A little less than a year ago, author Michael Lewis created a firestorm with his book, ‘Flash Boys: A Wall Street Revolt,’ that chronicled the world of high-frequency trading (HFT).
At the time of the launch, he went on 60 Minutes and announced that ‘the market is rigged’ and that everyone who had money in the stock market was a victim of predatory traders.Â Michael Lewis is one of my favorite authors, but I was pretty annoyed with his gross overstatement about the effect that HFT has on everyday investors.
We are not high frequency traders by any stretch of the imagination and so I don’t really have a dog in the hunt, but my view is that HFT is a bit like skimming, which is unfair, but that HFT keeps markets competitive and has lowered costs for all investors.
Overall, the benefit that HFT brings to the market is greater than the cost in my judgment.Â For a more detailed assessment, read my article from last year.
I bring all of this up again because we recently hired a firm to analyze our trading to find out whether we’re being picked off by the HFT community.
When we trade, there are two costs.Â The first is the explicit cost, which is the commission that the custodian charges to execute the trade.Â Most of the time, the commission on a stock or exchange traded fund (ETF) is $8.95. Â That part is easy to identify and evaluate.
The second cost, the market impact of your trades, is harder to see, but is very real.
I am oversimplifying, but basically, if you are trying to buy and everyone else can see it, then they are going to raise the price that they are willing to sell to you in order to increase their profit. Â The same is true on the other side in a sale, but in the other direction.
Although I don’t think that the market is rigged, I did expect to find that our trading had a small negative market impact.Â We are basically ‘price takers,’ which means that we have no ability to dictate the prices that we pay.
The trade cost analysis (TCA) covered six months’ worth of trading data and in that time, we did 3,408 trades with a notional value of $79.8 million.
Keep in mind that I’m only referring to individual stock and ETF trades. Â We aren’t evaluating individual bonds trades since they aren’t done on an exchange, or mutual funds since all investors get the same price after hours.
For the last six months of last year, the TCA firm found that our trading actually had a positive impact on performance.Â Instead of the market taking money out of our pockets, our trading actually added some value: $807.51.
While I am happy that the number is positive, the more important news is that our market impact is negligible: $800 either way is nothing on nearly $80 million in trades. Â I would be perfectly happy if the market impact number was negative and actually expect it to be negative on average over time.
We intend to keep doing the third-party TC to make sure that we are getting best execution on behalf of our clients and will keep you posted about how we fare even when the numbers are negative. Â In the meantime, we are going to look at opportunities to improve our trading execution.
I don’t believe that the market was rigged, but if it is, our clients appear to be protected based on the data we have thus far.