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The market is rigged: Here's how not to be a victim

The stock market is rigged!

That’s the headline as suggested by author Michael Lewis during a segment on last night’s 60 Minutes. Promoting his book, “Flash Boys: A Wall Street Revolt,” Lewis argued that High Frequency Traders (HFTs) are in effect stealing from individual investors, pension funds and literally anyone else who ever buys or sells a stock.

The HFTs using high speed computer algorithms, fiber wire and other terrifying stuff to pervert the otherwise level playing field on Wall Street. How do they do it? In effect they front-run traders; buying the shares you order faster than you can, then sell them back to you for a profit.

Related: Stocks are "radically" overvalued: Henry Blodget

“It’s bigger than a scam,” Lewis exclaims, “it is the stock market.”

Yes. Yes, it is. It’s also called being a middle man and it’s how Wall Street has worked since its very inception. Connecting buyers with sellers has traditionally been the function of large brokerage houses, floor traders and trading desks at major banks. It’s an incredibly lucrative system and as close to risk-free as any position on Wall Street ever gets.

The trading desks of four different major financial institutions posted gains every single day during the first quarter of 2010. The tradings desks of JP Morgan (JPM), Bank of America (BAC), Citigroup (C) and Goldman Sachs (GS) combined posted 244 winning trading days against zero losses.

Were the playing field truly level the odds of a firm making profits or losses on any given day would be roughly 50%. The chances of going 61-0 on such a trading field of dreams would be 2.31 quintillion to 1. The chances of Goldman, Citi, Bank of America and Goldman independently posting 61 winning days in a row are roughly the same as four best friends in completely different sides of the world each winning Powerball, getting attacked by a shark and dying from Fugu sushi poisoning.

Less than two months after the end of this collective perfect quarter the market experienced a “flash crash” that drove the Dow down more than 1,000 points in minutes.

In 2010 a Goldman spokesperson said its trading gains came as a result of “striking the right balance and being a big enough player. We’re at the center of flows for customers.”

In other words Goldman was buying securities from one group of customers then turning around and selling the same shares to other customers, collecting a slight profit in the middle.

Has the system changed? Are nefarious HFTs the only players front running orders? In 2013 JP Morgan made money from trading every single day for the first three quarters of the year. Draw your own conclusions.

Don’t be a Victim: Use Limit Orders

Wall Street has been rigged in one way or another since it was established in 1792. That doesn’t mean you have to be a victim. The way the High Frequency Trading hustle works is by convincing investors to increase the amount they're willing to spend on a stock in the short term. The bad guys of HFT are looking to collect tiny amounts of money on every trade by targeting impatient day traders.

Main Street investors will never be able to move faster than the computers so they shouldn’t try. The way to beat the HFT crowd is by setting a price you are willing to buy or sell a stock in advance. It’s called a Limit Order and it’s available at no charge from any on or off-line brokerage service. For example Microsoft is trading at $41.15 today. If you want to make a longterm investment in the company simply set a Limit of $41.20 and wait. By law you won’t pay more than $41.20 per share plus commission.

The brokers and HFTs aren’t targeting you personally. Stocks fluctuate throughout the day but if you enter a limit at or near the market price you’ll mostly likely get your order filled. Don’t be afraid to wait and don’t get talked into paying more than your limit price.

Long Term

Day trading is a sucker’s game for individuals but investing for the long-term is the best way to build wealth. The only way to get fleeced by the HFTs is to play their game. Let the day traders worry about making pennies on tiny trades and focus on the long haul.

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