A Response to Flash Boys: Why the Stock Market Is Still a Fair Place to Invest
By Warren Olsen
I just read Michael Lewis’ new book, “Flash Boys (A Wall Street Revolt)”, and similar to his previous books such as “Liar’s Poker”, “Money Ball”, “The Blind Side” and “The Big Short” it’s a terrific, fast read. Lewis is one of my favorite authors for both the topics he chooses (generally involving economics or the financial markets) as well as his ability to tell a crisp, interesting story. “Flash Boys” certainly isn’t any different. The book centers around high-frequency trading (“HFT”), its effects on the stock market and a group of traders and technologists who try to overcome its unfairness by creating their own stock exchange. The book examines dark pools, Russian computer geniuses, firms laying fiber optics to shave off nano seconds from their trading times and, of course, Goldman Sachs (interestingly in both a bad and good light).
I liked everything about the book except for the conclusion (which is being picked up widely in the press including 60 Minutes) that the stock market is somehow “rigged”. While I think the book has some important lessons and reminders for investors, I strongly disagree with its ultimate thesis.
Maybe it’s simply semantics, but when I think of something being rigged, I think of the 1919 World Series or a poker game. In these cases others are conspiring to cheat and you definitely don’t want to be playing. The stock market is far from that and is arguably the fairest it’s ever been. In today’s world, information moves faster, more freely and cheaply than ever before creating a much more level playing field for investors who are willing to do the work. The ability to glean good, relevant information about stocks and more importantly, the companies that those stocks represent, has never been easier to obtain. The cost of accessing these stocks has never been cheaper and the “friction” involved in trading these stocks has never been less.
Just to be sure, however, that I don’t get accused of being naïve or not realizing that I don’t know what I don’t know, I have always started with the premise that when I buy or sell a stock I am going to get hurt somewhat. I think that’s the nature of not just the stock market, but pretty much any market for the buying and selling of anything where you need or want people to facilitate transactions. My assumption is that my brokerage firm is always trying to maximize their economic benefit from one of my buys or sells and that I am never that broker’s “best” client (i.e. the customer they make the most money from). Although that firm may be an “honest” broker, they are still economically rational so that they or a better customer is going to nick me somewhat on a trade.
From my perspective, whether or not this is actually true isn’t particularly relevant because it doesn’t impair my ultimate goal of investing. First, I want to be an investor and not a trader because someone will always have an edge on me as a trader. (Read the book if you think you disagree with that conclusion). As an investor, when I make any given investment, I want my margin of error to be relatively high (Warren Buffett refers to this as “jumping over a low bar”). If the success of my investment is predicated on whether my stock gets filled at $30.00 per share or $30.02 per share, I shouldn’t be investing.
As an investor, I need to minimize the amount of times I get nicked by buying or selling stocks. If I’m jumping in or out of the stock market (referred to as “turnover”) every time I feel the market is going up or down, those small nicks can spill some real blood (not to mention the tax costs for those of us who are taxpayers, but that’s another story). To think of this in another context, and with apologies to those of you who are residential real estate brokers, think of how ugly it would be if you bought and sold your house 4 or 5 times a year while paying a 5 or 6% commission because Russia had just invaded Crimea or you didn’t like the tone of the Fed Chairman’s speech. If, however, you realize that stocks are longer-term investments, and make good buy decisions, which lead to relatively long holding periods, the friction involved will not materially affect your underlying returns.
Interestingly, the entities that need to clean up their acts in all of this are not the high-speed traders. They may not be adding much, if anything, to society (or the markets for that matter), but they seem for the most part to be playing by the rules. The more disconcerting behavior is coming from the brokerage firms and the exchanges who are selling information to these high speed traders for vast sums to enable this type of trading. If the trading rules need to be changed, that should probably be the focus.
The market can definitely be fairer and more transparent; however, the conclusion that it is patently unfair or that individuals should avoid the market is not correct. As an individual, just remember to approach the market as an investor and not a trader.
Read the book. It’s fast and it’s fun.