The share-trading scam
Filed under: Investing
Days when you would open your letters in the expectation that they would contain important information. Days when people were straightforward; when they offered important services, which we paid for in good faith.
Wherever you look these days, there seems to be a scam -- they are the modern-day affliction.
Scams are everywhere
These days, there are so many spam and junk emails that email software has had to be designed to filter out as many of these as possible. For me, the phone calls are worse, as we have yet to develop a technology to efficiently filter out 'spam' phone calls. You either end up missing important calls, or you have to listen to endless recorded adverts or cold calls from foreign call centres.
There are scams about car insurance. There are scams about payment protection insurance. There are scams about personal injury. The list goes on and on.
I guess it was only a matter of time before we had a scam in share trading and, lo and behold! Here it is, with a vengeance: it's called high-frequency trading.
Win-win? I'm afraid not
Defenders of high-frequency trading say that it adds to the liquidity of the market. They argue that these rapid-fire, millisecond trades should not make any difference to the ordinary investor like you or like me.
I disagree. Investment banks and hedge funds make billions of pounds a year from high-frequency trading. They make so much money that they are willing to spend £200 million to increase the speed of their trades by six milliseconds.
Now, I don't think these institutions are plucking money out of thin air. They haven't discovered the financial equivalent of the perpetual motion machine.
No, they are making money at the expense of investors -- either directly through the shares we buy, or through unit trusts and pension funds. I think that high-frequency trading substantially increases volatility and can lead to events such as flash crashes, which can be very expensive for investors.
I don't think it is coincidence that stock markets in recent years have been so incredibly volatile, with rally followed by crash followed by rally. If this is the future of equity investing, then count me out.
Charlie gets it in one
Berkshire Hathaway vice chairman Charlie Munger got it in one when he compared high-frequency traders to rats in a granary. Just as we should get rid of rats in a granary as soon as they appear, so we should eliminate the scourge of high-frequency trading, too.
After all, where's the social utility? Where's the benefit to humanity? I'm sorry, but I just can't see it. And Charlie doesn't mince his words about what he thinks should be done about it, saying: "If you let me write the laws, it wouldn't happen... I wouldn't allow anyone to make money in short-term trading. I might have Tobin taxes. I would do something. I think if we change the incentives a lot of this regrettable behaviour would go away."
Scams are what happens when the free market and capitalism goes crazy; when creativity and lateral thinking goes hand in hand with immorality. It is what Edward de Bono has described as "ludacy" -- playing the game to an extreme extent, without any thought about benefits to humanity and to society.
As Munger says, we should tax or ban high-frequency trading, just as we should all scams. Once the incentive disappears, you will be surprised how quickly the scam does, too.
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