“The stock market is rigged!”
So declared best-selling author Michael Lewis in a recent 60 Minutes interview. His latest book “Flash Boys” takes aim at High Frequency Trading, a computerized strategy of quickly moving in and out of securities to reap fractions of a penny per transaction. High Frequency Traders were largely blamed for causing the Flash Crash a few years ago (the Dow lost about 1,000 points in a matter of minutes, only to recover as quickly) and exacerbating volatility in the stock market.
In reality, High Frequency Traders have actually provided some benefit to the average investor over the years (namely lower trading costs and greater liquidity), but it is their contribution to volatility that grabs headlines. Even dramatically swinging prices however are not as ultimately harmful as they may seem. On the contrary, in his 2013 Berkshire Hathaway letter, Warren Buffett described the upside to volatility:
“It should be an enormous advantage for investors in stocks to have those wildly fluctuating valuations placed on their holdings – and for some investors, it is. After all, if a moody fellow with a farm bordering my property yelled out a price every day to me at which he would either buy my farm or sell me his – and those prices varied widely over short periods of time depending on his mental state – how in the world could I be other than benefited by his erratic behavior?”
We view the market simply as an entryway to quality businesses. By extension, our mutual fund managers are decidedly low frequency in their trading (though they are always listening to offers from a moody neighbor). Those who through constant activity treat the market as a revolving door are more susceptible to high-tech pickpockets.
How does one avoid losing a rigged game? Naturally, it is by not playing. As Buffett said some years ago, “I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.”
Or, to perhaps coin a new strategy: No Frequency Trading!
Aaron Pettersen, CFA, CFP®