Rats in a Granary
Pfäffikon SZ, Switzerland – “They are like rats in a granary,” said Charlie Munger, the illustrious business partner of investor Warren Buffett. Munger was referring to high frequency traders. This week the Flash Crash celebrated its fourth birthday. At 14:42:44:75 on 6 May 2010, the Dow Jones lost about 1,000 points in a few minutes. The financial world stopped for a moment. Apparently, the hunt for the picosecond knows no bounds.
In the Spotlight
In recent years, high frequency trading (HFT) has increasingly been in the spotlight. Gaining an advantage by purchasing advanced computer equipment and placing it in an advantageous location is not prohibited. Munger is quite firm in his opinion. “It does the rest of civilization no good at all,” said the wealthy old boss. That said, in Europe and the U.S. there are differences in the way we trade. In the U.S., parties can purchase first class locations to access the trading platform, and that has its advantages. In Europe, we are more fragmented. I have noticed that many European stocks are traded in the U.S.
Minister Dijsselbloem sees no reason to intervene in HFT; in fact, he actually sees benefits. “More efficient price formation, more liquid markets and a decline in transaction costs are seen as positives,” said Dijsselbloem recently in his reply to the Dutch House of Representatives. On the point of liquidity, I don’t agree with the Minister of Finance, who I respect very much.
Differences
The high frequency trader is not a liquidity provider – he pretends to be and he would like to keep it that way. He does not guarantee liquidity, whereas the market maker does. In fact, the market maker is required to do so. Additionally, the market maker can only mark up prices for one fund, while the high frequency trader can scour the entire granary. These are significant differences, which allow the high frequency trader to make use of a piece of foreknowledge in the form of time. He can then decide what to do, driven by a pre-determined trading strategy, carried out by powerful computers. Or he buys and sells without fixing the amounts.
Eric Scott Hunsader, the founder of Nanex – a company specializing in investigating stock market data – makes no bones about it: the advantage in speed and time is “the equivalent of having tomorrow’s Wall Street Journal in your hand today.”
You can close the Stock Market for 5 years
We invest in such a way that closing the stock market for five years would make no difference to us. HFT does not affect us. However, the fact remains that we must place well-researched orders and that today, in my opinion, a different approach is required to stay out of the clutches of the computerized trader. The broker’s choice also plays an important part, because many brokers can’t live up to their promises – don’t forget to go over the small print with a fine tooth comb. It amazes me every time how easily investment managers and asset managers ignore it. I openly wonder whether the customer is aware of this.
It remains for me to wish you a good weekend.
Jan Dwarshuis is a senior asset manager at Thirteen Asset Management AG, where he is responsible for the Thirteen Diversified Fund. Dwarshuis writes his columns in a personal capacity and is not paid for them. Nor is he paying for his columns to be placed. Professionally, he holds positions in major European, American and Russian stock funds. The information in his columns is not intended as professional investment advice or a recommendation to make certain investments. At the time of writing, he has no position in the above shares and has no intention of doing so in the next 72 hours.
