The Market Is Rigged… Here’s How To Beat It
When it comes to the stock market, we’re all sheep quietly marching to get slaughtered…
At least that’s what the alarmists are saying when it comes to Michael Lewis’ new book, “Flash Boys: A Wall Street Revolt.” His analysis has roiled commentators the world over by shedding light on the unsung world of high-frequency trading (HFT).
You’re probably familiar with Michael Lewis, even if you aren’t readily aware of it. Lewis, a former bond trader with Salomon Brothers in the 1980s, used his experiences to write the best-selling book Liar’s Poker and has since written multiple best-sellers such as Moneyball, The Blind Side and The Big Short.
In Flash Boys, Lewis paints a picture of Wall Street’s dark underbelly, where complex computer algorithms make lightning-fast investment decisions normal humans are simply incapable of.
#-ad_banner-#In the simplest of explanations, this sensitive information allows traders to work about two to three nanoseconds ahead of the rest of the market (to give you an idea of how fast that is, it takes roughly 100 nanoseconds to blink your eye).
Most experts have no idea what’s in these algorithms, but they do know that Wall Street traders can profit from them by executing buy and sell orders during that small window of time.
While the margins are small (each trade earns about $0.01 to $0.02 in profit), HF traders can execute this strategy millions of times a day. Thanks to the volume of trades involved, those pennies add up. It’s believed that the most aggressive high-frequency traders can collect as much as $45,267 per day.
These revelations have caused quite a stir. Lewis has been featured on 60 Minutes, explaining his findings… and the FBI is even getting involved now, looking into potential abuses by these sophisticated trading firms.
This controversy has entered the mainstream financial news, too. Earlier this month, there was a heated exchange on CNBC, in which Brad Katsuyama, one of the central figures in the book whom Lewis paints as trying to ‘fix’ the system, pitted against William O’Brien, President of the BATS Global Markets exchange. This debate got so intense, floor traders on the NYSE stopped dead in their tracks as they watched the two throw verbal jabs at each other.
This whole controversy seems to have delved into one central question: Does this mean the market is rigged?
At this point, I want to make some perfectly clear. If you regularly follow our advice here at StreetAuthority, then high-frequency trading should not worry you.
Yes, it’s unfair. And yes, it means that — to an extent — the stock market is rigged. But high-frequency trading isn’t the problem.
The problem is that professional traders — the ones who use strategies like high-frequency trading — have made careers out of buying and selling stocks in the short-term. It’s how they feed their families… pay their mortgages… and finance their vacation homes.
So while high-frequency trading does provide traders with an advantage, you have to remember that these people make their livings by finding those advantages. If high-frequency trading were banned tomorrow, these traders would just discover another way to rig the game. They’ve been doing it since The Rothschild banking empire started using carrier pigeons to detect cross-border arbitrage opportunities in the early 1800s.
The good news is that the stock market wasn’t intended to create employment opportunities for fancy Ivy League business graduates. Sure these guys might earn a few million dollars every year using this strategy. But in the long-run, their overall effect on the market is relatively insignificant.
For example, one of the most notable cases regarding high-frequency trading involves the May 6, 2010 “Flash Crash.” During that time, the market lost around 6% of its value in a matter of minutes as the complex algorithms high-frequency traders were using suddenly started issuing mass sell orders. As a result, anyone who was actively trading stocks on that day probably lost money.
But within hours, the market corrected itself. By 3:07 p.m., the Dow, which had fallen over 1,000 points during the crash, had erased almost all of those earlier losses.
That means even in the most high-profile example, high-frequency trading had zero long-term effect on the market. All it did was increase volatility. If you weren’t buying or selling stocks on that day, the crash had virtually no impact on you.
That’s one reason we’re so fond of buy-and-hold strategies here at StreetAuthority. By looking at your portfolio over a much longer timeframe, you can mitigate some of the distortions created by these short-term traders.
But that’s not the only reason we’re such big fans of buy-and-holding investing. By far the best thing about this strategy, despite what people might believe, is that it’s hands down the easiest way to generate long-term wealth in the stock market.
Dave Forest, Chief Investment Strategist of StreetAuthority’s Top 10 Stocks newsletter, has been saying this for months. Here’s what he told readers in a recent research report…
The truth is, you don’t have to trade every day… or every week… or even every year to beat the market. In fact, your success actually increases the fewer trades you make and the longer you hold.
The best proof comes from the recent study by Oppenheimer. They looked at the S&P 500… going all the way back to 1950. Over that time, the S&P 500 has NEVER suffered a loss in a 20-year period.
Of course, we all know you can’t say the same for holding stocks for a year or two. When you hold stocks for a short period of time, your odds of losing money are much, much higher.
He goes on to prove his point with an example…
I even did a little digging on my own. I looked at the annual returns of the S&P 500 myself, going back to 1950.
You can see what I found in my chart…
On a rolling annual basis, the S&P 500 has dropped 16 times over a 1-year period since 1950… but zero times in any 20-year period.
The trend is clear. The longer you hold an investment, the better your chances of making money.
Of course, not all stocks are suitable for a buy-and-hold strategy. The market has always had its Enrons, WorldComs and Tycos. Holding period didn’t matter a lick for any of them.
The secret to successful buy-and hold investing, as Dave explains, is finding what we call “Forever Stocks.” These are a handful of companies who enjoy huge (and lasting) advantages over the competition… pay their investors each and every year by dishing out fat dividends… and buy back massive amounts of their own stock.
We’ve talked about many of these companies in the past. Names like IBM… Cisco… and Microsoft.
Will you make a million dollars from trading in and out of stocks like these? Unless you’re one of these high-frequency traders, the answer is no. But by owning high-quality companies that reward their investors over many years, you don’t have to. You simply buy them, hold them and let time take care of the rest.
So read Lewis’ book if you’re interested. But we’d encourage you not to let all this talk of the market being “rigged” let you be distracted from the time-tested strategies that we all know work.
P.S. — For those of you interested in finding high-quality stocks to buy and hold for the long term, you may consider Dave Forest’s new research on “Forever” stocks. These are world-dominating companies that pay investors a fat dividend, dig a deep moat around their business to fend off competitors and buy back massive amounts of stock, boosting the value for the rest of the shares. They’re solid enough stocks to buy, forget about and hold “Forever.” To learn more about these stocks — including some of their names and ticker symbols — click here.