Wow, this well known phenomena seems to have come out of nowhere! High frequency trading (HFT) has been around for more than 10 years. Sure the algorithms have gotten better and faster but the concept is not new. In fact, my old trading partner and I went to watch options master Jon Natharian (co founder of Options Monster and CNBC host) speak at an event hosted by my alma mater (plug here: University of Chicago Booth School of Business). This is three years ago and Jon had a presentation that visually depicted the HFT front running that has now apparently just been discovered by Mr. Lewis in his new book “Flash Boys”. The reality is this is not new and has been very well understood for many years. However, the media has picked up on this now and so now it has just become real to the average American. Another sad example of the false reality we live in day to day until our modern media brings us into the real reality. But I digress. The point here is that the market is rigged! I keep hearing it on TV.
The market is rigged. However, HFT is probably the least of the rigging. Sure if you have $100k per month to spend on a cheap algo trading system you can get in on this game. The real rigging comes by way of the banks. Banks use inside information all the time to generate excess returns. The entire commodity super cycle from 2003 to 2008 and even through 2012 banks took control of supplies via warehousing in hard commodities. Both Goldman Sachs and JPM were able to use warehousing to control both hard commodity supplies to the consumer market and control information in order to control trading profits. And hard commodities are not the only market segment that asymmetrical information is used to generate excess returns (see LIBOR scandal, which also was known by the regulators and not acted on until the ‘story broke’ by major media). If one uses common sense and looks at the trading records of these banks it is quite obvious the game is rigged. The trading desks of many investment banks like Goldman Sachs have gone entire quarters without having a down day, which means they had no days where their trading profits were negative. This type of record not only suggests but necessitates asymmetrical information is being used. Asymmetrical information means it is not available to all. Essentially it is inside information. This is illegal yet very rarely investigated. Typically when the SEC does investigate it is pointed at hedge funds and not banks.
The point here is that markets are absolutely rigged and in many ways. It astounds me that a well recognized manipulated system all of a sudden becomes a problem because a known author writes a book about it. The realisation should be that if any system can be rigged to benefit those who are able to rig it in their favour it will be rigged. Look at Washington DC. Our legislative system is completely rigged. Lobbying is probably the biggest rigging in America and we all recognize it yet we do nothing about it. So let’s not pretend that rigging the game is a breaking news concept. We see it all around us all the time and we as Americans have chosen to do relatively little about it. The responsibility is on all of us. If we are deciding now to alleviate rigging from the markets then let’s really do demand it. But let’s not stop with the markets. Let’s rid America of the art of rigging the game by those who have the wealth to do so. Markets like legislation is intended to be fair to all but if we the people allow it to happen those who can will certainly carry on rigging the game.