In spite of all of the talk about equity, fairness and helping the middle class that’s been circulating in Washington, the stock market is now rigged to help the rich and powerful – and little is being done about it.
The individual investor is told to invest long-term and plan ahead. But the real money is being made in nanoseconds by supercomputers. If you have the right algorithm, you don’t need to plan for the next minute, never mind 30 years from now.
The SEC has been clamping down on insider trading, in which individuals use knowledge that isn’t available to the public for personal gain. But is high-frequency trading (HFT), in which computers mine data to find and take advantage of pricing inefficiencies, any different?
It’s legal for computers to make decisions based on information that isn’t available to the public, but it’s not legal for people to do so.
In its defense, the SEC recently began investigating a broad range of HFT-related issues, including the structure of proprietary market data feeds, the adequacy of testing of automated trading algorithms and the development of order types geared toward automated trading.
The SEC also recently fined the New York Stock Exchange $5 million as part of a settlement of allegations that the exchange violated market regulations by providing customers of its proprietary data feed with access to market data faster than that provided the data to the public.
However, HFT is currently out of control. As we’ve previously written, it now accounts for a majority of all trades on American stock exchanges – 73%, according to the TABB Group.
HFT not only creates an unfair advantage to those with the means to use it, it also creates volatility, distorts stock prices and loosens the relationship between how well a company is managed and the price of its stock.
Consider Wednesday’s rise in the price of Netflix stock. On a day in which the stocks of many major companies were down significantly (Apple -10%, McCormick -8%, Coach -15%, Cirrus Logic -7%), the price of Netflix stock jumped 38%.
True, Netflix announced an unexpected profit during the fourth quarter so its stock price should have increased … but by 38%? That would be a huge jump in a year, yet Netflix’ stock gained traction in a matter of minutes.
No one knows for sure why the price jumped so much and so fast, but it was likely the result of a short squeeze, in which shareholders with short positions are forced to purchase shares to exit their short positions. Regardless, HFT appears to have made the squeeze a crushing one.
HFT can also be used with other price-altering schemes, such as momentum ignition, in which a primary igniter attempts to trigger other participants to trade quickly and cause a rapid price move.
Last month, the Securities and Exchange Commission considered cease-and-desist proceedings against Netflix for posting on its Facebook page that it now streams a billion hours of video per month. The SEC claimed that Netflix may have violated its fair disclosure regulations, even though the Netflix Facebook page has 200,000 followers and 3.6 million likes.
Yet the 38% price increase is unlikely to cause any regulatory reaction.