Q. What is high frequency trading?
A. Five years ago, if you asked me to name two arcane financial subjects that I’d probably never hear discussed in a diner in the Keys, I’d have said ‘credit default swaps’ and ‘trading algorithms.’ During lunch at Mangrove Mike’s in Islamorada a year ago, however, I first overheard someone mention swaps. If that shocking 1,000 point drop in the Dow Jones last Thursday was any indication, you may soon become familiar with the term “high frequency trading,” too.
High frequency trading or HFT is many things – including another example of how Wall Street is more interested in being a casino than a steward of wealth. Simply put, HFT is stock trading done by blazing fast computers at Wall Street firms – some of which are located literally right next to the computers that drive the NYSE and NASDAQ. The powerful algorithms on these HFT machines can create and change orders for stock in milliseconds. It is believed that a handful of HFT firms now account for half of all trading volume on the nation’s stock exchanges.
The problem is that through loopholes in the rules, high-speed traders get an early glance at how others in the market are trading. Seems odd, no? After all, if you learn a big secret about a company, trade on that secret, and then make money a month later, it’s considered insider trading and you’d go to jail. When HFT firms get to peek at the buys and sells of others in the market and then make their own trades split seconds later, however, it’s condoned and encouraged by the major stock exchanges. Not only that, HFT machines routinely take advantage of slower traders…or, in other words, us.
Why the loopholes? The exchanges say to “create liquidity,” or to ensure that large investors can buy or sell positions quickly. As you might have guessed, though, the exchanges also earn fees for allowing sneak peeks.
Did a HFT glitch cause the historic crash of last week? Officially, it remains to be seen. Candidly, though, I’ve got a hunch.
My column today from the best little newspaper south of Jewfish Creek, the Keys Weekly.
Q. What exactly did Goldman Sachs do to get into such trouble?
A. Late last week, the country’s premier investment bank Goldman Sachs was accused of securities fraud in a civil suit filed by the Securities and Exchange Commission. The SEC claims Goldman created and sold a complicated mortgage investment that was covertly designed to fail.
The investment that Goldman sold to investors was called a synthetic collateralized debt obligation, or CDO, which is essentially a bet on another bet tied to a bundle of very low quality mortgages. Goldman appears to have tricked investors into believing the CDO was being managed by people who wanted mortgage holders to keep making their payments, when in reality it was secretly created by a hedge fund that was the world’s biggest short-seller in the subprime mortgage market. Those guys badly wanted the mortgage holders to default, and they did. Investors lost over $1 billion, while the short-seller made a profit of $1 billion.
Why would Goldman do this? Fees – both from their own role in structuring the deal, as well as those paid by the hedge fund for other services it may have had Goldman provide. Whether or not Goldman made money by actively betting against the same bad CDOs they secretly helped create remains to be seen.
The case is significant for a number of reasons. The first is – and there is really no pleasant way to put this – the SEC has been a consistently horrible regulator for quite some time now. Pursuing this case against Goldman may mean the agency has finally found a spine. It also means the odds of serious financial reform just increased dramatically because Goldman can no longer push back.
This case highlights a major flaw in the business models of Wall Street banks, too. Namely, they treat their customers atrociously. The ultimate outcome of this case is in some ways immaterial. Everything you could ever want to know about how dishonest a big Wall Street bank can be is summarized in this case. And it is far more damaging than a lawsuit could ever be.
My friend Neal in Key West sent me this note this week:
“In August 2008 my oldest daughter was 18 and in her first year of college. I sat down and drafted a one page list of what I thought at the time were timeless pearls of money wisdom and gave her the list. It was based on 20 plus years of personal experience and education regarding money management. Anyhow, I came across it last night and after reading it, I still think it represents timeless personal financial planning wisdom. I thought of you and I’ve attached a copy for you. I’m sure it’s pretty basic stuff for someone who manages money for a living but I thought you might like to see what type of advice some parents give to their teens.”
Here was Neal’s list:
-Save first, spend later: have emergency savings, retirement savings, and investment savings plans.
-Pay yourself first, live on what’s left: use automatic investments direct from pay or checking account.
-Live within your means: don’t try to compete with others.
-Be frugal, but not stingy: avoid wasting money.
-Diversify between and within investment classes.
-To excel at something, immerse yourself: educate yourself on whatever you invest in.
-Swear off debt: borrowing money is like wetting the bed, it may feel warm at first but the cold reality hits in soon.
-Do what you love: find work in something you love and it’s more like a hobby than work; there are few things worse than getting up everyday and going to a job you don’t enjoy just because you need the money.
-Know where your money goes: track income and expenses closely and analyze the results periodically.
-Equities build wealth: it’s the best way to build wealth over time.
-Money can’t buy happiness.
-Don’t get too good at the wrong stuff: be good at something that will get you noticed and that has a future for either growth or advancement.
-You can’t reliably beat the market; use index funds and take the average.
-Take risks where you can within your personal risk tolerance: greater risk normally means greater returns, but not always.
-If you can’t afford to lose your investment, don’t invest, save.
-Tap the power of compounding: start saving early.
-Carry small amounts of pocket cash and use small bills to avoid feeling wealthy which may deter needless impulse buying.
-One credit card maximum: for emergencies only and then pay off the balance each and every month.
-You can’t fight the market so join it; use index funds.
-Buy low, sell high: have a target buy price and sell price with reasons for both, and stick to it.
-Don’t follow the herd: if it makes sense for you, do it even if it runs counter to the crowd.
-You don’t know more than the market knows: use index funds.
-The less you pay, the more you keep: look for low costs or fees and/or tax free or deferred investments.
-Always get it in writing.
-Leave your money alone: rebalance your investment portfolio once a year.
-Invest for the long term: stay the course.
-Be humble about what you don’t know: don’t be afraid to ask questions.
-Develop a healthy skepticism: if it sounds too good to be true, it probably is.
-Be careful of the people you trust since by definition they are the only ones that get the chance to screw you.
-Ignore short term market swings: avoid trying to time the market, you can’t.
-Nobody plans to fail, but many people fail to plan: make one and stick to it.
-Real estate has been the secret to getting rich for centuries.
-Avoid speculation: don’t buy anything you don’t want or sell anything you don’t have.
-You can’t get something for nothing.
-Character, not assets, counts the most in the end: don’t lie, cheat or steal.
I think it’s great. What do you think?
@PlanMaestro Roger that. Thx. Will add to the list. More ideas than cash lately. in reply to PlanMaestro 1 week ago
