Is the U.S. Stock Market Rigged?

Steve Kroft of CBS 60 Minutes reports on a new book from Michael Lewis that reveals how some high-speed traders work the stock market to their advantage:
This month marks the fifth anniversary of the current bull market on Wall Street, making it one of the longest and strongest in history. Yet U.S. stock ownership is at a record low and less than half of Americans trust banks and financial services. And in the last two weeks, the New York attorney general and the Commodities Futures Trading Commission in Washington have both launched investigations into high-frequency computerized stock trading that now controls more than half the market.

The probes were announced just ahead of a much anticipated book on the subject by best-selling author Michael Lewis called "Flash Boys." In it, Lewis argues that the stock market is now rigged to benefit a group of insiders that have made tens of billions of dollars exploiting computerized trading. The story is told through an unlikely cast of characters who figured out what was going on and have devised a plan to correct it. It could have a huge impact on Wall Street. Tonight, Michael Lewis talks about it for the first time.
I will let you watch the clip below. I never heard of Brad Katsuyama, the young trader at the Royal Bank of Canada who first realized that the market that he thought he knew had changed. I wish him a lot of success in his new venture at IEX and hope all the large investors that read my blog will support this new exchange.

Zero Hedge is the blog that first talked about high-frequency trading back in March 2009 (they love reminding us in their typical self-promoting style). I have written a few comments on high-frequency trading and wrote all about the Knightmare on Wall Street, the Wall Street Code, the Real Wolves of Wall Street and Wall Street's License to Steal.

I haven't read Michael Lewis' book, Flash Boys, and not sure if I will buy it. One thing is for sure, if he didn't interview Haim Bodek, he didn't do his homework. In fact, I'm shocked at how sloppy 60 Minutes is becoming in their reporting. How the hell can you discuss high-frequency trading and not interview Haim Bodek? He is the undisputed master of high-frequency trading and has done more to expose the inner workings of the U.S. stock market than anyone else, including Brad Katsuyama. This report by 60 Minutes was very sloppy and nothing more than a big promotional plug for Lewis' new book.

So is high-frequency trading a serious threat? Yes and no. Proponents will argue that they provide much needed liquidity and while this true, the reality is high-frequency traders are wreaking more havoc than the benefits they claim to provide. They are frontrunning large and small investors, clipping billions in profits in the process. There is no transparency and fairness in the current system dominated by high-frequency traders, which is one reason why I keep telling politicians to bolster defined-benefit pensions for everyone. Shifting employees to defined-contribution plans in this market is literally feeding them to the wolves.

And high-frequency trading isn't just about the stock market, it's happening all over, including bonds, currencies and commodities. But the stock market is what garners all the attention because most people invest in stocks and expect there to be a level playing field.

I see high frequency bullshit every day trading my own stocks. Check out the volatility on Idera Pharmaceuticals (IDRA) in the last week (click on image):

It's absolutely crazy and I tell my friends and anyone trading these small biotechs, if you can't withstand crazy volatility, don't bother investing, you will suffer severe anxiety attacks! The same thing happened with solar stocks, the high frequency assholes pounded them to oblivion so the insiders can buy them on the cheap and then, "BOOM!," they ran them up hard!

By the way, I don't buy the nonsense that the bubble in biotechs and solars is over. There is a serious correction going on in biotechs as you can see by looking at the IBB and XBI ETFs (you're better off sticking with ETFs if you want to play biotechs and not worry as much about individual companies). I stick by my Outlook 2014 and hot stocks of 2013 and 2014 and guarantee you the big boys bought the latest biotech dip really hard, setting themselves up nicely for the next biotech beta move.

It's also worth noting the line between pension funds, mutual funds and high-frequency traders is blurred. For example, Ontario Teachers' Pension Plan and the Caisse invest in Citadel, a well known elite hedge fund that engages in high frequency trading. Fidelity and other large mutual funds also use high frequency traders to unload or buy stocks. In other words, it's not as clear cut as people think.

Finally, how should individual investors react to all this hoopla of the U.S. stock market being rigged? My advice is to ignore it and read my comment on why market timing is a loser's proposition. Let the high frequency-traders engage in intellectual masturbation, effectively cannibalizing each other in a loser's game. The best way to beat them is to follow the Oracle of Omaha and buy a few great companies and stick with them through market cycles.

Below, watch the 60 Minutes clip looking at whether the U.S. stock market is rigged. I prefer the fascinating and revealing documentary from VPRO about Haim Bodek, aka "The Algo Arms Dealer," a genius algorithm builder who dared to stand up against Wall Street. After watching this documentary, you will gain a better understanding of how "quants" have forever changed the financial landscape, for better or for worse, and how your pension contributions are their "dinner or low hanging fruit."

Postscript: Read my follow-up comments on The Great HFT Debate, which turned out to be a total dud and why dark markets may be more harmful than high-frequency trading.