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September 29, 2013

A crisis in confidence

Since the depths of the financial crisis, we have witnessed a stock market that has more than doubled and substantial improvements in other key measures of economic health.

Yet a recent survey conducted by The University of Chicago and Northwestern University business schools revealed that America’s confidence in the economy continues to slide. One of the main reasons cited by the study’s authors is a growing distrust of the country’s financial institutions and a deeply held view that our political leaders lack the will to fight the powerful Wall Street interests and institute the necessary protections for the average investor.

Supporting that view, a recent Gallup poll indicates that stock ownership among the average retail investor is down substantially from 10 ears ago. Although the American public has generally viewed the financial securities industry and the institutions that regulate them with suspicion, confidence in the markets has been further undermined by two “once in a lifetime” market declines in the last 13 years that inflicted extensive damage on the nest eggs of American workers and retirees.

Add to that the wave of improprieties, recklessness and outright corruption perpetrated by some of the nation’s largest banks, brokerage houses and hedge funds and it’s no surprise that many investors view the financial markets as an insider’s game that stacks the odds against them. How accurate is this perception? To answer this question we need to distinguish between trading and investing.

Trading in individual company securities, especially stocks is a fool’s errand. The evidence is overwhelming that the financial markets are not a level playing field for short-term traders. Big players like hedge funds and investment banks have access both legally and illegally (through company insiders) to market moving information before the investing public.

These “early peeks,” combined with the use of sophisticated technology and complex algorithms allow them to move in and out of individual positions in seconds, enabling these traders to earn profits (fractions of a cent on thousands of shares) on a remarkably consistent basis, an impossible feat for the average investor. In this realm of trading, it’s delusional to think the small investor can compete successfully with these institutional traders in identifying individual securities to buy and sell profitably.

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