IT'S WEALTH EXTRACTION, NOT INVESTING

Back in the good 'ol days the New York Stock Exchange (NYSE) operated on the simple principle that said if you have something to sell on the floor of the NYSE someone would buy it. If it wasn't worth the price you could either lower the price or simply withdraw the product. Simple enough, right? Under this principle NYSE specialists accounted for 80% of all trading on the NYSE.

Today the NYSE specialists have been overwhelmed by firms like Goldman Sachs (and other bailed out institutions) that are gaming the system by using supercomputers on the floor of the NYSE that fool other computers. Here's how it works.

According to Money Morning's Martin Hitchinson, the supercomputers fool other "institutional" computers by making orders and then quickly withdrawing the order. The goal is to see how many orders will be met, which allows the supercomputer to obtain information on a large buyer’s limits. They use this information to buy shares elsewhere and sell them (on-sell) to institutional investors before they know what's happened. The end result?

1. NYSE specialists now account for roughly 25% of trading (instead of 80%).

2. Firms like Goldman Sachs are now having profitable "$100 million trading days."

3. The goal of this type of High Frequency Trading (HFT) is not "investing."

4. The goal of HFT on the NYSE is simply "rent-seeking" (which is a fancy term in economics for market manipulation).

As Money Morning's Contributing Editor Martin Hutchinson put it, "The bottom line for us ordinary market participants is that insiders are using computers to game the system."

Several of you who know something about the market might be asking yourself, "Isn't it illegal to trade on insider knowledge like this?" The short answer is yes. In fact, the Securities and Exchange Commission (SEC) has promised to ban flash orders like HFT ... on September 1. In the mean time, many of the great days you're seeing on Wall Street may have little to do with market confidence than with big financial institutions (most of which got us into this economic mess) playing more games with the market.

At the end of day these guys are not providing value to the market. They're simply extracting wealth. Think about that the next time some talking head tells you that the market is recovering.

- Mark