Market rigging is nothing new

Both Main Street and Wall Street continue to react to Sunday's 60 Minutes piece on high-frequency traders (HFT).

The takeaway, in the words of Flash Boys author Michael Lewis, is that the U.S. stock market is rigged as high-power computer trading firms front-run the trading of regular investors and the brokerage firms and fund companies they transact through.

Using strategies like "momentum ignition" and "quote stuffing," the HFTs are essentially using advanced telecom system and superfast servers to skim the cream off the top of the trading book. And they're potentially destabilizing as well, as evidence grows that these firms were largely responsible for the May 2010 "flash crash" plunge -- spurred by violence in Athens that sent the Dow Jones Industrial Average down nearly 1,000 points in a matter of minutes before it mostly recovered.

HFTs are a dominant force. For example, their share of the European market rose from less than 10 percent of share volume in 2007 to nearly 40 percent by 2011, according to Credit Suisse.

And they're predatory. Quote stuffing involves sending large numbers of orders and cancellations to the exchanges in fractions of a second with the intent to jam up the system and slow down market data. Momentum ignition involves a sudden flood of buy or sell orders designed to trigger other traders' buy or stop losses. The aim is to quickly cause a rapid change in price and a surge of trading volume that can the HFTs can exploit.

Nearly everyone is hoping that fresh attention on the HFT issue will force regulators to take action.

But it's important to remember that these types of games are as old as Wall Street itself. In 1792 William Duer used his connections to men like Alexander Hamilton to run an investment pool in shares of America's nascent banking system -- after first making a fortune trading government securities using inside information on the Treasury's dealings.

Duer fueled a speculative market bubble that eventually burst, sending him to debtor's prison and igniting the country's first financial panic. One of his creditors confronted him in his cell with a set of dueling pistols, demanding either payment or the defense of his honor.

During the Gilded Age men like Jay Gould and Jim Fisk would engage in multiple schemes, from trying to corner the gold market to duping Cornelius Vanderbilt by selling him freshly printed shares. They learned a few tricks from Daniel Drew, cattlemen turned speculator who originated the term "watering stocks" by giving his herds salt licks, letting them engorge themselves with water, then leading them to the scales at auction.

Then there were the "bucket shops" of the early 20th century, gambling parlors dressed up like brokerage offices where folks would bet against the house on the rise or fall of stock prices. Bucket shop operators used telegraph connections to the actual stock exchanges to raise or lower prices to ensure the maximum number of "customers" lost everything. These were people of modest means, too small to buy or sell actual securities at a legitimate brokerage house.

Muckraker Merrill Teague, writing in Everybody's Magazine in 1906, compared bucket shop operators to a jackal that "drags down the maimed, the weak, and the small." In an 1879 editorial, the Chicago Tribune decried the character of bucket shop patrons:

"Boys of larger growth and men, clerks, salesmen, bookkeepers, men in business, hackmen, teamsters, men on salaries, and men employed at day's work, stone cutters, blacksmiths and workmen of all wages and occupations; students and professors of colleges, reverend divines, dealers in theology, members of Christian Associations, members of societies for the prevention of cruelty to animals, and for the suppression of vice, gentlemen who war on saloons which permit minors to play pool, and teachers of Sunday schools, hard drinkers and temperate men, old men and young men -- all, in person or by agent, purchase their 500 or 1,000 or 5,000 or 10,000 bushels, depositing their margins, and confidently hope to have their money back with 100, or even 500 percent profit."

More recently, whether it's shoddy Wall Street research on dot-com stocks or the promise of "risk free" mortgage-backed securities during the housing bubble, the game continues.

Only the means that have changed, from telegraph wire to fiber-optic cable, as the cheats, con men and criminals stay one step ahead of the regulators.

Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters, as well as Mirhaydari Capital Management, a registered investment advisory firm.

Comments

Market Data

Market News

Stock Watchlist