders. However, flash trading does make a difference if you are named Fidelity or Vanguard. Industrywide, the difference looks to be about $1.2 billion in 2014, down from $4.9 billion at its peak in 2009.

Several studies have shown that flash trading actually has the net effect of lowering the net cost of trading. Remember, there is some cost to every stock trade – that’s how brokerage firms make money. And, several studies have shown that the overall cost of trading is in fact, dropping. Some say that is due in part to the greater trading volume caused by flash trading. Others respond that, “No, flash trading increases costs but it is being overwhelmed by other factors that lower costs.” I’m not a trader, but I have been in this industry for 30 years, and I agree with the latter camp. I think flash trading should be banned.

Here is what you need to remember, though in order to put ultra-high-speed trading in proper perspective. Ultra-high-speed trading does not change the fact that over the last 100 years, stocks have on average given investors the highest return. Real estate is a strong competitor for that title, but real estate is much more difficult to buy and sell and is very difficult to own in a retirement plan, unless the plan is very large.

Bottom line: Whether or not flash trading is banned should not change your decision on where to invest your money. Hope that helps.

Dave Hoshour

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