Shah Gilani: You want to know the truth? The truth is that Wall Street has stacked the deck against you. That’s why you need to understand how the game is played.  Otherwise you’ll end up a Wall Street patsy.

So, here’s the truth along with some lessons that will help  you play the game like a pro.

First, though, we’ll need to debunk a few myths…

Let’s start with the myth that the Street lowered brokerage  charges for the benefit of retail investors. At one time, these fees used to be  obscenely high and fixed.

But, on May 1, 1975, fixed commissions were abolished after  brash upstarts like Charles Schwab and disgruntled investors decided to attack  The Street’s price-fixing schemes.

The negotiated commissions regime that followed lowered the  cost of access to the stock market, essentially ushering in the era of the  “individual investor.”

The influx of these individual investors, many of whom  didn’t have enough money to create diversified portfolios, soon became a boon  for mutual funds – which have since grown like weeds in an untended sod farm.

Wall Street Changed the Game

Since the commission business was no longer profitable, Wall  Street moved its retail business to an “assets under management” model.

So instead of making money on commissions the game changed  to gathering as many assets as you could into a retail investor’s account and  charging a fee to “manage” them; in other words, just watch them.

That’s one of the reasons why Wall Street advocates a “buy  and hold” strategy for retail investors. They don’t want you to take those  assets away from them.

It’s the same thing with mutual funds.

And conveniently, if your broker puts you into mutual funds  that are losers, it’s not your broker’s fault.

Now, it’s the mutual fund manager’s fault. That way the  broker can’t be blamed if your account loses money.

Instead, your broker can tell you, “Don’t fire me, let’s  fire the mutual fund manager and let’s find you a better fund to invest  in. But, no matter what happens, we need  to buy and hold and not try and time the market.”

That’s what retail investors are told to do over and over  and over again.

But guess what? That’s definitely not what Wall Street firms  do.

In fact, while you’re being told to buy and hold, exchange  specialists, market-makers, hedge funds and every trading desk at every Wall  Street bank and firm are busy trading.

Some individual investors began to see how Wall Street was  really making its money and started trading themselves.

Of course, that only increased the competition for easy  trades as more retail investors traded in and out of stocks.

To continue their advantage over the public, Wall Street  fought to do away with the uptick rule.  The rule was wiped out so traders could short sell any stock at any  time.

But it’s the big Wall Street players who benefit from the  rule change because they can use their huge capital positions and work with  each other to drive down stocks they have shorted.

Who gets hurt? The buy-and-hold retail investors who are  told to buy more at lower prices are the ones who get fleeced.

And, who is selling to them?…

You want to know the truth? The truth is that Wall Street has stacked the deck against you.

That’s why you need to understand how the game is played. Otherwise you’ll end up a Wall Street patsy.

So, here’s the truth along with some lessons that will help you play the game like a pro.

First, though, we’ll need to debunk a few myths…

Let’s start with the myth that the Street lowered brokerage charges for the benefit of retail investors. At one time, these fees used to be obscenely high and fixed.

But, on May 1, 1975, fixed commissions were abolished after brash upstarts like Charles Schwab and disgruntled investors decided to attack The Street’s price-fixing schemes.

The negotiated commissions regime that followed lowered the cost of access to the stock market, essentially ushering in the era of the “individual investor.”

The influx of these individual investors, many of whom didn’t have enough money to create diversified portfolios, soon became a boon for mutual funds – which have since grown like weeds in an untended sod farm.

Wall Street Changed the Game

Since the commission business was no longer profitable, Wall Street moved its retail business to an “assets under management” model.

So instead of making money on commissions the game changed to gathering as many assets as you could into a retail investor’s account and charging a fee to “manage” them; in other words, just watch them.

That’s one of the reasons why Wall Street advocates a “buy and hold” strategy for retail investors. They don’t want you to take those assets away from them.

It’s the same thing with mutual funds.

And conveniently, if your broker puts you into mutual funds that are losers, it’s not your broker’s fault.

Now, it’s the mutual fund manager’s fault. That way the broker can’t be blamed if your account loses money.

Instead, your broker can tell you, “Don’t fire me, let’s fire the mutual fund manager and let’s find you a better fund to invest in. But, no matter what happens, we need to buy and hold and not try and time the market.”

That’s what retail investors are told to do over and over and over again.

But guess what? That’s definitely not what Wall Street firms do.

In fact, while you’re being told to buy and hold, exchange specialists, market-makers, hedge funds and every trading desk at every Wall Street bank and firm are busy trading.

Some individual investors began to see how Wall Street was really making its money and started trading themselves.

Of course, that only increased the competition for easy trades as more retail investors traded in and out of stocks.

To continue their advantage over the public, Wall Street fought to do away with the uptick rule. The rule was wiped out so traders could short sell any stock at any time.

But it’s the big Wall Street players who benefit from the rule change because they can use their huge capital positions and work with each other to drive down stocks they have shorted.

Who gets hurt? The buy-and-hold retail investors who are told to buy more at lower prices are the ones who get fleeced.

And, who is selling to them?…

The same short sellers who are driving the price down.

“Decimalization” is another idea Wall Street pushed on the  markets under the guise of helping investors.

Stocks used to be priced in increments of eighths of a  dollar (NYSEArca:UUP), they are now priced in pennies.

So who really benefits from decimalization? Wall Street  does.

The net effect of decimalization was to lower spreads at the  cost of lowered liquidity.

That’s because fewer large investors were willing to put  down orders on exchanges to buy and sell at set prices when specialists and  market-makers could “front-run” them and risk only a penny if they were wrong.  Standing orders were withdrawn and the markets (willing buyers and sellers)  became thinner.

Interestingly, as these markets became thinner, Wall Street  started to open private trading venues and “dark pools” to cater to big  institutional clients because they were afraid to put down orders at exchanges  or with market-makers.

Needless to say, retail investors aren’t invited and the  splitting up of orders across multiple venues works against those who don’t  have access to dark pools and private trading venues.

The catchword here is volatility. Everything Wall Street has  done has increased volatility.

What’s so great about volatility? Volatility is what makes  trading profitable. Without volatility traders wouldn’t have the same  opportunities for the quick profits they enjoy.

But, of course, this same volatility puts retail investors  at a complete disadvantage.

Only you don’t have to be patsies. Retail investors can play  a lot of the same games that Wall Street does.

Here’s How to Play the Markets Like a Pro

First of all, unless you’re getting excellent advice from  your broker and you don’t mind paying the fees they charge, move your portfolio  over to a discount broker.

And don’t get caught up in the myth that mutual funds are  the answer to beating the market. They’re not. Most of them buy and hold a lot  of the same stocks and end up trailing general market performance.

Check out the fees they charge. Are they worth it? Are you paying fees to lose money because you  believe mutual funds have a leg up?

Remember, mutual funds are Wall Street businesses, run on  the same assets under management for a fee principle.

Second, realize that buy and hold is dead. While it’s great  to buy and hold onto winning positions, it’s holding onto losers that will kill  you.

The only time you should hold onto a losing position is if  you actually plan to add to it when prices come down, and only because you  understand why the stock has dropped in price.

It’s okay to add to that position if it’s fallen because the  rest of the market fell, but only if the company’s business model and  fundamentals are sound and growing. Otherwise it’s a sell.

Just make sure you have an out or a price at which you say  to yourself, “That’s it, I’ve reached my limit on this position.” And then promptly get out.

The way to play the Wall Street game is to do what they do, not what they say you should do.  In other words: Trade.

Trading doesn’t mean day-trading. It means thinking like a  trader. Know what entry points are good places to buy. Know what points are  good selling points. Trading means having a plan.

First pick the stocks or exchange-traded funds (ETFs) you  want to trade. It’s important to diversify by building a portfolio of stocks  that represent different asset classes, like U.S. big-cap dividend-paying stocks (NYSEArca:DVY), tech stocks (NASDAQ:QQQ), materials stocks (NYSEArca:XLB), emerging markets ETFs (NYSEArca:EEM), or  commodity-based ETFs (NYSEArca:DBA).

What matters is that you have a handful of stocks that you  know and watch and that when you hold them you are diversified. Learn how they  move and why they do what they do.

Trading is the first step in investing. You have to take a  position, and that means putting on a trade.

But don’t fall in love with any position unless it keeps doing  what you expect it to do and you’re making money holding it.

Even then, don’t be greedy. Pick a point to take some or all  of your profits.

Finally, always have an exit plan.

Every trader I know has one – and after 30 years as a Wall  Street trader I know a lot of them.  Whether they are winning or losing, every single one of them has  plan. You should, too.

It’s not hard to play the Wall Street game. Don’t try and  beat them, you can’t.

Just play the game the way they set it up for themselves and  you’ll figure out pretty quickly that volatility can be your friend, and that  you can make money trading from both the long and short side of rapidly rising  and falling markets.

Otherwise, you’ll just end up as one of their patsies.

Written By Shah Gilani From Money Morning

Shah Gilani is the editor of the highly successful trading research service, The Capital Wave Forecast, and a contributing editor to both Money Morning and The Money Map Report.  He is considered one of the world’s foremost experts on the credit  crisis. His published open letters to the White House, Congress and U.S.  Treasury secretaries have outlined detailed alternative policy options  that have been lauded by academics and legislators.

His experience and knowledge uniquely qualify him as an expert.  Gilani ran his first hedge fund in 1982 from his seat on the floor of  the Chicago Board of Options Exchange. When the OEX  (options on the Standard & Poor’s 100) began trading on March 11,  1983, Gilani was working in the pit as a market maker, and along with  other traders popularized what later became known as the VIX (volatility  index). He left Chicago to run the futures and options division of the  British banking giant Lloyds TSB. Gilani went on to  originate and run a packaged fixed-income trading desk for Roosevelt  & Cross Inc., an old line New York boutique bond firm, and  established that company’s listed and OTC trading desks. Gilani started  another hedge fund in 1999, which he ran until 2003, when he retired to develop land holdings with partners.

 

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