I do not directly invest in the stock market. I do not have the knowledge to do so nor sufficient interest to invest the time to study how it works to make the kinds of informed decisions that are required. Of course, my retirement money is invested by others on my behalf but that goes on automatically without any involvement on my part. I have no idea what is going on.
But any slight inclination on my part of become an active investor was further dampened by this report by Rob Curran that says that in these days of high speed trading, those with access to information that is even a fraction of a second before others get to know it can make a killing at the expense of the rest of us.
Terrence Hendershott, a professor at the Haas business school at the University of California at Berkeley, wanted to find out. He was recently given access to high-speed trading technology by tech firm Redline Trading Solutions. His test exposes the power of latency arbitrage the way Ben Mezrich’s Bringing Down the House exposed the power of card counting.
According to his study, in one day (May 9), playing one stock (Apple (AAPL)), Hendershott walked away with almost $377,000 in theoretical profits by picking off quotes on various exchanges that were fractions of a second out of date. Extrapolate that number to reflect the thousands of stocks trading electronically in the U.S., and it’s clear that high-frequency traders are making billions of dollars a year on a simple quirk in the electronic stock market.
One way or another, that money is coming out of your retirement account. Think of it like the old movie The Sting. High-speed traders already know who has won the horse race when your mutual fund manager lays his bet. You’re guaranteed to come out a loser. You’re losing in small increments, but every mickle makes a muckle — especially in a tough market.
“It’s clear to us these guys are just raping, pillaging, and plundering the market,” as Joe Saluzzi, co-founder of agency brokerage Themis Trading put it.
In this day and age where we think of ‘instantaneous’ global communications, we need to be reminded that the limit imposed by the speed of light actually plays a tangible role in everyday life. Those brokerage houses that are physically closer to the exchange have an advantage because the electronic signals carrying the information get there a fraction of a second before the more distant places. Brokerage houses are moving closer and laying dedicated high-speed cable lines just to gain a few fractional seconds.
This is another case where technology has outpaced a legacy system. Although there are ways to counter this defect, the stock exchanges have not taken steps to adjust. I cannot tell whether this is due to institutional inertia or willful neglect because the system is run by and for the insiders. But being the cynic that I am that the world is rigged to favor the oligarchy at the expense of the rest of us, I suspect the latter.