Is the stock market rigged?

Some people think so. And after reading Flash Boys, it’s difficult to disagree.

Michael Lewis (the author) is known for shining light on dark places and bringing transparency to otherwise opaque industries. If his name sounds familiar, it’s because he also wrote The Blind Side, Moneyball, The Big Short and, my personal favorite: Liar’s Poker.

In this recent novel, Michael Lewis examines the investing injustices caused by High Frequency Trading. The details may have faded over the last 6 months since I read the book, but the underlying problem and the thought that “the stock market is rigged” still sits in the back of my mind. I truthfully didn’t love this book enough to recommend it, but a summary may prove useful during your visits to the water cooler.

What you need to know about Flash Boys:

• While “trades” used to occur person-to-person on a “trading floor,” most trades nowadays are made electronically by computers and advanced algorithms.
• Speed is everything and not all information travels at the same speed. If 2 people uncover news and want to buy the same stock – those 2 orders are not made simultaneously. Being the fastest can be profitable.
• Speed matters so much that banks/brokers have tried to place their servers as close to the exchanges as possible. Some have gone to the extremes of burying fiber optic cables in straight lines between New York/New Jersey/Chicago/etc. in order to gain milliseconds. I repeat…milliseconds. Milliseconds = Million$
• “Front-running” is the primary concern with varying speeds. If I know that you want to buy a certain stock, I can buy it before you (causing the price to rise) and then sell it to you (for micro-profits).
• Our incompetent leaders government (SEC, Senate, etc.) claims that High Frequency Trading provides much needed liquidity in the markets even though there is absolutely no risk taken on by these organizations and there’s potential for billion dollar losses and recoveries (see: Flash Crash) in the span of seconds.

If I piqued your interest, then “go me!” and go read the book. And have fun worrying about all of your wealth disappearing instantly and viewing the stock market as a casino. 

Why I Invest in the Stock Market (knowing that it’s rigged)

Now, 393 depressing words later, I’m going to tell you why I am still very bullish on stocks even though I know that someone will steal some pennies from me on each trade. (I tell myself that I’m little affected by high frequency trading because I’m a buy and hold investor, but who am I kidding? They’re robbing me, too.)

1. History

The first disclaimer in every investing pamphlet or prospectus usually reads: “Past Performance Does Not Guarantee Future Results.” It actually makes me laugh because immediately following this disclaimer is “You Should Invest with Us. Look How Well We’ve Done!” Although future results cannot be determined by past performance, history can often serve as a useful tool. I think it was Mark Twain who said: “history doesn’t repeat itself, but it rhymes.”

The rhythm of the stock market is hard to ignore. The trend has noticeably been “up and to the right.” Over long periods of time, the stock market has created vast amounts of wealth. I’ll gladly follow that pattern.

2. Innovation

If they could redo Back to the Future 2 and visit the year 2015, do you think they would show every person staring at their cell phone and complaining about something? Probably not, what a terrible movie that would be! But, aside from our diminishing attention spans, our lives have become extremely easy and productive thanks to continuous innovation and technology. The future that we know about (3D printing, big data, biotech, marijuana) offers some great investing opportunities, but I’m willing to bet that what we don’t know about is even more promising.

3. Inflation

There’s a monster that sneaks into your house every night while you’re sleeping and steals miscellaneous items from you. What’s scary is that the monster is invisible. But, he’s not stealing items and you’re not sleeping. The monster is (hopefully obvious by now) inflation and it’s decreasing your wealth each and every day.

Stocks have, historically, been a great hedge against inflation. Choosing to “do nothing” with your money and losing purchasing power can be combated by higher returns in the stock market – whether it be through stocks, index funds or mutual funds. Since the US dollar is no longer backed by gold, the Federal Reserve can expand our monetary supply to whatever levels they deem appropriate. It’s difficult to feel this impact now as oil prices are falling, but a lot of smart people predict inflation as soon as wages grow.

4. Liquidity

There are other assets – such as real estate, gold, etc. – that also provide a hedge for inflation; but, there are few that offer the simplicity and liquidity of stocks. As the dollar weakens and prices rise, the value of my house will likely rise as well. But, what if I want to sell that house? Or, what if I want to sell a portion of that house? These real estate transaction can be difficult (if not impossible) whereas I can click a button labeled “sell” on TD Ameritrade and transfer the money to my bank account within a day or two.

Readers: Do you think that the stock market is rigged? If so, do you care?

Disclaimer: Someone could just as easily put together an article highlighting why they’re pessimistic about the future of the stock market. They may say that the stock market is due for a pull back because it’s been on an absolute tear over the past 5 years. They may say that rising interest rates may affect PE ratios and investors willingness to pay higher multiples of companies’ earnings for higher potential returns. And they’d be right. But, it’s much more fun to be optimistic than think the sky is falling.