60 Minutes recently reported on a new book by Michael Lewis entitled “Flash Boys.” The book explains how high frequency traders have “rigged the US Stock Market” by using computers to identify the stocks you want to buy, purchasing the shares of that stock (effectively pushing up the price), and then selling them back to you for slightly more than they paid for it. See the entire 60 Minutes story below.
Although no one wants to feel like there is someone out there ripping them off, by employing a disciplined investment philosophy you can not only avoid getting ripped off, but you can actually take advantage of opportunities.
So what’s an investor to do?
Here’s our philosophy:
To achieve this diversification in a cost-effective way, we often use mutual funds. Mutual funds trade at NAV (net asset value) essentially meaning we purchase based on the closing price for the day (which isn’t bid up by high frequency traders.)
We utilize professional money managers like Dimensional Fund Advisors that have the ability to actually provide value through trading rather than being slowly nibbled to death through trading costs.
Every time you buy and sell investments that is called turnover. Turnover costs money, whether it is through high frequency traders, transaction costs, or taxes. Employing a low turnover strategy keeps the money you have working for you.
High frequency traders have been blamed for flash crashes and other short term disruptions in the stock market. An investor who panics may do long-term damage to their financial plan. By having a plan and the discipline to stick to it, we help our clients avoid short term noise and capture the long-term returns of the stock market.
While there are problems with high frequency traders, they also increase market liquidity. By increasing stock market liquidity, the spreads (the difference between the bid and asking price of a security) actually drop. The disciplined investor will not only avoid the problems associated with high frequency trading, but will be able to take advantage of the increased liquidity provided. So what do you think? Are high frequency traders and computer algorithms ruining the stock market? Or will the same technology that allows lightning fast trades be able to improve transparency in the markets? We’d love to hear your take in the comments below.