Is stock market rigged? Depends on who’s playing

MarketWatchMay 13, 2014 

Of course, the chairman of the U.S. Securities and Exchange Commission testified before Congress recently that the stock markets are not rigged.

What would you have expected her to say?

The question is not whether you believe Mary Jo White saying “the markets are not rigged” and proclaiming the “U.S. markets are the strongest and most reliable in the world” — as she did during a House Financial Services Committee hearing — it’s whether you should take the agency’s approach that “it’s clearly an issue … we’re focused on.”

There have been claims about the market being rigged for institutions and against individual investors for years, but they have become much louder since the release of Michael Lewis’s best-selling book “Flash Boys,” which details how high-frequency traders have wormed their way into the market, developing an information edge that gives them a window of milliseconds where they can front-run a trade, making the cost fractionally higher for the investor/institution that placed the order.

That’s just one piece of the case for the market being rigged; you can make others, and while some of them sound like raging paranoia, all of them have a basis in real actions that at the very least seem shady.

You could also spend a lot of time fighting those cases and trying to debunk them. That’s what White and the SEC are doing.

As an individual investor, however, you are better off giving into it. Don’t fight it; simply accept that in some ways the market is working against you.

There’s not much doubt that high-frequency traders are skinning investors, just as market-makers — the guys who maintained liquidity in stocks for decades — did in the past.

Those sharpies, presumably, are winning. They are getting theirs.

It doesn’t mean you can’t get yours; you just can’t win playing their game.

For all of the criticism of high-frequency trading — most of which has focused on “flash crashes” rather than front-running — there’s a lot of evidence that the action they have created actually has been good for investors.

Laurence Siegel, director of research for the CFA Institute, penned a piece this week, in which he noted that “it’s possible to imagine a kind of (high-frequency trading) that is completely harmless and in fact beneficial.”

Since high-frequency trading improves liquidity, there’s a case to be made that it improves pricing.

Whether some or all of that benefit is lost due to the front-running and other nefarious activity is an open question.

But truthfully, for a small investor it doesn’t matter much.

John Rekenthaler of Morningstar.com recently noted that big investors — specifically hedge funds — are the ones suffering from the issue covered in “Flash Boys.”

“Hedge fund performance has plummeted since the mid-2000s, when (high-frequency traders) came to prominence,” Rekenthaler said. “There are several reasons why, including the possibility that before (high-frequency traders) were hatched, hedge funds were the de facto micro-traders, using their superior resources and technology to beat retail day traders.”

Not surprisingly, hedge-fund managers are among the people beating the drum loudest about the market being rigged.

That’s proof that this is more of a rich man’s worry than an average investor’s concern.

High-frequency traders don’t care about the 100 shares of Proctor & Gamble you’re trying to buy, or even the 500 or 1,000 shares of Johnson & Johnson. There’s no real money for them in your trade.

Meanwhile, even if you are convinced they’re out to get you, the worst you wind up facing is an extra penny or two of costs. On that 1,000-share trade, that’s $20 bucks max; nobody wants to pay more than they must, but hold those brand-name stocks for years and those few dollars are negligible. (Moreover, it could be a wash, a give-back of the benefit you received due to improved liquidity.)

Distasteful? Sure.

A reason to avoid the market? Hardly.

The stock market is not a zero-sum game, or a winner-take-all poker tournament. Over time, if the market rises as the economy grows, everyone can profit.

Focus on long-term goals and ignore market noise, and you can coexist with the predators; you quickly realize that whoever is responsible for actions that lead to claims that the market is rigged is simply part of the sounds you are brushing off.

Chuck Jaffe is senior columnist for MarketWatch. He can be reached at cjaffe@marketwatch.com or at Box 70, Cohasset, MA 02025-0070.

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