Are the markets rigged? Yes and No.

800px-_Guthrie_Cotton_Market___Peak_of_trading_on_Harrison_Avenue_is_captured_by_Photographer_Swearingen,_after_1893_-_NARA_-_51643The media has been is an up roar about the most recent 60 Minutes interview with author, Michael Lewis. In the interview, Lewis claims that the stock market is “rigged” due to the high-frequency trading.

We have come a long way (since markets of yester-year)!

My concern about this perception is that investors who need to participate in the markets (Financial Capital that replaces their Human Capital concept) will be scared away from prudent investing by mutual funds.

Bottom Line … this hurts the Day-trader trying to trade against the big boys.

Whether advisors, or their clients, are negative on markets and feel they are “rigged” doesn’t change the fact that most investors need market (stock and short term bonds) exposure if they want their assets to outlive them. The good news is that if advisors use Dimensional they (and their clients) can let them (or Vanguard) worry about advancement in markets, technology, and trading strategy.

There is a prudent, structured and sensible manner to approach the markets.

Below is a counter argument approach and summary to high frequency trading.

CBS MoneyWatch Article: Jack Bogle: Michael Lewis is wrong about rigged markets by Jonathan Berr

Loring Ward blog post addresses this issue and the question being raised.

Talking Points from DFA:

The issues discussed in the 60 Minutes segment are not new, and do not generally apply to what we do. Regardless of what one believes about market structure, high frequency trading is actually a positive for Dimensional because we are comfortable with the technology (use similar tools to HFTs) and can exert control over our trading process.

  • The 60 Minutes segment discussed an issue that does not generally apply to Dimensional because it relates to market orders and order routing practices we do not typically use. This issue is not new. Over time as technology advances, we should expect that some market participants use speed or information to try to profit. Dimensional pays close attention to trading costs and has advanced its trading methods as markets have evolved.
  • The issue highlighted in the show affects parties that are primarily “seeking” liquidity and care about executing trades in specific securities within short periods of time. This is not consistent with Dimensional’s cost sensitive trading approach.

Dimensional’s distinct approach to investing is designed to protect those clients from being exposed to unnecessary costs.

  • We design strategies to minimize unnecessary turnover.
  • We generally avoid crossing the spread, or stay on “right side of the trade”, by not demanding liquidity or seeking immediacy in our trades.
  • One of our key differentiators is that we generally do not require our traders to execute every share of an order candidate.
  • Traders have – and frequently use – the option to reach the end of a trading session with orders that are partially filled or not filled at all.
  • There are two key drivers of that flexibility:
    • We can look at similar securities with similar characteristics as close substitutes for one another.
    • Traders have real-time flexibility to be patient and opportunistic in executing candidate orders from portfolio managers.
  • A large part of our trading implementation is that we are not generally required to trade any given stock.

Dimensional considers and monitors trading costs very carefully.

  • We engage and rank very well according to third-party trading cost analyses.
  • We have a team dedicated to studying our trading tactics and outcomes.
  • We work with leaders in this field of study within academia (one of which is Sunil Wahal).

Dimensional has access to IEX and trades on IEX.

  • IEX is a non-displayed Alternative Trading System commonly referred to as a “Dark Pool,” where buy or sell quotes are not visible.
  • We do not prioritize IEX in any way or treat it differently than we would any other dark pool similar to it.
  • IEX is trading less than 0.5% of the US equity market volume.


Photo source.

In the interest of disclosure: I do use DFA sub-managed SA Funds with most clients (not a fund requirement, but a business decision I’ve made for clients). This blog is not a solicitation; simply an explanation.

Dimensional is the sub-adviser for SA Funds  I use with investor portfolio design. You may obtain a prospectus (click link here) or simply asking by clicking on the “Ask Larry” button above.

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