The Rich Have a Stock-Trading Edge on You, and Always Have

With enough money, a trading operation can buy heavy-duty computing gear and co-locate its servers with the major stock exchanges' servers, thereby allowing it to trade at lightning-fast speeds. As one Fortune writer put it earlier this year: "Against that kind of computer power, retail investors don't stand a chance."

In the wake of the trading meltdown at Knight Capital (NYSE: KCG  ) , high-frequency trading and the advantage that high-octane, super-fast computers give some well-heeled investors over the rest of us have been once again thrust onto center stage. It's a meme that's been concerning commentators for some time now -- The Atlantic's Daniel Indiviglio offered a similar dire view a year ago, writing, "Because of the stock market's evolution, Americans don't have a chance investing as amateurs."

And let's be clear right up front about whether high-powered computers give big-money investors an edge: They do. Not everywhere or in all ways, but in certain ways, a retail investor stands no hope whatsoever when it comes to beating a physicist-programmed, co-located server-on-steroids.

Relax, it's just more of the same
What's novel in the advantages that super-fast computing brings to wealthy investors is the form that it takes. What's not novel at all is the idea that investors with more money can garner advantages over everyone else.

Consider the development of the first "stock ticker" as noted in The New York Times last week:

In 1867, Edward A. Calahan, a draftsman with the American Telegraph Company who previously worked as a messenger on Wall Street, unveiled the first stock ticker. The device, which earned its name from the unique sound it created, featured two wheels of type placed under a glass jar. The ticker printed off company names and stock prices on a narrow strip of paper, which was read aloud by a clerk.

That development allowed investors to find out stock prices much faster than they previously could. Any guess as to who was able to get their hands on early iterations of this ticker? I'll give you a hint: It wasn't Ma and Pa Smith on Main Street USA.

A century later, there were still plenty of stock-trading advantages for those with deep pockets. In 1969, long before computers were doing the trading, the way to get ahead was by being on NYSE Euronext's trading floor, in the mix with all the other shouting, hand-waving traders. That year, a seat on the NYSE went for around $500,000, or more than $3 million in today's dollars.

The advantages don't stop with proximal access, though. Stock market information providers like McGraw-Hill's Standard & Poor's and FactSet Research Systems (NYSE: FDS  ) offer highly useful data -- at a price. Accenture (NYSE: ACN  ) gets tapped by hedge funds and private-equity shops to do exhaustive industry research and specialists like the Yankee Group offer deep insights into particular industries (mobile in Yankee's case). A moneyed investor group can hire its own in-house staff of MBAs, statisticians, former industry executives, or politicians.

So yes, computers that can trade stocks at lightning speed may indeed offer the richest investors an edge over retail small-timers, but the potential advantages that money brings to the investment process neither start nor end with high-powered machines.

As it should be?
As investors ourselves, we're well aware of the leg up that comes with financial firepower.

In a showdown for market share in the mobile market between Apple (Nasdaq: AAPL  ) and Research In Motion (Nasdaq: RIMM  ) , Apple has the edge (is there any argument there?). The insightful and revolutionary design of Apple's products has had a lot to do with that. But Apple also has had a tremendous financial edge over RIM -- going back to Apple's fiscal 2006, the iPhone pioneer has maintained a cash pile 10 to 15 times that of RIM. That gives Apple an impressive amount of muscle and flexibility when it comes to spending on areas like development and marketing, which have helped Apple crush RIM like a bug.

Is this "fair"? I'll let you debate that in the comments, but the reason that many investors flock to companies with strong, liquid balance sheets is because with financial might come advantages. Should we be surprised that the same holds true for investment operations?

Your mission...
To be sure, what's carried out with computers isn't all on the up-and-up. Some flavors of high-frequency trading may indeed be underhanded and detrimental. Plus, the sheer data volume that comes with some of those practices may be creating serious hurdles for normal market functioning.

However, as far as pricey computers and fast data connections as an edge -- this is just the latest twist on the advantages that money has always provided investors with deep pockets. But this doesn't mean that all is lost for retail investors.

In the business world the strongest balance sheet doesn't always win -- consider the upstart Google coming out of nowhere to clobber then-entrenched giant Yahoo!. When a company is at a financial firepower disadvantage they are forced to think creatively to find ways that they can beat their competitors without the same resources. Trying to win a pricing war is destined to fail, but listening more closely to customers and building a better, or more targeted, product has a shot at slaying a corporate Goliath.

Individual investors who try to match up to Wall Street powerhouses on playing fields like trading speed are bound to leave bloodied and poorer for the experience. But as the Street narrows its view to doing everything faster and on the basis of price ticks on a computer screen, this opens up opportunities for winning strategies based on patience and evaluating investments on fundamentals like profit growth and valuation.

It shouldn't be expected that individual investors be able to match Wall Street's firepower. But that doesn't mean they can't win in the markets, it just means they have to get creative. Or, as Sun Tzu put it, individual investors need to "attack him where he is unprepared, appear where you are not expected."

Can you beat the robots with Apple?
Apple has a great balance sheet and the right products, but it's certainly not without its risks. The Motley Fool's technology expert, Eric Bleeker, has turned the spotlight on Apple to help investors figure out whether it's the right stock for them. To find out what he thinks, check out the premium report "Can Apple Still Juice Your Portfolio?"