The Wild West of Finance
Human beings, at heart, are wild animals in love with the thrill of the hunt. I can prove it merely by pointing to the existence of the exchange-traded fund FAZ, which one friend calls “day trader’s crack.” For most of us, the stock market has been moving far too much, far too quickly. For those who buy FAZ, though, that speed is not fast enough.
Known formally as the Direxion Russell 1000 Financials Bearish 3X ETF, FAZ follows the gyrations of some of the most twitchy stocks, like banks, insurance companies and real estate firms. As an exchange-traded fund, it takes a security made up of a bunch of underlying assets and makes it behave like a stock. Investors can buy and sell FAZ, moment by moment, to try to grab quick wins.
But FAZ is not a simple basket of financial stocks. It’s composed of odd derivatives and loans that are designed to reverse financial stocks — to go up when they go down and vice versa — and triple gains or losses. It is designed for gunslinger day trading, as investors try to profit by predicting how the market will act in short bursts.
However reckless FAZ may sound, there’s a reason to root for the sector of the financial world that created it. Day trading is part of the often demonized Wild West of investment. It’s a world of online brokers, boutique money-management firms, private-equity companies and others — a gold-rush universe where anybody can sell almost anything as long as you don’t (technically) tell any lies. It isn’t a glamorous life. Day traders, for instance, stare at computer screens all day buying shares, only to sell them seconds or minutes later. Their hope is that if they buy low and sell a tiny bit less low enough times in a day, they can add up some real profit. Surveys indicate that most lose money and give up fairly quickly.
Hedge funds, which allow rich people and institutions to outsource their financial gambling, are the major players in the Wild West. And, contrary to public belief, they are no more likely to succeed than independent day traders. The handful of firms that have made huge and consistent profits hide a remarkable secret: study after study shows that most hedge funds either lose money or make tepid returns. Many — and, some argue, most — actually shut down after a few years.
What’s to celebrate here? The Wild West represents something akin to a normal, thriving market. It is largely overseen by the S.E.C., which takes a forgiving approach to firms that sell products to active investors. The downsides to this lax regulation are well known, but it is not without its benefits. Entrepreneurs with nothing more than a good idea can enter the market relatively quickly and compete against established firms. If they can offer better products than their competitors, they’ll succeed; if not, they go bust (hopefully before they almost blow up the world). One major sales pitch for capitalism is that constant competition makes us all better off. If FAZ — or a hedge fund, for that matter — doesn’t appeal to enough people, it will eventually collapse. And there is nothing wrong with that. Failure is as important to healthy capitalism as success.