The Stock Market is rigged – In the favour of “low frequency traders”

Michael Lewis’ accusations aimed at high frequency traders (“HFTs”) can be seen as a revelation that strikes at the very core of the problems of the incentive system behind today’s financial markets, or a cynical and misstated attempt to sell a new book.

The reality is probably that it is both. However little these activities truly impact markets, the reality is that there is no victimless crime, and so investigation and some kind of regulatory action seems appropriate. However, for ordinary investors, it is probably something best ignored.

This is because, for most of us, making money through investment is about long time horizons, not short ones. It is almost received wisdom that focusing on buying at the right price and ignoring short term moves is what works – most strategies that have evidence of success, and particularly value investing, rest their claims on sticking with an approach for multi-year time periods.

The problem is that for many of us, this is very hard to do. There is plenty of academic evidence that investors, through overconfidence or panic, trade too much. This is costly, both in terms of fees and in simply making the wrong investment choices. Nor is over-trading and short term time horizons  limited to individuals, in an industry that focuses so closely upon short term performance measures it is perhaps no surprise that among fund managers portfolio turnovers have increased and holding periods have declined. Many simply do not have the patience to follow their own investment strategies.

And this is a good thing for the low frequency traders.

The more investors succumb to the pressures of short term volatility, the more opportunity that is offered to those prepared to tolerate it. When others worry too much about the short term, it can leave bargains on the table for those who are more emotionally resilient. And this opportunity for positive returns can far outweigh any “skimming” of individual daily trades that HFTs may carry out.

And unlike the HFTs for whom: “if it wasn’t complicated it wouldn’t be allowed to happen” this is a route to investment success that is almost too simple.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.