Considering the recent Wolf of Wall Street movie and a controversial 60 Minutes piece on the release of Michael Lewis’ Flash Boys: A Wall Street Revolt, it’s no surprise this question is getting a lot of media attention. If you missed the 60 Minutes piece that aired on March 30, 2014, take the 15 minutes and watch the clip below.
Coupled with blaspheme terms such as high frequency trading, scalping, leverage, latency, etc., it makes matters more controversial for the trading world. For those that didn’t make it through the whole video, suffice it to say, there are certain traders who are able to essentially see into the future of stock prices by having a speed advantage. So back to that question…
Is the Stock Market rigged?
60 Minutes did a really good job of using a choice word in this piece: rigged. Using the term rigged sets the wheels in motion for a controversy immediately, especially when the subject of the interview says “Yes, the markets are rigged.” Rather than use rigged, a more proper term would be inefficient. Inefficiencies exist in every market, and those that are intelligent enough to capitalize on them will do so as long as they possibly can until that inefficiency is corrected. Because these inefficiencies exist, so will these scapegoats who find the inefficiencies and capitalize on them. Is it wrong to capitalize on inefficiencies?
This can be the topic of a heated debate, but it is the free market’s job to become efficient as possible. But what happens when the free market (the exchanges) are the ones capitalizing on the inefficiencies? I contend that if the market is truly a free market then it will correct itself. The twist is, we have regulated markets. Therefore, maybe the market is not completely free?
Enter Brad Katsuyama, who saw this inefficiency and has attempted to, and succeeded at, capitalizing on it in a different way by creating a more efficient exchange, IEX (Investors Exchange). Mr. Katsuyama leveled the playing field by slowing down everyone’s trades. Therefore, those that gained an edge by having faster trade execution times no longer had that edge. In a perfect world, everyone would leave these exchanges that were front-running orders, or “High Frequency Trading/Speed Trading” and go to IEX.
Oddly enough, there are countless exchanges available for investors to choose from, all of which are regulated to prevent activity such as this.Or so we think.
Almost four years ago, 60 Minutes aired a piece on “Speed Traders,” which is a shockingly similar story to this latest piece. However, in this expose we find out that large financial firms, such as Goldman Sachs, have developed their own private exchanges to conduct high frequency trading. Goldman’s Sigma X exchange was designed for the purpose of carrying out high frequency trading in-house, not to the open public.
Here is the 60 Minutes piece on Speed Traders which aired October 10, 2010.
Here’s the catch, the SEC was to be checking into these Speed Traders as of airing in October of 2010. After all, the SEC is the regulatory body set in place to ensure the markets are fair, because surely the free market is too ignorant to figure it out themselves. Although, the regulators were to be looking into this four years ago, and large institutions openly admitted to using such techniques, the high frequency trading went on.
Fast forward four years, and a more efficient exchange later, the same issues exists. However, this time we have leaders of the exchange outraged that Brad Katsuyama developed a level playing field in the exchange. Brad is even demonized on CNBC by the Director of a particular exchange, BATS, which is alleged to doing this front-running. Why on earth is Mr. Katsuyama and a book release the catalyst into an investigation on an illegal issue which was publicly aired on a hugely popular national television show four years prior?
So what do you think? Is the stock market rigged because of high frequency traders?
Of course it’s rigged, and likely always will be to a certain degree. It’s been that way since day one. If it wasn’t, this wouldn’t have been the talking point of 60 Minutes, Senators and regulatory bodies four years ago, and again recently. In a perfect world, the regulators would prevent this or they would step out of the way and allow exchanges to conduct business as they please. But they are the very ones who allow these high speed data feeds in the first place. What we have here is a grey area, where the Bernie Madoffs of the world can be audited 7 times and never found guilty of anything until a non-regulatory whistle-blower comes forward.
As the 60 Minutes clip mentioned, many of these high frequency traders are now moving into currency and commodity markets. The problem with these markets are not only are the regulators considerably more relaxed, but the brokers themselves have many more tools to rig the system. However, that is not to say inefficiencies don’t exist… I have been able to find these, and I have also been burned by brokers whom decide to make up rules as they go. This will be the topic of another post. Check back on Tuesdays for more trading posts by The Trading Travelers.
We are Brittany and Charlie - we traded the 9 to 5 and the so-called "American dream" to live our own dream and see the world. We sold all of our belongings and left the US in August 2013. For 5 years, we lived primarily in Thailand and built our online business and location independent lifestyle while we traveled to over 30 countries. We’ve had house sitting gigs on 3 different continents and we’ve even appeared on HGTV’s House Hunters International.
Bernie only imprisoned because he ripped off wealthy, prominent people directly; had victims been poor or “taxpayers” collectively he could have run for governor of Florida. lol
Hey dude, I was a day trader in California for nearly a year back in like 2010 haha, I love this little niche on here. I mainly follow tech stocks really, but I traded in energy when Obama first came in and got out after he abandoned his “green initiative”. We should chat sometime! I got out, since I don’t have the money to trade like that now, but its still the first thing I check everyday haha.
Wow some definite food for thought here guys, thanks for posting. As I’m just beginning to dive into this world of day trading, you got me hooked! I’ll be gripped like a gargoyle to my keyboard til I see your follow up.
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