Markets ARE rigged, but not because of high frequency trading

Don’t let Michael Lewis scare you about high frequency trading: we have a reasonably well functioning stock market

Michael Lewis is a great book seller. He’s worked retail investors investors into a frenzy of panic about high frequency traders (HFT), accusing them of “rigging” the market. High frequency trading might sound scary, but it doesn’t hurt retail investors. What does hurt everyone is insider trading. And the market sees too much of it.

For example, National Australia Bank Ltd (ASX: NAB) trader Lukas Kamay and Australian Bureau of Statistics employee Christopher Russell Hill were arrested last week after a sting by the AFP. It’s pretty appalling that someone who works for the government was allegedly taking bribes so someone who works at NAB could allegedly place trades based on inside information. It’s pretty fortunate that foreign exchange broker Owen Kerr was able to uncover the connection using LinkedIn. NAB says that the charges did not relate to his work at the bank, although it’s fair to say that Kamay’s interest in foreign exchange trading might just have had something to do with his role at the bank. Bizarrely, Kamay used his allegedly ill-gotten gains to buy one of the apartments that featured on pop TV show, The Block. Sadly, people like Kamay do rig the market – that’s essentially what insider trading is.

Basic logic should tell you not to pay much attention to Lewis’s attack on high frequency traders. HFT takes away from the massive buyers and sellers who move around billions, not everyday investors, with portfolios valued in 5, 6 or 7 figures. Let’s be clear, high frequency traders don’t hurt small investors in any noticeable way. Indeed, by causing big sellers to move the market more, they may even help us, as we can take advantage of that extra volatility quite easily. All that long term investors need to do to prevent HFT’s taking a cut is to set limit orders at the price you are willing to buy or sell and not budge from there.

In an excellent response to Lewis’s book, finance expert Scott Locklin recently wrote that, “They seemed shocked, shocked, that the market would move away from their ham-fisted dumpings of huge blocks of shares to someone else’s routing system… Lewis tries to make this seem like a battle between the underdog “good guys” and the evil establishment. To believe this, you’d have to believe that Goldman Sachs and people like Einhorn are underdogs, rather than the actual establishment.”

Speaking of Einhorn, he has been convicted of insider trading, as have former employees of the big buy-side firms including J.P. Morgan, Goldman Sachs and Morgan Stanley. There is no reason to fear HFT if you are a normal investor: worry about the establishment instead.

In Australia we have fairly decent laws to prevent insider trading, though unfortunately they are not enforced as much as they could be. As Kamay’s arrest demonstrates, they do work sometimes. The few arrests that actually do happen act as a powerful deterrent for others who might want to commit such crimes. By and large, we’re very lucky in Australia to have a market that functions reasonably fairly most of the time.

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Motley Fool contributor Claude Walker (@claudedwalker) does not own shares in any of the companies mentioned in this article.

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