The Ticking Time Bomb

Posted: Aug 07, 2012 12:01 AM

Certainly, you remember many comics or television shows where they show a long fuse that is burning toward an eventual blow up. Or, hidden deep into some vault, there is a tinny tick, tick, ticking. That is the market today.

Knight Trading’s problems just bring that time bomb a little closer to the surface. Some will say that Knight was careless and should have tested their program in a parallel environment before they launched it. It begs the question, how many programs are launched that aren’t tested? How many times has this been done before with no market repercussions?

The market dislocations are becoming all to common since the Flash Crash exposed the weakness of our current market structure. The SEC blamed that occurrence on a one order fat finger and instituted circuit breakers to try and stop it from happening again. Are you sleeping better knowing the SEC has your back? Ask Bernie Madoff investors how that goes.

If you follow people like Themis Trading, daily they can show you a flash crash in a particular stock or ETF. Daily. In futures markets, we see it happen every week in some market somewhere. The only good news about the futures market is that there are daily limits where the market cannot possibly trade through. But when a future jumps in price within a millisecond, it changes the dynamic of the underlying market and makes hedgers wonder if there is safety there or not.

Unfortunately, these kinds of gyrations combined with all the other uncertainty in finance has caused the average investor to pull out of the market. It’s also affecting the high end of the market, as experienced and well heeled investors do the same. Losing confidence in the viability and fairness of the broader markets chip away at the foundation that America was built upon.

Cynicism isn’t a strategy to build wealth. Creeping cynicism by virtue of the crony capitalism in our governments, and the crony capitalism that is codified in our market structure is undermining the true reason that markets exist. To allocate resources efficiently and build wealth.

People may delight in the lofty number posted by the S+P($SPY, $ES_F) and take comfort in it. “We are back”, they say. Market pros from both sides of the political aisle look at that number, look at economic growth, look at corporate investment, and look at Federal Reserve policy and know full well how that number was posted. Sugar highs aren’t lasting.

Computerization by itself isn’t bad. It’s the market structure that stinks. Internalization, payment for order flow, multi-tiered distribution systems, dark pools of liquidity, quote stuffing, phantom orders are all anti-competitive ways for the big boys to avoid risk and make money.

What happens when the next time bomb explodes? The bombs are in there, ticking……

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