But It's The Only Game In Town

Canada Bill Jones was a notorious card sharp and con artist who worked his trade in the mining camps and cattle towns throughout the Wild West. He had a number of famous quotes.

Including:

It’s immoral to let a sucker keep his money.
A Smith and Wesson beats four aces.

But his most famous quote was delivered to a complaining victim of one of his cons, “Yeah, the game is crooked but it is the only game in town.” Something good to remember if you ever think you are going to get an edge on the major Wall Street Trading Houses. Computers, cell phones, and the Internet have certainly evened the playing field and lowered brokerage fees, but the big boys will always have the edge, don’t ever forget they play by a different set of rules. Here are some examples from a recent article found on MSN Money (the link is listed at the end of this post).

High Frequency Trading: Sophisticated computer programs analyze real time trading data looking for anomalies that signal large scale movements such as those made my mutual or pension funds. Their computers then execute orders faster than the human players in the market can possibly respond. These programs are the result of decades of research and millions of dollars invested in programming and hardware. They really work. It isn’t illegal, but don’t think for a minute the little $3,000 technical analysis program running on your PC will ever be able to compete with Goldman Sach or the major hedge funds.

Flash Orders: This one is a little harder for me to understand. Evidently there are new, small, on line stock exchanges competing with the better know exchanges such as the New York Stock Exchange and NASDAQ. To lure in large customers these little exchanges have invented something called the flash order. If they can not fill a large order they flash that information to the computer of a large brokerage house giving them not only an opportunity to fill the order but inside information on a trade that will not be made public for a few seconds or minutes. That is more than enough time for the brokerage house computer to execute a trade at a price that the individual investor will never see. The Security and Exchange Commission is concerned that flash orders skirt the edge of legality and they are under investigation.

Dark Pools: Major trading houses set up off line electronic trading venues for their largest and best customers. Within these secretive private exchanges, high rollers can move huge quantities of shares away from public view. They affect the value of your stocks but you will never know what happened in private until it is way too late to do anything about it. If the dark pools become large enough, they will also affect the number of shares available on the open market creating a double price structure. Guess which price is the real price. It is currently estimated about 7% of all trades take place in dark pools.

There is one more thing to worry about. These trades occur so quickly there is no way they can be reviewed by a human. If an algorithm used by a major player goes haywire there are no circuit breakers that can possibly react fast enough to prevent a meltdown such as the one that occurred on Black Monday in October 1987. The safeguards currently in place were designed to prevent a repeat of that disaster, but in the last 20 years computer speed and the sophistication of the algorithms they run have advanced to the point that what use to require seconds now occurs in nanoseconds.

I know the game is crooked but I play it anyway. It is after all, it is the only game in town.

And, hey, let’s be very careful out there.

http://articles.moneycentral.msn.com/Investing/CompanyFocus/wall-sreets-high-tech-war-on-investors.aspx