How many years have I been addressing the injustices of HFT – high frequency trading – in my newsletters? I have no idea either, but it’s been a long time since I came to the realization that stock prices were being manipulated by forces that could not be explained. For example, if a stock is offered at $5.25/share and there are 5,000 shares are for sale, I’d place a limit order (the most I’m willing to pay) at $5.25 for the 5,000 shares. Ten years ago it would fill immediately. An example of what’s been happening in recent years: the order would not fill and the price would jump to $5.28 for the 5,000 shares. As a strategy, I don’t chase the higher price but leave my lower bid out there (as I scold my trading app). I’ll let the sellers come to me. I refuse to play a game in which I did not understand the rules.
Finally, we have the answer to what’s been happening in recent years. If you happened to see the Sunday, 3/30 episode of 60 Minutes, you would have seen Michael Lewis, author of Liar’s Poker and the The Big Short (great reads), discuss his new book and findings. Lewis says that computer-based high speed trading is set up to benefit these traders at the expense of investors by anticipating orders by a fraction of a millisecond. The new book follows Brad Katsuyama, former head trader at the Royal Bank of Canada, who says he realized that when he sent an order to exchanges, it would reach the closest exchange fractions of a second earlier than the others and that high-frequency traders would be able to use the infinitesimal time difference to buy the stock at the other exchanges and sell it back to him at a higher price. I just started reading Flash Boys and feel vindicated after all these years of complaining to Schwab that its trading app was too slow and my orders were being jumped.
The goal of high-frequency traders is to figure out which stocks investors plan to buy, purchase them first and then sell them back at a higher price. To show how lucrative the tactics are, Lewis said a technology firm spent $300 million to build a fiber optic line that would shave three milliseconds off the time it takes to communicate between New Jersey and Chicago, then leased it out to securities companies for $10 million each. High-frequency traders account for about half of share volume in the U.S., a statistic that shows their pervasiveness and hints at the obstacles faced by proposals to rein them in. Exchanges rely on HFTs for profits as well as liquidity, with electronic market makers all but eliminating the old system of human floor traders who oversaw the buying and selling of equities. Keep in mind that the speed traders’ strategies – developed over the past decade with help from exchanges – are currently legal. Go figure!
HFTs comprise a diverse set of software-driven strategies that have spread from U.S. equity markets to most developed countries as computer power grew and regulators tried to break the grip of centralized exchanges. While the tactics vary, they usually employ super-fast computers to post and cancel orders at rates measured in thousandths or even millionths of a second to capture price discrepancies on more than 50 public and private venues that make up the American equities market.
Goldberg Capital trades for the long-term and is never involved with frequently trading in and out of stocks. We never trade to earn a few pennies on a trade. We’re investing for the long haul, so a few pennies here or there typically does not matter. Where we often feel the impact of computerized trading is when a stock rises or falls quickly with no explanation. Years ago, I could often explain what happened to a stock on a given day, but this is nearly impossible today. Stocks can blow up simply because a statistic has tripped an algorithm.
Dot Hill is a good example. The stock had been on a tear since we last purchased it at .82c a little over a year ago. The HFTs and momentum investors got involved when the price reached $4/share and ran the stock up to $6 a few weeks ago. Dot Hill then reported its year-end results and exceeded their upwardly revised expectations. Furthermore, its prospects going forward are excellent. However, none of this mattered – the momentum and computerized traders decided to exit based on some technical component in their computer model and the stock’s price dropped precipitously. We’re still up 20% for the year and 250% in the last 12 months and are remaining long term holders, regardless of what the HFTs may or may not do. I STLL BELIEVE that fundamentals will beat technical or computer modeling for the long-haul! Stay tuned; I’ve already had several discussions with Schwab regarding allowing us to use an exchange that keeps the HFTs in-check.
GCM is currently sitting on a lot of cash. There have not been many great opportunities since we bought RF Micro Device under $5/share seven months ago. It’s important that you know that an erratic market or a flash crash cannot hurt a real investor if cash is available when prices get far out of line (i.e. – Dot Hill @ $.82 a year ago). A climate of fear is our friend when investing; a euphoric world is our enemy. We will make mistakes with stock picks and selected businesses, but they will not be the disasters that often occur when a long-rising stock market induces purchases that are based on erratic human (or machine) behavior. In other words – I will not invest monies just because capital is available!
YUMMY…..Turns out stem-cell burgers aren’t as terrible as they sound. Scientists in the Netherlands unveiled a technique that could use a tissue sample from a cow’s rump to create a 175 million patties. Once stem cells are plated onto a petri dish, a gel made from the calf’s blood is used to nourish them, and they start dividing. The cells contract around the gel, bulking up into a ring of muscle tissue. When 20,000 of the muscle rings bond, the result is 100 percent lean burger with- reportedly-the same taste as traditional meat. Gross but can you see the elimination of a factory farming’s big environmental footprint and possibly…. world hunger!
Here’s to a healthy diet in 2014,
Goldberg Capital Management is an investment adviser registered with the State of CT Department of Banking. This Newsletter and its contents are for informational and educational purposes only. You alone will need to evaluate the merits and risks associated with the use of the information provided herein. Although this Newsletter may provide information relating to approaches to investing or types of securities and other investments you might wish to buy or sell, no information provided in this Newsletter is intended or should be construed as an investment recommendation or endorsement from Goldberg Capital Management. Please remember that past performance is no guarantee of future results.