By now, most traders and investors are aware of the boondoggle at Knight Capital Group Inc. (NYSE: KCG, Stock Forum) two weeks ago.
In less than an hour, the firm’s computers executed a series of orders – involving millions of shares – that were supposed to be spread out over a period of days. The resulting loss – almost four times the company’s 2011 profit – crippled the firm and brought it to the edge of bankruptcy.
This glitch, coming on the heels of the Flash Crash in March 2010, where the Dow suddenly plunged nearly 1000 points only to recover those losses within minutes, has further eroded the confidence of many investors. Indeed, some are throwing in the towel, insisting that the stock market is too treacherous a place – and certainly no home for your hard-earned savings.
“Faster, Easier, Cheaper and More Transparent”
This increasingly commonplace view is almost certainly wide of the mark. The truth is the individual investor has never had it better. Technology, competition and, yes, even regulation have combined to make trading faster, easier, cheaper and more transparent than ever before. Better still, today’s deep-seated skepticism about the stock market is handing you an opportunity on a silver platter. Here’s why…
SEC Chairman Mary Schapiro called Knight’s glitch “unacceptable.” And indeed it was. But circuit breakers in individual stocks were instituted after the Flash Crash. These guide the exchanges in determining which trades can be rescinded, giving the marketplace greater certainty. And the Knight incident will speed up a proposed rule to increase penalties on firms whose systems don’t work as designed.
This is part of the long march toward greater investor protection. In 1997, for example, a settlement between regulators and Nasdaq market makers accused of price fixing dramatically reduced the spread between buy and sell orders, saving traders millions of dollars.
When I was a stockbroker in the 1980s, the spread between stocks was often an eighth of a point, sometimes a quarter. In the 90s, it changed to a sixteenth of a point. In 2001, the SEC required prices to be quoted in decimals rather than fractions of a dollar, narrowing spreads even further. In the past decade spreads were reduced to pennies – and some stock spreads today are a fraction of a penny. This is all good. Tighter spreads mean bigger net profits for traders.
Money Loves Speed…
Executions are also vastly improved. In the 1990s, it took minutes to get a trade confirmation. By 2004, the average order was filled in 12 seconds. Today, it’s less than a second. That’s a huge advantage, especially in a fast-moving market.
These days, individual investors with a high-speed internet connection are likely to receive real-time quotes and news feeds. They have more sources of information and analysis than ever, and much of it – like Investment U itself – is free.
And this widespread skepticism about the stock market? It’s not just a good thing. It’s what investors who understand the psychology of the market actively seek: a bleak outlook.
According to the Investment Company Institute, last year investors yanked $132 billion from mutual funds that invest in U.S. stocks, the fifth straight year of withdrawals. And – thanks to gathering storm clouds in Europe – April saw this biggest net redemption of equity funds of any April in 17 years.
Don’t Follow the Herd
How can this be a good thing? Because heavy net mutual fund redemptions are an excellent contrarian indicator. When investors pile into equity funds willy-nilly, as they did in the late 90s for example, it generally means the end of the bull market is near. And when they cash out in a big way, as they have over the past several years, it means stocks are a bargain. Those who understand stock market psychology aren’t surprised that the stock market has doubled since the March 2009 lows – when pessimism was rampant – and remains cheap today at just 13 times trailing earnings.
Gallup recently asked Americans: “If you had a thousand dollars to spend, do you think investing it in the stock market would be a good or bad idea?” A clear majority answered “bad idea.”
This is good news indeed. Investment legend John Templeton once observed that bull markets are born on pessimism, grow on skepticism, peak on optimism and die on euphoria.
Do you seriously believe we are anywhere near optimism or euphoria about stocks?
Me neither. And that’s a good indicator this bull market has legs.