on April 2, 2014
I retired from the hedge fund world and I can tell you that this book is mostly on target. For those who deny that HFT (high-frequency trading) is a rigged game, either they are un-informed or disingenuous.
It wasn't always like this. There was a time, when a bid was a bid, and an ask was an ask. If you liked the ask, you could hit the buy button and have a buy order confirmed instantly. Likewise, if you liked the bid, you could hit it and have a sale order confirmed instantly. That instant used to be measured in seconds or less. Then came along the HFT algo. All of a sudden, a bid is no longer a firm bid, and an ask is no longer a firm ask. You can hit the bid, but instead of selling instantly, you now become the ask price, and the bid just got lowered by a penny or more, and the market is moving away from you. Most of the time, the price move is a head fake - an illusion, trying to get you to trade at a price with "scalping" built-in against you. If you are willing to stick around, the precise price you want will return and you can have your trade. But other times when execution really matters, it was all real, the price you were willing to trade at just got shifted permanently right before your eyes and somebody "front-run" you.
I decided to retire, partly out of disgust, partly out of my lack of financial ambition. I learned a while ago, if the first million can't make you happy, that you have to accumulate more, you will never be content. If you have to play the rigged game to add more riches to your money pile that most human beings will never see in their lifetime, I feel sorry for you. Life is too short for me to play that game.
Addendum: This book was written for the lay person, so was my review. Sorry for not bandying about the jargons as some would expect, my bad. As much as I tried, I seem to have failed to write in plain English and draw the analogy to a functioning market. That's where Michael Lewis' book excelled, hence my recommendation. Granted, true free market doesn't exist in the financial world (no matter where you look, New York/London/Chicago/Tokyo). Only the naive will expect any market to give all participants the same level of positioning to engage in any transaction. My favorite analogy is my local farmers' market. When I show up to buy strawberries, some farmers/dealers have way more information on the supply and demand, and have inventory to reflect their view. They will rightfully make a profit when I buy the basket of strawberries from any of them. What I don't want to see is some jerk get in the way and buy up all the strawberries just before I hand my money to the seller, then turn around and sell the strawberries to me as if he had been the seller all along. The price quoted at my farmer's stand should be the price I can buy strawberries at, not a new price some jerk just jacked up to after seeing my intention to transact. I hope the description above clears any doubt about what this book is really about. It's not about someone having some legitimate edge after doing extensive research, or illegitimate edge resulting from inside information. It is about the financial market must be well functioning and free of unnecessary intermediation. That said, still two thumbs up on the book! For those who deny the unfairness of HFT front-running, either you haven't seen it (which should disqualify you from commenting on this topic) or you are so jaded that you can't see its harm (which begs questions about your integrity). As for myself, still happily retired after a short stint in the world of finance, thank you very much! I never learned much and never enjoyed rattling off the jargons.
on March 31, 2014
"Flash Boys" has all the qualities you would expect from Michael Lewis. It's a wonderfully-written set of intertwined narratives that make the primary characters come to life. Lewis is able to do this in a way that is perhaps without equal, especially when the topic is complex. In many ways the book seems more like a novel than a nonfiction book: if you enjoy a good story, you won't be disappointed.
The main narrative involves Brad Katsuyama, a trader at the Royal Bank of Canada, a relatively obscure firm that is no where near the top tier when it comes to Wall Street trading. Katsuyama discovers that his trades aren't getting filled as he expects, and he becomes suspicious and goes looking for the problem. He ultimately discovers the world of high frequency trading, and the fact that the stock market is essentially rigged by firms that are able to use their speed advantage to game the system and siphon a little money off nearly every trade.
The book is a great read, and gives a pretty cohesive overview of high frequency and algorithmic trading. Lewis focuses almost entirely on the speed advantage from shorter fiber paths, but in fact there are many issues beyond that. For example, artificial intelligence is used to build trading algorithms that read special machine-formatted news feeds and place trades almost instantly. If you enjoy this book, you might also like The Lights in the Tunnel: Automation, Accelerating Technology and the Economy of the Future, which looks at the more general impact of computers, algorithms and artificial intelligence on the whole economy and society. We are soon going to face huge issues that go way beyond just Wall Street trading. Lewis doesn't delve much into these broader impacts, but the book does make the main point clear: Wall Street trading has been taken over by machines that operate at speeds far beyond what a human can possibly comprehend. That will make regulating the markets and avoiding the next financial crisis all the more difficult.
on April 23, 2014
Michael Lewis’ new book “Flash Boys: A Wall Street Revolt,” hit the top of The New York Times bestseller list a week after its release. As you would expect, the book is skilfully assembled and quite sensational. When I first started to read it, I too was convinced that Lewis was on to a big story, an important narrative about the seamy underside of Wall Street.
But the more I read and, more important, the more I checked his story with my colleagues on the operations side of the financial markets, the more it becomes apparent that Lewis has missed the real story – and perhaps deliberately. The headline of “Flash Boys” is about Wall Street traders using fast technology and unfair tactics to trade ahead of retail investors – and they do – but Lewis misses the real issues, namely: 1) a lack of transparency and 2) deliberate complexity.
It is important to distinguish between issues related to the “flash crash” of May 2010, when the deliberately fragmented ghetto that is the US equity markets almost melted down and the daily business of HFT. The former is discussed in an important 2011 paper by Ananth Madhavan of BlackRock, Inc. Unfortunately, as the title of his book confirms, Lewis combines the two issues together into an often confusing narrative that is almost impossible for laymen to understand.
The abusive aspect of HFT which Lewis rightly identifies is not so much about the speed of the trading but rather always being first in line. If you think of the current market price of a stock, a couple of years ago, the trader using HFT used to sit just above and below the current market price, and sought to execute quickly when the market price either went up or down. The fact of computers and fast network connections enables this HFT activity, but it is not really the key part of the strategy. Instead the key is to always be first in line.
The important part of the story that Lewis misstates is that there is no conspiracy, no illegal activities. All of the strategies used in HFT are not only legal, but they are the result of extensive rule making and public hearings by Congress, the Securities and Exchange Commission, FINRA and the major exchanges. So while Lewis is right to say that these strategies “screw” retail customers in a practical sense, the fact is that the activity has been entirely blessed by Congress, regulators and the major exchanges.
In the first aptly named chapter, “Hidden in Plain Sight,” Lewis describes groups of traders attempting to conceal their activities, great stuff if your chief objective is to sell books. But the reality is that the top three HFT firms – Goldman Sachs, Morgan Stanley and Credit Suisse – have been very visibly investing in trading technology for decades. These investments in computers and fast network connections not only give them an advantage over other firms, but afford these firms bragging rights on the Street. If you are an equity trader, you don’t want to work at a “flow shop” like Merrill Lynch.
Part of the reason that the Big Media is making such a fuss over “Flash Traders” is that they have no idea how the equity markets actually work in the brave new world of Reg NMS – 600 pages of unintelligible rules and definitions. Lewis notes that as the size of equity trades after 2000 “had plummeted, the markets had fragmented and the gap in time between the public view of the markets and the view of high frequency traders had widened.” This passage and others give readers the false impression that the speed of the HFT is the key point, but this is incorrect.
Going back to the point about being first in line, let’s take an example. The BATS order type known as “display-price sliding” allows an investor to essentially position themselves in the center of the equity market for a given stock. This means that when the market price changes, instead of the HFT “market order” being canceled as per the National Best Bid and Offer (NBBO) rule, it simply “slides” to follow the market. Most investors and advisors don’t even know that such an order type exists.
For example, when Lewis talks about the fact that Virtu Financial had made money almost every day for five years, the reader is given the impression that the speed of the trading gave Virtu and other HFT shops the advantage. But the reality is that the high frequency trader not only executes before the retail customer, as Lewis describes, but is always first in line. This structural duplicity is programed into the system, but is perfectly kosher under Reg NMS.
Indeed, the real scandal is that all of this has been entirely blessed by the SEC, FINRA and the major exchanges and is described in the voluminous public documentation for permitted order types. But suffice to say, virtually nobody in the Big Media or at most Wall Street firms understand any of this or knows, for example, that there are over 100 different order types allowed by the SEC and FINRA under current law and regulations.
The crime of HFT is that Congress, the SEC and other regulators have allowed a handful of Wall Street firms to assemble a set of opaque market rules that few people understand. You could probably put all of the Wall Street operations people who really understand HFT in a large conference room. Outside of the small community of traders and operations people who make HFT work, almost nobody else on Wall Street really understand the nuances of the business. And virtually nobody at the SEC has a clue how this works in practice.
We should thank Michael Lewis for using his celebrity and considerable writing skills to draw attention to this issue of HFT, but “Flash Boys” incorrectly demonizes individual traders and firms. Lewis “Puts a Face on HFT,” but in doing so misses the real point of the problem. Instead of drawing an accurate picture of HFT, namely corruption and stupidity in Washington, admittedly a banal and boring tale, Lewis chose instead to create a sensational and interesting fictional narrative that will obviously sell more books.
“Flash Boys” is a book written for Hollywood instead of the history books or policy makers. Just as the hyper-popular “Wolf of Wall Street” was not an accurate portrayal of fraudster Tom Prousalis, as his daughter Christina testifies, the story line in “Flash Boys” is more fictional dramatization than fact. The true perpetrators in Michael Lewis’ tale of Wall Street greed and corruption are, in order of complicity, the US Congress, the SEC, FINRA and major exchanges, and last but not least the community of Buy and Sell Side Advisors, who genuinely do not understand how HFT really works. That covers just about everybody.
As illustrator Walt Kelly’s Pogo said famously: “We have met the enemy and he is us.”
This review was published in Zero Hedge in April 2014: [...]
on July 30, 2014
I'm a fan of Michael Lewis, but he has in my opinion gone bad with this latest book. It's not just that the book is kind of bad, which it is, but he himself seems to have lost his grounding - intellectually, stylistically and even morally. It's as though he started out with a marketable tagline: "The markets are rigged" and then worked backwards to produce a book to justify it. I like Lewis well enough that I was prepared to give him the benefit of every doubt here, but I'm afraid this thing still comes up short.
The phenomenon that he has turned his focus on is High Frequency Trading. He applies his usual technique of examining his subject through the eyes of several quirky participants who have a special vantage on it. In this case, his main character is Brad Kaysuyama, formerly a senior trading manager at Royal Bank of Canada. In pursuing trading strategies at his bank, Kaysuyama finds that the security prices appearing on his screen have developed a maddening tendency to give way to less favorable prices by the time his orders execute. Kaysuyama digs into the problem and eventually traces it to the activities of secretive high-frequency arbitrageurs in the market. These are the guys who run computer algorithms that in milleseconds scan all the exchanges on which any given security lists, then automatically scoop up the best prices ahead of traditional traders like Brad. Then they scoop up the best prices on the opposites sides of the same trades, dumping all positions and locking in tiny risk-free gains for themselves. The result is higher trading costs for Brad and other institutional traders. This is indeed a fairly big deal for them, because they are in a high volume/low margin business, and anything that cuts into the already-low margins poses an existential threat.
The main problem with Flash Boys, however, is that while High Frequency Trading is bad for professional traders, it's not really that big a deal for the rest of us, despite what Lewis labors very hard to imply. "Basis Point" is Wall-Street speak for a hundredth of a percent, and the HFTers play the game for the sake of a basis point or two on each transaction. At the high volumes they do, this can aggregate into meaningful money for them, but it hardly matters that much to the "average investor" Lewis claims to speak for in this book. This mythical individual, who presumably is not an amateur day trader, does not transact in enough volume for a few basis points on each trade of have a material impact on his or her returns. Besides, as most "average investors" know, trading spreads have moved down, not up, in recent years, and are way down from where they were decades ago, when HFT didn't exist.
Another odd thing about a book focused on High Frequency Trading is that we, with one exception, don't actually meet any High Frequency Traders. I believe this omission is by design. By leaving us largely in the dark about who they are, Lewis suggests by implication that they are huge institutions secretly stealing from all of us. Lurking this way in the deep, the HFT villains are meant to grow ominously in our imaginations. In fact, as Lewis knows perfectly well, they are relatively obscure little firms armed with crackerjack computer programs hardwired strategically in such a way as to minimize transmission speeds and order lags. They compete directly against one another and generally run circles around the big banks, who tend to have relatively clunky systems not well-suited to HFT. Indeed, as Lewis himself explains to us, several of them have given up the game and outsourced their "order flow" to HFT firms better able to execute effectively.
The book has a happy ending of sorts, because Brad Kaysuyama finds a way around his problem. He and his colleagues at Royal Bank of Canada create their own set of algorithms that succeed in stalemating the HFT monster and allowing RBC to gain access to fair trades. Brad and his boys throughout are portrayed as a bunch of honest nice guys who are really not that interested in money and are only trying to "do the right thing" for the good of the markets. In fact, having accomplished their goal at the bank, they decide to strike off on their own, in true David-and-Goliath fashion, and create an independent exchange designed to bring the HFT monster to its knees. Their new exchange would be known as Investors' Exchange (IEX) , and its mission would be to bring pricing justice to us all. To succeed, though, IEX would need to attract enough volume to allow it to cover costs, and weirdly it is none other the Goldman Sachs - that most vilified of Big Banks - who rides to the rescue by shifting a chuck of its order flow to our little band of heroes. Lewis takes pains to explain - correctly I believe - that Goldman Sachs is actually a fairly decentralized place, and it's only a couple of forward-thinking managers there who have made the decision to support IEX. Thus does Lewis leave those of his readers so inclined to go on imagining the institution itself as rotten to the core.
Goldman Sachs does re-assume its evil persona in the a sub-story running through this book of Sergey Aleynikov, the computer programmer who achieved his 15 Minutes Of Fame in 2009 when he was arrested for stealing confidential code from his employer, who happened to have been none other than Goldman. Lewis doesn't tell us much about what Aleynikov was really up to, and portrays him - not very convincingly - as being largely ignorant of the use to which his work was being put. Lewis seems to take at face value Aleynikov's defense that the trading software he took home with him was mostly open-source and of no proprietary value. Goldman's pursuit of him is thus seen as pure irrational vindictiveness. Near the end of the book we see Aleynikov sitting in his jail cell talking philosophically about his fate and accepting with Gandhi-like equanimity the ruination of his life at the hands of the vile bank. Mired as it was in paranoia in 2009, Goldman surely was being petty in pursuing the programmer with such total-war vengeance. Lewis's exaggerated melodrama, however, strains credibility.
What angers me about Flash Boys is its dishonesty. To my knowledge, there's nothing material in the book that's factually wrong - Lewis is too good a journalist for that. It is, however, a word-storm of misleading innuendo designed to throw red meat to a press hungry for the markets-are-rigged message. And while there are plenty of reasons for questioning both the integrity and the competence of large financial institutions today, the real problems have little to do with High Frequency Trading. The central argument of this book is thus a Red Herring.
Michael Lewis is already a highly successful writer, deservedly so in my opinion. Flash Boys, however, seems to have propelled him into the stratosphere, judging from the publicity he's received since its publication. There's even talk of turning it into a movie, bringing to mind the image perhaps of Brad Pitt made up in a crew cut and glasses playing our nerdy hero Kaysuyama, and some soulful Russian actor as the tragic Aleynikov. The fashionable message is selling, as Lewis knew it would, and not enough people are noticing the slight-of-hand.
The odd thing is, for a book conceived with its own marketing campaign in mind, Flash Boys is probably the least accessible of Lewis's works. The lightly humorous touch he is famous for is largely gone here. What's taken its place is an alternating current of shrill message-mongering, melodrama and geeky techno-finance commentary that will elude most readers, even though he explains it about as clearly as the dense subject matter allows.
I'm sure I'll read Lewis's next book too, but if Flash Boys is indicative of a permanent new turn for him, I'm going to have to look around for a new favorite author.
on April 1, 2014
Disclaimer: I have a lot of experience trading electronically (although I don't do HFT), and I try to keep up with everything HFT-related, exchange market micro structure, nooks, academic articles, news, SEC/CTFT/FINRA meetings, etc.
Flash Boys presents a story about a trader, Brad, who's not technical, and who's trying to learn about the market. The trader find out about a new kind of investors, the high frequency trades, and Brad "figures out" that speed is very important and that his trades are being gamed. Enraged by this, Brad decides to create an alternative trading system, ATS, that would be more "fair" to the long term investors. The book tries to accomplish 2 things:
1. tell a story in an entertaining way
2. raise flags about how to stock market is "rigged"
On (1), Michael Lewis does an ok job, although the story is forced. Some chapters have very little relation to each other. (the Sergey Aleynikov chapters for example) However, Michael Lewis is not the first to this story of HFT, and in particular Scott Patterson has a more entertaining story in his book "Dark Pools". Also, the book's entertainment value is much lower than some of Michael Lewis' other books, in particular Liar's Poker, Moneyball and The Big Short. The second part of the book is dry and it reads like a commercial for IEX. (the new ATS started by Brad)
On (2), Michael Lewis has too many wrong facts, and basically he loses credibility because of this. Moreover, the whole book is only focusing on the speed aspect of HFTs, and latency arbitrage, that's only a small part of HFTs and market making. In addition, he only presents facts that support his point and many facts where they are blatantly false. Next, I will go thru some of these facts presented in Lewis' book
False facts presented in the book:
1) On the first page, Michael Lewis sets up Brad as a trader working for RBC, a very conservative bank -- "It was stable and relatively virtuous, and soon to be known for having resisted the temptation to make bad subprime loans to Americans or peddle them to ignorant investors" Yeah, right... this is an actual misconception that is seen from time to time in the news. The Canadian banks, including RBC, received 114 billion dollars in bail-out money (which is more per capitalization than the American banks), but their bail out was secret. The people only found out in 2012, and this is why this misconception exists. Michael Lewis should have known about this.
2) On the second page, Lewis continues to set up the Canadians (and Brad, the hero of the book) as being super conservative "Debt was a foreign concept in Canada. Debt was evil". This is pure BS. As of March 2014, the household debt-to-income in Canada is 165% and about 105% in America. Their real estate is in big problems right now, and may burst soon. Canadians are, on the contrary, in more debt than Americans.
3) Lewis complains several times that the are some exchanges that pay traders to take liquidity. He says: "For instance, the BATS exchange, in Weehawken, New Jersey, perversely paid takers and charged makers." "Why would you pay anyone to be a taker?" At some point he mentions SIRI, and how after the BATS with the new reverted fees, the volume in SIRI tripled. He claims this is proof of high frequency trading taking fees. I hope Michael Lewis is reading this review. He's why there may be a competitive advantage in reverted fees and in particular for SIRI: basically, when you execute an order, your cost is going to be price+rebate/fee. if you have a bit at 100.14 and ask at 100.15, including the regular rebate/fees, the price would be roughly 100.1370 and 100.1430 assuming a fee/rebate of about 0.0030, which is roughly what Nasdaq has. Now, for a reverted fee exchange, these prices would be different: 100.1430 and 100.1470. What is important to notice is that the actual spread is much smaller in a reverted fee configuration (0.0040 vs 0.0160). SIRI is an extremely cheap stock -- a penny stock where the spread is huge by regulation. With inverted fees, the reduction in spread is very important, because it reduces the costs of trading. Less costs, more activity, more trading.
4) Michael claims there is no paper/trade/quotes trail: "You want to see a single time-stamped sheet of every trade. To see what followed from what. Not only does it not exist, it can't exist, as currently configured. No one could say for sure what caused the flash crash -- for the same reason no one could prove that high-frequency traders were front-running the orders of ordinary investors. The data didn't exist." Actually, the data does exist, and is recorded by many institutions on every little details. You can buy level 2 data (which includes every order on the public exchanges, places, cancellations, repricings, executions, etc) from Bloomberg, Reuters, 7 ticks, FTEN, and many others. You can actually look and see what happened during the flash crash. You can actually check when your orders get on the book, etc.
5) "Back when human beings sat in the middle of the stock market, the spreads between the bids and the offers of any given stock were a sixteenth of a percentage point." Wrong, the tick was 1/8 of a dollar, and in reality it was 25 center (1/4 of a dollar), because the human market makers had a gentleman's agreement to keep the spreads high. Higher spreads, higher profits for the market makers. This gentleman' agreement was a big part of the reason why the SEC force the market to go electronic -- because the old human brokers and market maker were cheating the investors.
6) "There used to be this guy called Vinny who worked on the floor of the stock exchange, said one big investor who had observed the market for a long time. After the markets closed Vinny would get into his Cadillac and drive out to his big house in Long Island. Now there is the guy called Vladimir who gets into his jet and flies to his estate in Aspen for the weekend. I used to worry a little about Vinny. Now I worry a lot about Vladimir" -- The implication here is that Vladimir makes more money than Vinny, and the investors must be paying more to the market makers. But the electronic market making scales easily, and to start there's 1 Vladimir for 1000 Vinnies.
7) "The price volatility within each trading day in the US stock market between 2010 and 2013 was nearly 40 percent higher than the volatility between 2004 and 2006" You need to be very precise when you define volatility. Usually people refer to the VIX implied volatility, and you can see the graph historically in yahoo finance. Take a look. Can you tell that the market now is in a different state? No, you can't. There were some higher volatility periods, but those periods were driven by big macro economic issues: 2008 crisis, 2011 debt ceiling debate and the following debt ceiling debates. In fact, the VIX has been close to historical low in 2013.
8) "It was what investors most noticed: They were less and less able to buy and sell big chunks of stock in a gulp" As market makers compete and get better at reading the market, they will provide a tighter spread. However, at the tighter spread they will not be able to offer as many shares as at a wide spread. Cheap stocks for which the spread is big (1 tick is a bigger percentage of the price) have long queues, and expensive stock will have very thin queues. SIRI probably has queues in the millions of shares and Google in 100-200 shares range. This makes perfect sense since a price in smaller increments (percentage wise) is much easier to ran over. When the market maker is ran over, he loses money. Why is this relevant? The decimalization, going to 25 cent spreads to 1 cent spreads has the same effects. When the spread was 25 cents you can offer a lot, but on 1 cent spread, you'll lose your shirt quickly. This is why the mutual fund execution should change when the tick size is small -- you just can't do the entire quantity in 1 shot anymore. Also, these guys are supposed to be professionals and know how to execute.
9) "A Hide Not Slide order was a way for a high-frequency trader to cut in line, ahead of the people who'd created the line in the first place, and take the kickbacks paid to whoever happened to be at the front of the line" Actually, anybody can use a hide not slide, not just HFT. In particular, hide not slide reprices automatically, and it levels the plain field between fast and slow investors. If used, this order is good for the slow investors.
10) On IEX, "the obvious starting point was to prohibit high-frequency traders from doing what they had done on all the other exchanges -- co-locating inside them" With co-location, you can have hundreds of investors, all at exactly the same distance, with a leveled plain field. Without co-location, the investors will fight for the spaces close to the exchange -- across the street, a block away, 2 blocks away, etc. The plain field will not be leveled and their costs will be higher, plus they will have to maintain their own little datacenter. This is bad -- it's going back to a worse time.
11) "What the **** is the point of a Post-Only order?" On most exchanges when you take liquidity you pay a fee, with post-only you get a rebate, so in effect an order at 100.10 post only would be an order priced at 100.0970 and not post-only priced at 100.1030. So the answer is: they have a different effective price.
12) "For instance, one day, investors woke up to discover that they'd bought shares in some company for 30.0001 Why? How was it possible to pay ten-thousandths of a penny for anything? Easy: High-frequency traders had asked for an order type that enabled them to tack digits on the right side of the decimal, so that they might jump the queue in front of people trying to pay $30.00." Completely false, pure fabrication. The exchanges can only trade in tick increments. (modulo the fees/rebates which are fixed for the exchange) This is against the SEC rules.
13) "In August 2013, the Goldman automated trading system generated a bunch of crazy and embarrassing trades that lost Goldman hundreds of millions of dollars..." Yes, but this was on the Options market, on Options exchanges, and has nothing to do with the rest of the book.
14) "They played only when they had an edge" All investors "play" when they have an edge. No investor plays to lose.
15) Brad's claim that when he did a sweep to take the liquidity on all exchanges, it first hits BATS, and the high frequency players can see that and take the liquidity from the other exchanges, then selling it back to Brad at a higher price -- it's very fishy. Why? Because if it was the case, you can easily game it. Put sell order at the ask, the hit BATS with buys, forcing HFT to buy your sells, in effect forcing sells at the ASK. Similarly, you force buys at the BID and make the spread. Moreover, this conjecture can be easily proved by looking at the L2 data after the failed sweep. Did somebody rush in and take that liquidity in front of you, or were those orders cancelled? Trivial to check. Did Brad and Michael do their homework and actually check this before making this big allegations? Since they didn't bother to actually check with the L2 data, it's hard for me to take them seriously.
At last, what bothers me is that the second half of the book is really a marketing material for IEX. I went to the IEX website, and here's what I found about how to prioritize orders:
"Among all orders at a given price, precedence will be given first to orders marked Agency or Riskless Principal, in time priority, and then to orders marked Principal, in time priority, belonging to the same Subscriber as the order being processed, and then to all other orders at that price in time priority; the oldest orders having the higher precedence."
In other words, their broker friends and other friends (agency and riskless principal) can jump the queue in front of the average investors. It looks to me that the system is set up to screw the investors, not to help them. But the edge is given to their friends. This is much worse than the lit exchanges, where there's just time-priority and nobody has an advantage. This is disgusting.
Conclusion: The style of the book is somewhat entertaining and the book is more than readable given the dry subject. Michael Lewis presents a lot of misconceptions and wrong facts about the market. His main point is that there's a particular case when somebody rushes to take all the liquidity at the best bid/ask, but can't because of fragmentation. He claims that HFTs are faster and after you take the liquidity in one exchange, HFTs can "front-run" you to the other exchanges because they are faster. Sounds believable, but the main problem with this assertion is that it can be easily checked by looking at the L2 feed -- in fact this would be the first thing to do to debug the problem. Michael and Brad don't do that. Instead they claim the data is not available, which is clearly a lie (real time and historical data is available in great detail) Further, today, the investors are using the same technology as HFT, such as co-location and fast feeds. E-Trade and Ameritrade flow is executed by Knight/Getco, Virtu, and a couple more aggregators, which are just as fast and sophisticated as HFTs.
Moreover, Michael promotes Brad's "solution" to the market, IEX. IEX's innovation is a delay on the feed of 350 microseconds, a speed bump, so that HFT's don't have an advantage. Sounds good at first, but at a second look it resembles a marketing gimmick. Say you put an order on the book, if the market moves and it's clear that you're behind, you would try to cancel the order, but since you'll be slowed down to, there's still a race between you and all other market participants to the stale order. If cancels are delayed less, then you have another problem: the HFT now has the order on the book and he can cancel easier, so he'll only clear when it's more convenient for him. In any case, the relative speed difference between players will be the same, and reacting fast to the market will be just as important, only that with the 350 microsecond delay, now you have another dimension to consider, and the complexity goes up. A smarter investor will be able to navigate a complex market better than a less competent investor. HFTs are the smartest on that time-frame. Looks to me that they will benefit from this "innovation".
A lot of commenters asked more details about high frequency trading. There are a lot of misconceptions and I think this book promotes some of these. Here is what it's known about HFTs:
- HFT profits were estimated at 1.3 billion dollars in 2013, down from over 7.2 billion in 2009, according to Larry Tabb, consultant, who has been vocal against HFT's in the past. To put this in perspective, the profit of a single big bank is up to 20 billion per year.
- HFT main competition are the old school brokers who are now extinct
- HFT drove the spreads down by a factor of 25 since decimalization. The low spreads means low margin per trade, which means human specialists can't compete anymore.
- many HFTs have a broad view of the market and react very fast
- HFTs use many strategies. The common ones are all sorts of arbitrages and market making (providing liquidity with investors that don't want to wait in the queues)
- HFTs have a small edge per trade, but they do many many trades. Because the law of large numbers, the result is that they generally have high sharpe (risk adjusted returns). The way they provide liquidity either works or it doesn't, and they can figure out if it works very quickly. If it works, they will rarely lose money.
- the risk of HFTs is that (1) they are not competitive anymore (somebody can read the market better and provide tighter liquidity, ie smaller spread) and (2) computer error (such as the trading error Knight Capital had, that lost 440 million dollars)
- some HFTs are still profitable. Virtu comes to mind. However, if you look where they make their money, they haven't grown in their established markets.
- some HFTs are much less profitable. Getco, according to SEC filings (it's now a public company), loser 95% of the profits recently.
- some HFTs had to close doors. Eladian Partners was a spinoff the trading shop inside Citygroup -- their technology used to work, but they became not competitive enough and closed. Goldman bought the market maker Spear, Leeds & Kellog in 2000 for 6.5 billion dollars. Today they are selling it for 30 million. Tradeworx used to be a prop shop, but now it makes money by consulting for SEC and handling orders for retail.
- HFT are good at reading the market, especially bad execution, like what Brad was doing in the book. This forced the brokers and investors to obfuscate their orders. Now, they all use algos to trade.
- when mom&pop trades in the ETrade account, they benefit by the small spread. They get ripped by the broker fee. It's funny that people talk about the $0.01 spread (and an HFT only makes a small fraction of that on average) but ETrade charges around $7-8 per trade.
- HFTs are not banks. Banks lose to HFT because of their culture. Technology people don't like working in the bank environment. Not even Goldman Sachs can keep up.
The biggest problem with this book is that it attacks the wrong properties of the market. For example, it attacks co-location which creates a leveled playing field, as everybody buys space at the same distance from the exchange. Before co-location, brokers were buying real estate around the exchanges, and nobody was equal. This was also very expensive, and gave advantage to brokers with a large bank account (mainly the banks like Goldman). Another big problem is that this book focuses on the speed issue. It's never been a better time than today, when more brokers and investors were connected at the same speed. Putting the speed issue forward, the book barely mentions the practice of some big market makers to buy flow from E-Trade, TD Ameritrade, etc. This has nothing to do with HFT, and this practice is orthogonal to HFT issues. While from a business point of view this is ok (it's a free world), the practice of hiding flow hurts the market and price discovery. Every single study that has been done on this shows that price discovery and other market properties are being visibly hurt even if only 10% of the flow is in the dark. This is why Australia, Canada and now Europe have put the brakes on the dark pools. These aggregators are brokers that specialize in internal matching and together with dark pools use lobbying to keep their advantage: dark pools are allowed to match at a price under a tick size, while exchanges are not; This is a regulatory advantage because they can market their service by saying that they offer a better price to retail, also called "price improvement". Moreover, some of the complexity of the exchanges is to go around this problem. Since their price levels are fixed, the only way to change the price level is do offer different fees/rebates (Bats opened 2 exchanges with different feeds, and DirectEdge also 2, and Nasdaq has 2 as well) and exotic orders (that have different fees/rebates).
on November 11, 2015
I just finished reading Flash Boys.
Then I turned around and gave it to my husband to read. He loves great books and this
Anyone who has any investment, large or small, will want to read this book.
I have read most of Lewis's other books. This is his best.
It reads like a novel, really a thriller. So faced paced that I couldn't put it down.
Who would have thought that a tale involving the intricacies of Wall St. chicanery could be so fascinating.
But apparently this is the special talent of Lewis. He can make just about anything irresistible.
Really, it's the characters.
The people in this book are real. Just people who, in no apparently connected way, rose from wherever they
found themselves, to take on some of the most powerful interests in the world, Wall St.
After you read the book go online and watch the 60 Minute interview.
Then watch the infamous CNBC interview with Lewis, the author, Brad Katsuyama, the major protagonist of the book, and the big, bad boss of BAT, a notorious high frequency trader, which is pilloried in the book. It is the most watched CNBC episode in their history. After you read the book it will take on a life that is shocking.
Nice to know that the BAT guy was fired after the show.
But unfortunately, BAT still lives on as one of the villains.
I am salivating waiting for his next book.
on June 2, 2014
I've been a big fan of Micheal Lewis for quite a few years. I just loved "Liar's Poker" (the line about bond traders hanging around his office like "an unfed house pet" was truly classic, as one example of great prose and explanations). I also thought "The Big Short" was a terrific book. "SAY THAT AGAIN" was just a hilarious and truly appropriate line attributed to Mr. Burry.
For "Flash Boys" though, I'm disappointed. It seems to me that, like other reviewers have stated, Mr. Lewis is pushing a political agenda based on the way he wishes the world were, and being fast and loose with facts along the way.
IMO, a much better book to shine light on the issues here is "Dark Pools", which actually has sourcing for many of the key accusations or opinions, unlike this book (unless I missed something).
At the end of the day, as a small trader who sells monthly or weekly options against part of his portfolio for income, and so needs to trade 100 or a few hundred shares of stock now and then (I may trade against a deep in the money LEAP instead of the actual stock) -- frankly, I DON'T CARE about the details of the competitive landscape among the HFT traders, and I am MUCH BETTER OFF financially trading, than I was just a decade or three ago. I believe 99% of small traders who actively trade a part of their investment portfolio are in the same boat on this.
So, round numbers, today it costs me (typically) a total of about $6 to trade 100 shares of any liquid stock like IBM or GILD, etc. Back in the day, between commissions, bid-ask spreads, and having to wait on a MANUAL process to get my physical paper ticket turned into an order and routed to the floor, it would cost me anywhere from about $50 to $hundreds to make the same trade. (Comissions, spreads, and TIME were all significantly larger factors).
So today, I don't care whether some enterprising HFT trader acting in a hypercompetitive environment and risking a significant amount of capital investment or trade funds makes, say, $5 or $50 front-running me, or whether my order flows through body parts of a herd of purple unicorns. At the end of the day, my orders are filled very consistently within a one cent price range, and technology makes ALL aspects of my trading at least an order of magnitude better and more convenient.
Now, could government do a better job regulating? Perhaps. But as the book implied, as soon as the regulations changed to, say, force all trading to be "like" that on IEX, the lawyers, technologists, etc. would be looking for ways to work around the rules. Also, do you trust the same entity that completely missed the Bernie Madoff fiasco despite SEVEN letters pointing right to it over several years from the same expert source? ("No One Would Listen", by Harry Markopolos) Or that runs the USPS? Or your local DMV? Or the IRS? The government is WAY too inefficient to meaningfully regulate HFT, so why blame it all on the traders and firms who are just trying to make a profit in a rapidly evolving, highly complex, system?
It's funny how when humans were the market makers and during the August 19, 1987 market meltdown -- when the communications system (including brokers and market makers) COMPLETELY broke down and phones went unanswered and people simply couldn't trade, that was somehow OK with the people who hate business. Or when even people like me sitting at a "green screen" couldn't determine whether trades were filled on the 19th and 20th of that month -- since they declared it a "fast market" -- and many of my trades indeed were NOT filled, even though they were placed to hit the bid, and the bid sat there for half an hour or more after my trade.
To me, I just say THANK YOU for the folks who have made the system so much better with technology -- warts and all.
I'm sure in the current world when people are angry about banks, income disparity (wrought by technology and poor government educational opportunities to help workers deal with it), and "the man" in general, it sells lots of books to point at demons and print lots of unsubstantiated quotes. I'm also sure doing this results in a rather poor book for a writer of Lewis' caliber.
on August 19, 2015
I first heard about "Flash Boys" last year on 60 Minutes. Up until then, I truly believed the stock market was still a bunch of guys screaming at each other, and that when I placed a trade through my bank, I was buying from another human. I figured the software just matched our orders up, similarly to Amazon Marketplace. I had no idea what a limit order was or why volume mattered. I was by every definition a novice.
I now trade almost daily. Prior to this book, I had done my own research into quantitative algorithmic trading and high frequency arbitrage, so many of the terms and concepts were familiar to me. With that said, I think Lewis' writing style is perfect for the layman and the experienced trader alike.
Without giving away too much of the plot, the main idea of the book is that Wall Street has changed a lot since the recession. The hottest commodity on The Street is no longer gold; it is bandwidth. Trading firms are willing to do whatever it takes to get access to orders and shave microseconds off their transaction times. In less than a blink of an eye, a computer can intercept your order, buy the stock cheaper, and then sell it back to you.
Lewis and some of the protagonists in the book seem to think that this is screwing the individual investor. Their argument is that these algorithms can read your order and manipulate the price of the stock. I personally agree to disagree with this notion. I think individual retail investors actually benefit from the liquidity that high frequency algorithmic trading provides us. This is why your orders get filled as soon as you click your mouse. It's also why the spread between the bid and the ask price is usually a penny (on highly liquid S&P 500 stocks).
There is some mention of the Flash Crash of May 6, 2010. Without a doubt, the 1,000 point drop on the Dow was due to algorithms gone haywire. However, it was also because of those same algorithms that the price came back up minutes later.
Personally I find this entire market fascinating. It's as if the market has evolved into a autonomous entity fueled by artificial intelligence and machine learning. Despite some of the disagreements I had with the book, I couldn't stop listening to it. It's written almost as if it's a movie; except this actually happened. I thought Dylan Baker's narration was superb and I am looking forward to listening to his narration of the Steve Jobs biography next.
I highly recommend Flash Boys for anyone interested in trading or technology.
on June 2, 2015
Early in the book, it was clear that no investor in the stock market really understood the stock market. By attempting to answer some fundamental questions about how the US stock markets work in the recently emerged computer trading era, a small number of relative outsiders came to a profound understanding of how markets work. Michael Lewis has written a compelling account of how these questions came to be answered, and the people who helped answer them. As information falls into place, supported by market data, it is clear that the US stock market (for at least the decade post 9/11/2001) was a difficult place to make a fair trade.
While nearly impossible to make a difference at the individual level, the book outlines the struggles and opportunities of major financial institutions to adopt change to embrace a fair market system. For all of the discussion about the mortgage crisis - we need to have a bigger discussion about the structure of our markets.
on June 7, 2014
I don't know enough about the mysteries of Wall Street, much less of high frequency trades (HFT's), to even guess whether Lewis' scathing indictment is factually accurate or not. From other reviews is appears that even those claiming knowledge aren't sure, either. But I have a bias--I am a "where are the customers' yachts?" observer, who believes that the function of the SEC is the same as that of the police who arrest a young basketball player for "point shaving"--protecting the professional gamblers so they can about in peace their business of fleecing the suckers. Just so, Lewis assets, repeatedly and forcefully, that the HFT's are basically front running other investors, gaming the market, and that It is the very systems the SEC has required of the markets that makes this possible.
What is, in my view, far worse than the game playing by the high frequency traders is that, according to Lewis, it is the exchanges themselves that make this possible to those traders willing to pay the price. Recently there was a flap about some organizations giving brokers an advance look at reports they were about to release which could affect the market, in exchange for which advance look, the brokers paid a "fee." Or we could call it a bribe. . How much worse to give the HFT's an advance look at the prices of stocks being traded, and at the book of bids and offers. Basically enabling front-running.
As I said, I don't know whether Lewis assertions are correct. If he is correct that large sums of money trade hands to increase the efficiency of HFT's, I suspect that those guys plan to get the money back by out-smarting the market. It may be that they are performing a function, but since they seem to go to great lengths to conceal what they are doing, and how much they are making by doing so, one does wonder.
Most importantly, I am disquieted that I have heard nothing in rebuttal from the SEC. I do not consider praise for the HFT'S a rebuttal. I want to know if the exchanges are selling access to information which should be confidential, and, if so, why the SEC does nothing about it.
As for the book, it is written in Lewis generally winning style, and is a fast read, subject to one criticism which may be personal to me. I found that his repeated use of "f word" added nothing to the story, and ultimately became aggravating. I was an enlisted man in the Navy for 4 years, and don't recall having heard that word as many times in those four years as it was repeated in this book. It could easily have been excised, probably to the benefit of the story, and certainly without doing it any harm. For that reason I have withheld the fifth star. Otherwise it is a "must read" for those who care about capitalism.