Flash Boys

by | Dec 31, 2014 | Archives

The Dow Jones Industrial recently soared past 18,000 and reached an all time high.   So why aren’t average investors all rich?   Most investors have not kept up with the Dow because the system has been stealing from you, me and most investors of US shares (and in other equity markets too).


Chart of Dow Jones Industrial Average at www.finance.yahoo.com (click on image to enlarge)

In the last five years the Dow Jones Industrial Average has risen from 10,000 to 18,000, about 80%.  Despite this, during the entire five years, US shares have been poor value.

During the same five years the Vanguard Total World ETF has risen from $40 per share to $60 per share about 50%.


Chart of Vanguard Total World Stock ETF (symbol VT) at www.finance.yahoo.com

In a moment, we’ll review why the Vanguard Fund is a far better value.  First, let’s review why one of your biggest obstacles to good investing has been and remains Wall Street, especially the big banks which promise to look after our money.   The reality is that these banks have been structuring investments that are sure to lose.  Then the very same banks bet against us, because they know our investment will lose.

The New York Times best seller “Flash Boys: A Wall Street Revolt” tells the tale of another way big banks and brokers have been ripping off investors.   The book shows how since the late 1800s banks and stock brokers and traders have been legally stealing (and sometimes illegally) from investors by front running.

Front running is the practice of a bank, stockbroker, trader or someone taking advantage of advance knowledge of your order to buy or sell a stock or bond.  The front runner executes an order for its own account and passes on a higher (or lower if you are selling) price to you.

“Flash Boys” tells the story partly through the eyes of Brad Katsuyama, a chief stock trader for Royal Bank of Canada and Ronan Ryan, a fiber optics tech who connects Wall Street traders to the stock exchanges and says: Ronan for his part couldn’t quite believe how ordinary the people on Wall Street were. “It’s a whole industry of bullshit”, he said. The first thing that struck Ronan about a lot of big investors he met was their insecurity. “People in this industry don’t want to admit they don’t know something.” he said. Brad soon realized that the most sophisticated investors didn’t know what was going on in their own market. Not big mutual funds like Fidelity. Not the big money management firms like T. Rowe Price and Janus Capital. Not even the most sophisticated hedge funds.

“Flash Boys” looks at high-frequency trading (HFT) in equity markets created by electronic trading.

The book claims that HFT traders front run orders on most US stock exchanges placed by investors.

The book explains how electronic trading creates a shift in trading times.  Never before had the speed of data been so important and measured in such short spots. The faster the data travels, the better the price of the trade and differences in fiber optic routes, switches and cable allowed some traders to gain just milliseconds advantage.  That’s a millionth of a second, but with this edge, when a trader placed order, HFTs could see the order, buy the share and the resell at a higher price.

The slice in each case was small but it is estimated that these high frequency traders were pulling as much $5 billion per year, perhaps as much as $15 billion per year or even higher.

Speed was so essential that one company spent 300 million dollars to bury an 827-mile fiber optics cable that saved just a few milliseconds off of the response time of trading shares.

This exposé shows once again how so much of the financial industry (as with mortgage-backed securities and collateralized debt obligations and credit default swaps) and the automated stock market trading functions more for the profit of insiders rather than investors.  The system creates a gap between investors and the market, a group of middlemen who earn fees, commissions, and rebates from order flow and volume.  They add little actual value to the market for huge amounts of pay.

The day after the book’s release the Federal Bureau of Investigation announced an investigation into high frequency trading, in particular about possible front running, market manipulation, and insider trading.

On May 1, 2014 the SEC announced a $4.5 million fine for the New York Stock Exchange and two affiliated exchanges, on charges related to Lewis’ book.  The exchanges neither admitted, nor denied the charges.

The book reveals that the cause was a loophole in a law that aimed to stop front running.  Research back to the late 1800s found the entire history of Wall Street littered with scandals.

Every systemic injustice arose from some loophole created to correct a prior injustice. The book says: No matter what regulators did, some other intermediary found a way to react so there would be some form of front running.

If you read the book you’ll see that your chances of knowing what really goes on with your stock buy and sell orders are pretty slim.

flash boys

Learn about the book Flash Boys at Amazon.com

Here is the rub.  Despite the predators on Wall Street who are waiting to take big gouges out of our savings and wealth, equities are still the best place of all to invest for the long term.  This chart from the 24 page Keppler Asset Management 2014 Asset Allocation Review shows that over the past 80+ years equities have dramatically outperformed other types of investments.


Subscribers to our multi currency report can access the password protected 24 page Asset Allocation review here. 

Get a password for our Multi Currency service here.

Rule #1 of our global investing strategy (you have seen it many times if you have been reading my messages for awhile) is “there is always something you don’t know. And that’s okay.”

Not knowing everything means our search for good investments requires a relentless search for value.  Our investments have to be good enough to reap a good reward even after the parasites, that have and will always infect stock markets, have siphoned away part of the profit.

Trade as little as possible and stick to low fee ETFs like the Vanguard Total World Stock ETF.   The USA equity market is one of the highest priced markets in the world and the US dollar strong.   This adds extra profit potential to this ETF at this time now.

Another good ETF diversification is in short term bonds.  ENR Asset Management’s Market Outlook for December 2014 says:
Every segment of the bond market has recorded a gain this year with the Barclays Aggregate Bond Index gaining 5.85% and yielding 2.2%.  This benchmark includes all investment grade bonds in the United States, including Treasury Securities.  We continue to recommend a short duration bond portfolio of no more than four years with an emphasis on high quality investment grade corporate debt.  Inflation might be super low at the moment but we believe a major correction is inevitable in the bond market over the near term.  Investors are advised to maintain a conservative duration.  

The ENR Viking Low Risk Portfolio holds the following ETFs:

Vanguard Total International Bond ETF  (symbol BNDX)
Vanguard Short-Term Bond ETF  (symbol BSV)
Vanguard Short-Term Corporate Bond ETF  (Symbol VCSH)

Click here for the ENR Asset Managers website

For more information contact Thomas Fischer at Thomas@enrasset.com


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