Yesterday the Nasdaq crashed, the system locked up for 3 hours, experts cite the reason to be an every growing complexity to the nature of the system, and I think this goes to show us, yet again, how insane we are to believe the stream of deception that individuals can compete within a fair market system.
We are being bombarded with data regarding the markets, we live in a day and age where have a two screen monitor set up and access to charting software is affordable for anyone with $500 to spend. And every man and his dog is now encouraged to be a speculator. I use the term speculator as Benjamin Graham did, since the proliferation of the term ‘Investor’ when it comes to all things trading is very misleading.
Every day it seems I get to see some nonsensical fact shared on social media, a barrage of ‘retweets’ of anything involving the word ‘stock’ from @cnbcfastmoney and a plethora of experts. I’m sorry guys, but some 14 year old tweeting that $FB is a ‘Buy’ because of (pull reason out of my backside) is no reason to actually attempt to trade.
So, you have your ‘data’ coming in from these Fast Money shows, and your streaming charts, the Nasdaq crashed because of the toys the real traders play with:
Dark Pools
There are now over 40 Dark Pools in existence; these are closed door transactions where institutional clients can trade large quantities of stocks hidden from the market. In an age where I am told market theory will prevail I find it hard to understand how an efficient market exists when a subsection of the market is allowed access to trading and data that is exclusive from the common man. Think of it this way, you could see that ticker symbol that some goofball is retweeting and put a buy order in for $10,000 at $10 per share. Meanwhile, the share is being traded at $5 within the pools.
High Frequency Trading
Algorithms dictate when to buy and sell a stock, hoping for fractions of a cent in profit and executing in those moments between regular trades. For example if Joe the plumber wants to buy $10,000 of Home Depot stock on his iPhone App at $10 per share and Tom the Baker wants to sell at $9.90 the trade, in a fair market system the trade could happen at any price between $9.90 and $10 to keep both parties happy. However with high frequency trading the HFT firm could in billionths of a second buy the stock from Tom at $9.90 and resell it to Joe for $10 and pocket the 10 cents difference.
I know a few guys who make and sell HFT technology and it is amazing what they do- even the physical distance between their superpowered computer and the stock exchange matters, since data travels through wires just as it does on your internet connection, the shorter the wire the faster the data flow. Joe the plumber walking around the mall responding to tweets from some Fast Money show and punching in a buy or sell order on his iPhone is so tragic that it is beyond laughable.
Market Making
What these firms are doing by controlling the Bid/Ask spread is market making, it is something that the exchanges actively encourage. In fact, since Lehman brothers collapsed the stock markets pay a premium to firms who are willing to get involved on the Bid/Ask spread and make it appear that there is a market for your equity. Think on that. Since the biggest financial fall in our financial history people running the stock market are injecting money (taken from profits from you ‘traders’) in order to prop up a trade to get real money in the game…
Solution
No matter how advanced you believe your trading solution to be, any strategy that you have has already been calculated, by the time something has been tweeted it is too late, by the time the ticker symbol finally moves across the screen it has been read and processed thousands of times by computers. You simply cannot trade on data in a system where the house stacks the game against you, it is like playing poker when they know what cards you hold.
If you want to be involved in this cesspit of double dealing, which is what the market is when the playing field is not even then you have two routes to take:
- Passive Investment Strategies – these do not respond to the market, they follow a disciplined strategy. Unfortunately HFT firms know of the rules that Passive Investors play and as such will jump into trades when the megaliths of this space, the Insurance and Pension companies rebalance their positions. So even then there is profiteering from the safer strategy, but at least its something…
- Long Term Value Investing – Value Investing looks at a stock as a share in a company, the original definition. It considers management, products, environment, as though you were buying the entire company. This should be the best way to invest, but being able to correctly price a company, and be resistant to the wild fluctuations of the market is often beyond the scope of most investors. Unfortunately this strategy is so hard to keep faithful to as perceived value trumps actual value in a market filled with statistical diarrhea.
I’m a firm believer in a fair market, and I love the idea of being able to invest and also being able to speculate within the markets, but I think that seeing the crash yesterday should remind us all that there is so much technology being plugged into it that even the market itself cannot keep up, and when you have created this great and powerful machine, it can only be fed by the little guys money. Be careful my friends.
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