Market Structure and HFT Does Affect Little Retail Investors

Ken Langone made the point on CNBC that retail investors should just invest in funds. Mr. Langone is a smart guy and I agree with most of his analysis. As a matter of fact, I agree that the average investor out there should invest in a no load mutual fund that replicates the S&P. Eugene Fama’s Efficient Market Hypothesis works. Fama ought to be given a Nobel Prize for it.

But the retail investor is affected by market structure. Anyone that puts their money at risk in the market is affected. On the same show, Richard Grasso disagreed with Langone. Grasso is the former President of the NYSE. He sees how market structure is screwed up and you can’t trust the tape.

The market is a lot more volatile than it used to be. Bids and offers are thinner. It sometimes is hard to know if its the structure of the market or the times we live in. The financial seas aren’t exactly calm. But, there is less size on each and every bid/ask spread than there ever used to be. The market isn’t transparent, and the economic incentives line up in favor of holding back rather than putting your order out there.

The reason that the current market structure stinks is that we haven’t contemplated it with the thought of 100% electronic trading taking place. SEC regulations have allowed the market to become highly fragmented. It’s possible to avoid the broader market altogether. That’s wrong in this day and age.

Why not have one Central Limit Order Book where everyone comes to compete?

The current market structure didn’t think about electronic firms that programmed orders to probe and set off stops. They didn’t think anyone would do illegal things like that on the screen. Certainly, it happened in a pit but you called the guy on it. Practices like that, and similar ones erode confidence in markets.

That’s the key. Once confidence in the capitalistic market system fails among the common retail investor, the bedrock of the system starts to erode. Once they pull their money, it’s much more difficult to create wealth in America. The market becomes a have vs have not arena. I think that’s one of the underlying causes of the poor opinion of investment bankers in this country today.

Once small investors start heading for the exits and abandon even the mutual fund strategy that Mr. Langone advocates for, all of us is in trouble. Grasso is correct. We need to make the marketplace flat, transparent, and accessible for all. Electronic trading should be able to do that efficiently. The way it’s presently structured does not.