Money Sundays: High Frequency Trading (HFT) and Why So Many Think the Stock Market Is Rigged

In light of all the recent media chatter about High Frequency Trading (HFT), and with the brilliantly marketed release of Michael Lewis' new book Flash Boys, I have a question for readers:

Why do so many people think the stock market's rigged?

Here's one possible reason. It's a rationalization. If you believe the market's rigged against the small investor, then you have a bulletproof "reason" for entirely ignoring stocks as a wealth-building tool.

If you really wanted to run with this rationalization, it could enable you to avoid the entire process of saving and investing for your future. "What's the point of learning how to invest? Why should I bother to read books about stocks? Forget it. The whole system's rigged anyway."

I'll go further. If there were ever an ideal time to deploy a psychological defense mechanism to rationalize not saving and investing, it's right now, after a multi-year period when it was a really, really, REALLY good idea to have been in stocks all along. The past five years have offered patient investors one of the best bull markets in history. But if you believe "it's all rigged" you can very easily excuse yourself for missing out on an extraordinary period of wealth-building.

Are you getting vaguely irritated, even angry, reading this post so far? Then this post is for you. Consider the possibility that you might be making this exact rationalization.

The point, of course, isn't to beat yourself up for past investment mistakes. Despite all the authoritative and decisive-sounding commentary in the financial media, nobody knows what the stock market's going to do. Know this, and act accordingly, by keeping some modest exposure to stocks at all times--usually via low-cost index funds or via shares in dividend-paying stocks. Along with other asset classes and a fully-funded emergency fund, stocks must be a part of your long term wealth-building strategy. Build your competence in using this important wealth-building tool.

Have you taken all the steps you should to protect your family's long term financial future? If not, perhaps it's time for you to stop rationalizing... and start taking action. Consider it.

Forget about HFT. If you act prudently, save aggressively, invest predominantly in dividend-paying stocks, don't overtrade, and--most importantly--use limit orders (not market orders) to make your investments, none of this HFT stuff matters. At all.

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chacha1 said...

interesting post. :-) I would say ...

I *do* believe the stock market is rigged, in that I think it is almost certainly manipulated by high-volume traders (not necessarily by high-frequency traders); BUT

I *do not* believe that this is likely to seriously damage my own investments as long as I buy and hold. If I try to game things, I will lose (statistics bear this out) but if I am patient and continue to contribute, things will work out in my favor over time.

My retirement account is in a stock-heavy 401(k). By stock-heavy I mean it's 80% in stock mutual funds and 20% in bonds.

The strongest determinant to lifetime success in investing is simply *putting money in the account.* That's what I've done faithfully over time, and as the market has risen so has my portfolio.

Sure, things go down occasionally. Perhaps when the high-volume buyers decide it "should." But as long as I leave it alone it's going to be fine.

The worst thing I could have done would have been to convert to cash at the bottom of the market and then sit around and say "it's all rigged, I'm never buying stock again."

It may well be rigged, but the point is that is rigged to make a profit for people who own stocks.

Daniel said...

I hear you. But I think "the stock market is rigged" is just the wrong paradigm for how to think about it.

There are always going to be situations where some investors are more informed, smarter, work harder, whatever. At times those investors may be on the other side of your trade, so to speak. But if you've chosen an attractive value at which you'd buy a given investment, whether the market's "rigged" or not doesn't matter.

For investors who don't buy individual stocks, having a set percentage mix of stocks/bonds/cash and rebalancing once a year or so effectively does the same thing.

There's a quote from Buffett that's directly relevant:

"If a moody fellow with a farm bordering my property yelled out a price every day to me at which he would either buy my farm or sell me his -- and those prices varied widely over short periods of time depending on his mental state -- how in the world could I be other than benefited by his erratic behavior?" Buffett writes. "If his daily shout-out was ridiculously low, and I had some spare cash, I would buy his farm. If the number he yelled was absurdly high, I could either sell to him or just go on farming."

The point here is the market (and the other participants in it) don't matter nearly as much as whether you've made an investment at a proper price at a good value.