Tags: HFT | Lewis | trade | cost

The Other Side of the Coin to Michael Lewis' 'Flash Boys'

By    |   Monday, 21 April 2014 07:38 AM EDT

Recently, Michael Lewis brought the issue of high-frequency trading (HFT) to the public. In reality, it was just great marketing exposure for his book, Flash Boys.

HFT isn't a new thing and neither is the subject that he discussed. You see, he says that the stock market is rigged. Why? It's because of the ability for traders to use computers and algorithms to trade in and out very quickly within seconds to even milliseconds and gain an edge.

Lewis talks about how an HFT order could jump ahead of other orders and gain an edge of up to a penny. He talks about how this made an individual's investing and trading more costly.

However, I'd like to talk about the other side of that coin and bring a good bit of balance to all of this.

Lewis' interviews make it out like there's no use in investing in the stock market since HFT exists and gives those guys a slight edge over the individual.

This thought process of his is ludicrous. Why? Ever since stocks have been traded, there have always been groups of people who had an edge over others. Yet it didn't prevent the others from making respectable gains in the market.

For instance, ever since stocks were able to be traded here in the United States, back in the 1800s, traders could "buy seats," which gave them an edge.

Surely you've heard of someone "owning a seat on a stock exchange" or about the price people pay to buy a seat on an exchange? This "edge" was so great to traders that the price to buy a seat on the New York Stock Exchange reached $4 million back in 2005. (I haven't checked it lately, but back in 2012, it cost around $2.5 million for a seat on the NYSE.)

This "seat" gave them the right to trade on the floor of the NYSE for their own accounts or for that of their clients. So, essentially, they paid for that edge.

No one flipped out then when you could legally purchase an edge and trade directly on the floor of the exchange.

Do you think the floor traders knew things before the Average Joe did? Of course.

Then, of course, there were specialists on the floor of the NYSE who made markets in these listed stocks on the NYSE. They took upon market risks personally, but they also had an obvious edge too. Did anyone freak out about that? No! Were people still able to trade and invest and profit? Sure!

In the 1970s and 1980s, the Nasdaq became a popular place to trade also. They had "market makers," which were similar to specialists on the NYSE. These market makers made markets electronically rather than by being at a physical post on the floor of a stock exchange. Yet they did a very similar job.

Market makers carried personal market risks as they "made markets" in bringing buyers and sellers together. However, they too had an edge as well. Were people able to profit back in the 1980s, 1990s, etc. with market makers having an edge? Sure!

In fact, you have a better shot at making money in the stock market today, as an individual investor, than you've ever had in your entire life! How so?

Back in the early 1970s, if you wanted to buy some shares of stock as an individual investor, it typically required you to have a high opening balance. Why? Well, for starters, your broker might charge you $100 to $300 per trade to buy or sell a stock. Now, imagine how expensive that would be today, much less back in the early 1970s! Therefore, stock trading was considered to be a "rich man's game."

But in the mid-1970s, the discount brokerage industry was birthed by firms like Charles Schwab. They helped to bring stock investing to the every-day man.

When I began working for Schwab back in the late 1990s, you could buy shares of stock for $29.95 per trade, which was significantly less than the $100+ per trade that a Merrill Lynch broker would have charged for the same stock purchase.

These days, you can sometimes get some free trades when you open an account. The account balances can be $2,000 to $5,000. Then, when you do start paying commissions on your trades, it's typically $4 to $9.99 per trade, depending on which stock brokerage firm you go with.

So, imagine being able to get started with a small balance and paying a tenth or twentieth of what you would have paid in commissions just 20 years ago.

Do you think you have a greater edge as an individual trader or investor these days with such lower costs? I certainly do!

In addition to this, you have another cost that a lot of people don't think about. It's called the "spread cost." This is the cost between the sell and buy quotes.

These costs used to be about 10 to 25 cents. In other words, when you purchased a stock, you'd instantly "go negative" on the investment until the sell price gained in value up to the buy price, which was your breakeven price.

These days, the spread cost between the buy and sell quotes are typically a mere penny. Once again, the hurdle that you have to overcome in costs is greatly reduced.

So when I've lived long enough to see commissions of hundreds of dollars reduced to a handful of dollars and I've seen spreads drop 10- to 20-fold, do you think I worry about an HFT gaining an edge of a penny on me?

As an investor, do I really care if I paid $25.01 per share and he paid $25? Can I still make money on an investment as I discerned the fundamental valuation to be undervalued, and therefore bought and then later on sold at a higher price? Sure!

Do I feel the market is rigged against my subscribers or me? Of course not! If I did, I wouldn't have chosen to invest in markets with my own money and help others to do likewise.

So I believe Lewis has marketed well and will sell tons of books. But in doing so, I believe he's got the average investor focused on the wrong thing. He's got them thinking they can't make money in stocks because the market "is rigged." Well, this simply isn't true.

Oh sure, these HFTs have a slight edge over you and me. But edges have always existed in markets and yet people were always able to make money.

Heck, when I first started actively trading back in the late 1990s, I couldn't even get real-time quotes on my stocks. They were always delayed by 15 to 20 minutes.

So there were so many barriers that the individual investor used to have, from delayed information to much higher trading/investing costs that simply are much different now. And it's different, in a good way!

Therefore, don't let Lewis' interviews deter you from investing for your future, your retirement and a better life for yourselves and for those you love. The stock investor is NOT at a distinct disadvantage. Only the ultra-short-term hyperactive daytrader has to worry about the edge that these HFTs have, not the guy or lady investing for their retirement.

God bless!

About the Author: Sean Hyman
Sean Hyman is a member of the Moneynews Financial Brain Trust.
Click Here to read more of his articles. He is also the editor of Ultimate Wealth Report. Discover more by Clicking Here Now.

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Recently, Michael Lewis brought the issue of high-frequency trading (HFT) to the public. In reality, it was just great marketing exposure for his book, Flash Boys.
HFT, Lewis, trade, cost
Monday, 21 April 2014 07:38 AM
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