Knowledge is Power
If you ever have a chance to visit the United States capitol building, your tour will likely culminate in the immediate center of the building. Directly under the famous dome shape synonymous with the Washington skyline. Your tour guide will then direct your to crane your neck and tilt your head skyward to gaze upon the underside of the dome. On that canvas is painted one of the most famous portraits in the country.
The ”Apotheosis of Washington” depicts the late president sitting on a throne in heaven, surrounded by angels. If you happen to speak Greek, you will already know that this painting is meant to depict George Washington becoming a God. To say hero worship was alive and well in the 1800’s would be an understatement.
It is understandable to think of why early Americans thought of Washington this way. Even to this day he is regarded as the father of the country. The savior of the American revolution. Stories ranging from his childhood to his triumphant crossing of the Delaware River have become ubiquitous in American culture.
Hoverer celebrated he may have been, if you had asked Washington himself, he would have told you that it was not him who was the hero of the revolution. It wasn’t Benjamin Franklin. It wasn’t Paul Revere, John Adams, Thomas Jefferson, or the French general Marquis de Lafayette. In Washington’s own words, “Our country owes its life to heroes whose names it will never know”.
Washington would tell you that the war was not won by him. It was won by his spies. The American revolution was in many ways a David and Goliath battle. The colonists, who could not afford to fed and house even their small army, were pitted against the largest fighting force the world had ever seen. Washington knew the colonists stood no chance winning a war if it was fought in the traditional sense. So, he fought on terms that would benefit his army. He introduced the world to the concept or guerilla warfare. He also introduced the world to the power of an effective espionage ring.
Washington’s Culper Ring of spies enabled him to stay a step ahead of the British. IT didn’t stop there. Espionage played key roles in the American Civil War, World War 1, and ultimately tipped the scales in World War 2 when the British SOE deployed the most effective espionage ring the world has ever seen.
Knowledge is power. The side who has better information, and has it sooner, almost always comes out on top. Washington knew that in the 1700’s. Churchill knew that during World War 2, and James Barksdale knew that when he paid over $200,000 per mile to lay a fiber optic cable between Chicago and New York.
New York City is home to the New York Stock Exchange. Chicago is home to the Chicago Board Options Exchange, where futures contracts and options are traded. In 2008 two traders approached Barksdale with an idea. Lay a new, one inch fiber cable, in as straight a line as possible between the two cities. The terrain it was to cover would not be easy. And the cost would likely total in the neighborhood of $300 million. That $300 million investment would shave 100 miles, and 3 milliseconds off of the transition time of the next fastest cable. To be clear, three milliseconds is three one thousandths of a second. An amount of time so small we can’t even wrap our heads around it. Remember when Michael Phelps won his eighth gold medal as his relay partner touched the wall what seemed like a fingernail length before the Aussies? That fingernail length was 8 one hundredths of a second. That’s 26 times longer, than 3 milliseconds.
Three milliseconds is almost an eternity in the world of automated trading. Barksdale knew that brokers all over wall street would be lining up to lease space on his fiber line. Barksdale was right. Those who joined his network early quickly recouped their costs by using that three millisecond advantage to arbitrage the price difference between futures contracts in Chicago, and the underlying stocks in New York.
The information race is nothing new to financial markets. In 1815 Rothschild bank in London used carrier pigeons to learn of Napoleons loss at Waterloo. In 1865 Jim Fisk used fast schooners to outrun mail ships with the news of the Union victory in the civil war. He made. Killing shorting confederate bonds. Banks and brokers have long been doing everything possible to be the first to know anything that might help them gain an edge.
What is the point of all of these stories? The next time you think you have outsmarted the market, remember this one thing, you haven’t. If you think you have discovered an anomaly in a stock price that makes it a perfect buy, you haven’t. If you think you have the inside edge on a company’s new product offering, you don’t. Remember that you are fighting against a system that is willing to pay hundreds of millions of dollars to get information three milliseconds faster than they used to. Whatever you think you discovered. Whatever you think you found out. Somebody beat you to it. And all of those automated trading systems, for which three milliseconds is an eternity, have already squeezed every ounce of profit there is from that stock.
I’m not saying it is impossible to beat the market. You absolutely can. But it usually involves getting lucky. You may get lucky once, twice, or even three times. But there comes a point when your luck will run out. As I always like to say, when you are relying on luck, you are gambling, not investing. If you want to gamble with a few dollars, be my guest. You wouldn’t take your life savings with you to Vegas. Don’t gamble it on single stock picking either.