How can you trust the stock market? Read today's article

[NW-Bound]

If you look at the stock market as a place to transact business, and not something which is designed to make you rich, or tell you how much you should pay for the securities that are sold there, it is probably the most trustworthy market ever known to man. Or is Ebay better? Or Craig's List, or the local livestock auction, or your local real estate market, or Sotheby's or commodities markets?

A buyer on the NYSE can be a complete ignoramus, and still get a fair deal. Who among us has sold a listed security through a licensed member broker-dealer and not been paid in a timely fashion? Who has bought a stock and not received it?

In most buying and selling, the buyer is at a large disadvantage. He knows somewhere between nothing and very little about the item being sold, even though he may have done a large amount of research on that class of items. His ability to really find out the hidden flaws/problems/title issues/ et cetera while not zero, is limited.

OTOH, if you are asking the stock market to take good care of you, and see to it that you make money, that is a lot to ask.

Ha

+1Million

Some of my friends who had been buying high/selling low complained that the market was rigged. I tried to point out that some big dogs made lots of money, yet equally big guys lost billions too. Who was rigging whom?

No matter. They didn't get it. I then tried to point out to them how MF managers complained that because of their portfolio size, they could not swoop in and scoop up what they found as a good deal. Due to the volume of their trade, the word got out on the street, and the price would move up, then they could not get the good price that they wanted.

I remember reading about the internal working at a medium-sized MF, whose manager got something like $20-50B under management, which was not really huge. He said that when he wanted to build a position in a company, it took him a month or two to nibble here and there to get all the shares he wanted. For a small investor like us, one click of the mouse and we are done.

Small investors have advantages over bigger ones too, mainly the agility, to make up for the lesser inside knowledge that we have.

 

[growing_older]

High Frequency Trading is just another source of volatility. At some fundamental level the values of stocks reflects the underlying value of the company who's shares they represent, but there are lots of reasons they track imperfectly. Unknown future developments, fashions in investing, cyclical economic factors, short term trading and HFT all introduce volatility and tracking imperfections. But if you are willing to be patient you can usually wait them out. Of all these HFT is the easiest to wait out, since the influence up or down is usually short lived.

Now, the two most sophisticated investors I personally know. both thought they could execute clever strategies and were essentially wiped out in flash crashes due to HFT. They each lost many millions. The many more people I know who are less sophisticated investors, who just plod along with mutual funds or stock investments and don't try to time or trade, have all barely been impacted by any HFT effects and have always quickly recovered.

If you are asking can you trust the stock market to accurately reflect the true value of securities over the short term, no. That answer has always been no, and HFT just makes it even more clear in very short time frames that it can be emphatically no. If your plan requires predictable price movements, you are going to get burned. If, on the other hand, your plan only requires general trend in your favor that money making companies are gradually worth more, then you can trust the market to do much like it's done before - be a convenient way for investors to participate in that and provide a way to diversify among many such companies.