Acclaimed author Michael Lewis has just released his latest book, Flash Boys, in which he claims that the United States stock market is "rigged by a combination of the stock exchanges, the big Wall Street Banks and the high frequency traders".
Lewis has received rave reviews and plenty of attention with his two of his previous blockbuster books, Liar's Poker and The Big Short exposing the flaws in big finance, the drama behind the global financial crisis and the crash of US securitised mortgages.
Now he's turned his attention to the high frequency traders (HFTs), who now make up an estimated 60% of trading in the US equity market. It also raises long held fears for retail investors and traders that they are competing on an unlevel playing ground, with HFTs benefitting the most.
Recent comments by high frequency trading firm Virtu that it had just ONE losing day in 1,238 days (more than three years) have confirmed those fears.
HFTs use complex and sophisticated algorithms that can execute trades milliseconds before other investors to gain a price advantage in stocks they are trading. In some cases, high frequency trading firms pay extra to receive price sensitive news information before other investors. Again, it's only milliseconds, but enough for the computers to crunch the data and execute a trade long before 'humans' can do the same.
"It's crazy that it's legal for some people to get advance news on prices and what investors are doing," Lewis says.
Wall Street Investment banks have the technology to facilitate the high frequency traders, and the stock exchanges have encouraged this activity by allowing firms to have co-located computers as close as possible to the exchange's own servers, and superfast fibre networks linking the firms and the exchange. High frequency trading firms also receive fee rebates because they lodge large numbers of buy and sell orders.
Locally, the ASX Limited (ASX: ASX), which oversees the main stock exchange and our investment banks are heading down the same path. HFT accounts for an estimated 27% of trading volumes on the ASX, according to Australian Securities and Investments Commission (ASIC).
Last year Industry Super Network estimated that long-term investors were losing more than $1.6 billion in profits, thanks to high frequency trading. And it seems just like in the US, our regulator has been caught behind, unable to keep up with the rapid changes. Last year, ASIC chairman Greg Medcraft said concerns about HFT were 'overstated'.
Foolish takeaway
As Peter Sorrentino, senior portfolio manager at Huntington Funds says, "If you're day trading against these guys you're going to get crushed", but he adds, "If you're an investor with a long term focus, then this is just noise." Yes Foolish readers, we have nothing to worry about over HFT, as long as you stick to the long-term investing path.
