Jim McTague, Washington editor of Barron's magazine since 1994, offers a sometimes scathing and darkly funny look at how money is moved in lightning quick mode now by high frequency traders (HFTs) -- often to the confusion or even detriment of investors -- in his book Crapshoot Investing: How Tech Savvy Traders and Clueless Regulators Turned the Stock Market Into a Casino.
Here's McTague's opening line in his introduction: "(Yet) few persons realized the greatness of the seismic shift (in how the market has worked since 2005) until May 6, 2010, when the major averages collapsed over the course of 10 minutes.
"The public suddenly realized that a venue designed to efficiently move capital from investors to the most promising enterprises had become as risky as a Las Vegas casino.''
McTague chronicles the moving of capital, from a relatively stable process to one of persistent volatility. He says because HFT trading caused capricious pricing, long-term investors, avoiding caprice, ran to safer havens.
May 6, 2010, an event that became known as the Flash Crash, saw the DJIA plunge more than 700 points in 10 minutes, the largest one-day fall ever; then rebound in the next 10 minutes. Why the whiplash swing?
"The event raised suspicions that it had been engineered by a new breed of market player, the so-called high-frequency traders.'' McTague says these traders work for firms that spend enormous sums on ever faster computing machinery that no human investor can compete with.
About" 73% of all U.S. equity trades involved high-frequency traders, who could execute an order in milliseconds.'' This volatility is against long-term investors' best interests, and raises the suspicion that HFTs can manipulate stock prices, McTague says.
For creating the laws and environment that led to HFTs, McTague blames Congress and the Securities and Exchange Commission for being "blind in their belief that automation would make the markets fairer and more efficient.'' Instead, the new environment "wrecked one of the world's great capital-allocation and job-creation engines and turned it into a wild playground for algorithmic traders.''
McTague says this has lead to few new IPOs, since capital now goes to government bonds, precious metals, and third-world countries.
He traces the beginnings of the modern-day HFT era: Computer scientists and mathematicians devised new and ever faster formulas to outsmart human traders; in the new electronic trading age, overall market volume went from 3 billion shares to 10 billion. New terms were coined, such as hot potato trading, which inflated "market volume statistics and made the market seem much more liquid than it was.''
No wonder skeptical investors ran for cover. Mutual funds and pension funds were so spooked, they hid from algorithmic traders in dark pools, trading venues where trades were invisible to the market at large.
Two asset management heads told their clients that trading executed by "amoral'' machines programmed to get rid of shares quickly "means that the prices of securities bear little or no relationship to the fundamental economic reality of the corporations that issue those securities.''
Is there any relief in sight for retail investors who remain skeptical about engaging in the HFT-driven market? Yes, says James McCaughan, CEO of Principal Global Investors (managing $212 billion in assets, including those held by 12 of the 25 largest U.S. pension funds). McCaughan predicts that most of the volatility will abate in five to 10 years and that stocks will be in demand again. Improved economic conditions and regulations to dampen the wild swings will help. So will re-establishing the up-tick rule, which makes it harder to sell stocks short in a quickly declining market.
Also, McCaughan suggests investors revise their portfolios; those nearing retirement might move some equity holdings to high-grade bonds. Other capital management executives and researchers offer a variety of strategies to reduce the impact of the volatile market on your investments, as does McTague himself. He offers examples of his investment tactics, which do require effort: "I recommend that investors studiously review a company's SEC filings, which are available online at the agency's Web site,'' as well as checking on such issues as short interest, bid spreads, previous year's price; analysts' expectations, etc.
Even with all that legwork, he says, because the market has become a "shark tank, and we are the anchovies, (Every) time you buy or sell a stock, you are rolling the dice and hoping for a good outcome.''
Crapshoot Investing: How Tech-Savvy Traders And Clueless Regulators Turned The Stock Market Into A Casino. By Jim McTague. FT Press. 235 pages. $26.99.