735 of 812 people found the following review helpful
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.
373 of 439 people found the following review helpful
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.
1,075 of 1,406 people found the following review helpful
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).
30 of 37 people found the following review helpful
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: [...]
415 of 576 people found the following review helpful
on April 2, 2014
I am (or sad to say, was) a huge Michael Lewis fan. Liar's Poker, The Blind Side and The Big Short are all classics. I love most of what Lewis writes for Vanity Fair -- his long-form pieces on Iceland, Ireland, Greece and Germany for example. I ordered Flash Boys as soon as it came available on Amazon.
With that said, Flash Boys is terrible. It is not just a major whiff, but a travesty. And it really ticked me off.
To state up front, I have no hidden allegiance to high frequency trading (HFT). I have never worked for an HFT outfit, never consulted for one or invested in one. I do not go out drinking with HFT buddies. In fact, if anything, I am one of the "dumb tourists" Lewis talked about in a Bloomberg interview (more on that to come). Our firm, Mercenary Trader, is focused on long / short trading with a global macro overlay. Our preferred holding time is weeks to months -- if a trade lasts less than 24 hours, something went wrong. So there is no industry bias here. I get no benefit from panning this book. I do so because the book made me angry.
Lewis, however, did have a major incentive to over-hype the story, as he all but admitted. I fully agree with Cliff Asness of AQR Capital, who wrote in a Wall Street op ed: "Making mountains out of molehills sells more books than a study of molehills." That is more or less what happened here. Lewis wanted to sell a lot of books. He wanted to capture "lightning in a bottle" (to use his own phrase). He captured irresponsible hyperbole instead.
In Flash Boys, Lewis' immense talent as a writer works against him. He is a master of storycraft -- of telling a complex story through the lens of key players. But when the actual story is distorted or skewed, the talent covers up for empty artifice. It's like watching a world class musician putting shine on a set of truly lame tricks -- or, as they say in the advertising business, "buffing a turd." The extra polish somehow makes it worse.
The key thing that made me mad -- there is more than one thing -- is the way a huge, huge aspect of the story is left out. Flash Boys is deliberately set up to suggest a "perfect world gone bad" scenario: As if, prior to the advent of HFT, markets existed in a 1950s "Leave it to Beaver" state where nobody ever got bad fills and liquidity was provided by a fairy godmother who never skimmed. It is hard to express how blatantly irresponsible, how downright dumb and deceptive, it is to try and talk about HFT without talking about what HFT replaced.
In the very beginning of the book, Lewis gives hand-waving mention to the old floor trading "dinosaurs" now all but extinct. He gives just enough print space to point out their extinction, then moves on. This is absolutely ridiculous. Why, pray tell, did floor traders and market makers play a key role in the function of markets for multiple centuries? Because floor traders provide liquidity. Liquidity provision is a service, and it has a cost. A discussion of what HFT replaced -- with examination of new systems, old systems, and continuity between the two, with attendant pluses and minuses -- should have been a third of the book if not half. Yet for Lewis it barely rates a paragraph.
Reminiscences of a Stock Operator, published in 1923, is the fictionalized version of Jesse Livermore's true story. A key point in the story is when Livermore (aka Larry Livingston) goes from trading in the "bucket shops" to actually trading real equities on the exchanges, by way of the ticker tape. In this book, more than 90 years old now, Livermore talks about how his "bucket shop" trading style had to adjust because instant fills were not available in the real world. He talked of a "lag" in the tape that forced him to adjust his style. Sound familiar? Liquidity has always been an issue. The more size you want to move, the more of an issue it becomes. There has always been a need for middlemen to provide it, and friction / incentive issues in doing so, ever since the fabled meeting under the Buttonwood tree.
In the late 1980s, the Justice department busted 46 traders and brokers in the Chicago trading pits. The stealing had gotten so bad, the FBI came onto the trading floor. At the turn of the 21st century, the stealing was still bad. I was an international commodity broker as my first job out of school circa 1998. We had lots of hedge clients, and did a lot of business with futures giant Refco (who later imploded in a fireball of corruption). I remember countless screaming conversations with scuzzy floor clerks in the pits, trying to get restitution on a horrible fill (which usually never came).
Then, at the same time, there used to be an old saying, "Have your daughter marry the son of an NYSE specialist." Because, of course, being an NYSE specialist was a huge privilege, passed down among family members, allowing the guy who held it to make buckets of money without a lot of brains. That money came from, you guessed it, privileged access to order flow. This system persisted for ages, however, because the specialist actually provided a service. There were costs, but they were perceived as worth it.
And then, too, you have the many billions the big investment houses (Goldman, Morgan etc) used to make on market-making activities. Lewis described this activity in Liar's Poker, ironically enough. Client order flow passing through a bank is like a bag of popcorn, or maybe a big chocolate cake. You reach in and grab some of the popcorn, or nick some frosting off the side. Bid ask spreads used to be huge, with most investors at the mercy of whoever was working them.
My point in recalling the above is simple, and it is a point so massive that Lewis should be straight-up ashamed for not addressing it. First, floor traders and market makers have always had "privileges" -- since time immemorial -- in exchange for providing liquidity. Second, floor traders and market makers of old used to flat out steal, a lot. Third, even when doing an honest job, those floor traders and market makers (especially within i-bank desks) took a lot bigger spread, on balance, than the HFT guys take.
There is a much better book on HFT than Flash Boys. It is called Dark Pools and was written in 2012. You can read my review of it. In that review I further cited yet another book review I had written, The Predictors by Thomas Bass, in the mid-2000s. In my review of The Predictors I said that electronic traders would be "the new market makers." I said that in 2005. And that is exactly what has come to pass nearly a decade later.
If you imagine that HFT came out of nowhere and started stealing at the speed of light, then okay, it is outrageous. If you imagine that HFT is a "tax" on markets that some jerks just decided to impose for zero economic give-back, then okay that is outrageous too. But if you understand that liquidity provision is a benefit, and that 21st century technology can allow for liquidity provision at a lower cost than the old system, you start to understand that all this talk about market "rigging" is a bunch of red herring garbage.
In some ways the markets are "rigged" -- insert tired soundbite for why all small investors should buy index funds here -- but in far more important ways the charge is nonsense as applied to HFT. It is uninformed hand-waving at its worst. Markets need liquidity to function well. Liquidity is a benefit. This is the whole reason commodity speculation was sanctioned in the first place, so that actual hedgers had someone to trade with in offsetting the risks of daily commerce. Liquidity providers will extract a very small edge for themselves in providing it -- if there were no payment, what would be incentive to do the job? They may find ways to do hinky stuff around the edges, but that is why liquidity provision technologies need to be regulated. Nobody ever said the entire Chicago floor trading system was "legalized theft" (even though it felt that way to us commodity brokers sometimes!). It was recognized that the essential service provided was a necessary good. It's the same with HFT.
Flash Boys reveals itself as a tempest in a teapot on pages 52 and 64. (I speak here of the hardcover edition from Amazon.) When Lewis is forced to use real numbers, the frivolity of his case is revealed.
On page 52, there is talk of an HFT "tax" that amounts to $160 million per day on $225 billion worth of volume. That is significantly less than one-tenth of one percent. Now, if the HFT guys were skimming while providing zero value, then you could argue they are, y'know, taking a nickel out of every hundred dollar bill that Wall Street transacts. But they are not skimming to zero value impact, they are providing a service. They are in the LIQUIDITY PROVISION business. So all this yelling about thievery and markets being rigged is not only blown way, way out of proportion, it is potentially 100% BS because the new system may well cost less, on net, than the old liquidity providers (floor traders and market makers). The market is "rigged" because six cents out of every hundred bucks goes to guys doing a better job than the old floor traders and market makers, more than a few of whom were crooked enough to steal the dimes off a dead man's eyes? Give me a freaking break, dude.
Then on page 64, there is open admission as to not knowing how much profit the HFT guys are making -- but oooh, they must be making a lot, because one of the book's heroes billed them $80 million over the course of three years for setting up computers and whatnot. Oooh, they paid out all that skrizzle and to just one guy, so the thieves must be thieving big time right? Never mind that the published revenues of existing HFT firms are MULTIPLES SMALLER than what the big bad i-banks used to make in their equity trading departments. Never mind that the billions banked by Goldman and Morgan on market making have been turned to notably lesser amounts by Getco, Virtu and the like. Just focus on the raw numbers and go "ooh" and "aah" like one of those idiot German bankers Lewis made so much fun of as the patsies of the subprime crisis.
This is a blatant case of mathematical sleight-of-hand. The whole damn book is hyperbolic sleight-of-hand. A number like $80 million might impress someone in a vacuum. But your favorite grocery store may have bought $80 million worth of hummus to sell this past fiscal year. What does it mean? Nothing. Wall Street is a huge business. Providing liquidity will be, fractionally, a large business in absolute size, with massive costs. What we do know is that the new HFT guys are significantly LESS profitable than the old i-bank equity trading departments used to be, which strongly implies they are providing a service at a lower cost, that used to be provided at a higher cost. Hey, what do you know, that is how technology is supposed to work.
Oh, and by the way, HFT is actually better for the "little guy." The average investor now gets better fills than he could before, on balance. Various sources of credible origin have pointed this out. And even large institutional firms (again note Asness, who has no skin in the HFT game either) say the same thing. So who does Lewis shed a tear in his beer for exactly?
But oh, I'm not done. The reason this review is called "Dumb Tourist" is because Lewis himself used that obnoxious phrase in a Bloomberg interview (after going on 60 minutes and saying the market is "rigged"). Here is the direct quote, as Lewis speaks to Stephanie Ruhle and Eric Schatzker of Bloomberg News:
LEWIS: Let me give you an analogy and I think is a very close analogy to the way the stock market is structured. It's a casino analogy. So I have a casino and I want to start a poker game in the casino, so I get three card sharks and I tell them, go sit there and start the game. Make it look like a good game's going on. There are no 4s, 9s, there are no queens in the deck. Only you will know that. And we will pay some tour group operators to bring like a bunch of dumb tourists in to pay with you. They won't know. You'll -
RUHLE: Hold on, a bunch of dumb tourists? So is David Einhorn is a dumb tourist?
RUHLE: Come on now.
LEWIS: In this analogy. Hold on. In this analogy, every investor -- David Einhorn did not know; he did not understand. He understood that whenever he tried to do something in the market, the market moved like someone knew what he was up to. In the same way that big pension fund managers and mutual fund managers saw when they tried to execute big orders, oh my god, it's like someone knows I want to buy before I buy. But he didn't know why. He didn't know - he didn't understand that high-frequency traders were putting machines in exchanges to be closer to the exchange so that they could get price information in two milliseconds before him. And so on and so forth.
Let me -- can I finish my analogy?
LEWIS: So of course the tourists get fleeced all the time in the poker games, because they don't know the deck is rigged. The poker players pay the casino a cut of what they make. The casinos, operators, pay the tour group - the tour group company money to bring in the tourists. So in this case, casino's the exchange, the poker players are the high-frequency traders, and the tour group operators are the banks and the brokers that handle the stock market orders. And I think the analogy is pretty close. So is that rigged? Is that a rigged game? I think it is a rigged game.
Now, as it so happens, yours truly (the one writing this review) is a seasoned high stakes poker player. As I write this review in my home office, I can literally see the Bellagio from my high rise window. I have logged thousands of hours in casino poker rooms (trusty laptop at hand). I have sat down next to billionaires and degenerates and everything in between, and won and lost $10,000 pots on too many occasions to count. And I can tell you that the casino poker analogy is perfect -- but not in the way Lewis thinks. It shows perfectly why HFT is not a big deal... and why Lewis himself is the "dumb tourist" in this whole discussion.
Let me explain, briefly, why Lewis' analogy is so apt -- but in a way that skewers him rather than making his point.
The casino is by far the best venue for high stakes cash games. You don't play high stakes in someone's house -- unless you know the host very well and he has amazing security -- because there is far, far too much money on the table. In the regular 10-20 game at Bellagio, stacks of $50,000 or more are not uncommon. You want to take a stack of high society into someone's house that might get robbed? Not to mention the challenge of getting these games together -- something a great room also provides. The Bellagio has been the top high stakes room in Vegas for years and years because they know how to get the players in. (Wealthy businessmen, we love you!)
Economic point being, the casino provides a SERVICE in terms of 1) providing a secure place for games of this size, 2) attracting the players and running the games, and 3) keeping the games running smoothly via skilled dealers and floor personnel.
This service is vital to high stakes poker players. The casino CHARGES for that service (duh) but their relative costs are very, very small. In a 10-20 blind No Limit cash game, you will pay a flat 30 minute rate -- typically six or seven bucks, known as the "rake" -- and you will tip the dealer when you win a pot, known as "tokes." The average sized pot in a high stakes cash game can easily be $1,000. Against that average cost, your rake and tokes will run three or four bucks. That is less than one half of one percent. Sound familiar?
Similarly, HFT is a form of liquidity provision -- that activity is a SERVICE -- that has replaced an older, less efficient, more expensive form of liquidity provision (floor traders and market makers). Lewis is running around saying "The game is rigged!" But all he really discovered, as the casino analogy shows, is the more modern-day equivalent for how liquidity is provided. And is six cents out of every hundred bucks a horrible price to pay? Considering many players large and small are reporting better liquidity than before? Umm, no.
What about Katsuyama then, and his new exchange in which big institutionals can match orders with each other? The poker analogy applies here too. Let us say a group of high stakes players say "We don't need the security of the casino, and we can get our own dealer. We will play at big Jim's house and save that 0.05%." That is certainly an option these players have. And if they can pull it off, why not. The key thing here is large players deciding they can create their own liquidity -- their own demand -- as such to forego the public option. Nothing wrong with that at all. It is part of the natural evolution of Wall Street services. But again, is the rake-and-tokes system of the casino, or the liquidity provision of HFT, "theft" as a core function? No, not at all. Katsuyama is simply providing an alternative, betting he can draw the necessary liquidity to make it work, in the same manner mother nature and mother free market provide systemic "alternatives" all the time. In yelling "Wah wah rigged!" Katsuyama is getting lots of free PR, and Lewis is being irresponsible in making him out as a hero.
Now let me share two more reasons this book made me angry -- angry enough to hammer out this lengthy review while having better things to do with an hour of my time.
First, Lewis didn't have to do this. He didn't have to push so hard for another "big score" that he created a fake issue and used his formidable talents to spin a BS story. He could have just said "I'm Michael Freaking Lewis," and sat back and made a million a year or whatever writing stories that weren't "big scoops," but remained insightful and true to point. He was already big enough that he could have kept his integrity and kept doing great things. He didn't have to sell out like this.
But the even deeper reason this book made me angry is because Lewis has given new firepower to the self-righteous idiot Luddites who like to kill flies with sledgehammers. I was more disgusted and frightened by the comments attached to various articles on the HFT issue than anything else. All these people who probably don't know the first thing about trading saying "Oh yeah, it's obvious HFT is a blatant scam, it's obvious the American capitalist system is a blatant rip-off," on and on. The only thing that is "obvious" is that the average commentator is an opinionated fool who feels far too strongly about far too many things he doesn't know the first thing about, and Lewis played right into that like the worst huckster.
Worst of all, the HFT debate seems to have given new lung power to cries for a "transaction tax" on all trades. I can't count how many times I have heard cries of "transaction tax!" since Flash Boys came out. The people proposing a transaction tax are the worst kind of meddlers. They are in the same camp as the debt doomers who argued that the system should have been allowed to get blown up because their gut told them it was a good thing. Do you remember the Tea Party candidate who actually argued that defaulting on America's debt would improve our fiscal standing in the world?
America has a real problem with excitable idiots and demagogue politicians happy to exploit that excitement, with very bad things the net result. (Government shutdown and near debt default anyone?) And by creating a hyperbolic issue where one should not exist, Lewis has given ammunition to those hyper "fixers" and muddied the waters of what could have been a more logical and fair debate.
In a more reasonable world, Lewis could have taken another year or two before rolling out this book. In addition to interviewing his "hero," Katsuyama, he could have interviewed a bunch of floor traders and market makers. He could have investigated the long history of liquidity provision, balancing out its pluses and minuses. He could have examined the transition from floor trader to black box as a form of 21st century change. He could have compared the profit spreads of HFT firms to the old i-bank divisions. He could have concluded that yes, HFT has some "wild west" about it, and there is some unsavory stuff going on, but we need to recognize that a core value function is being provided here, and that the industry needs to be cleaned up and polished, not written off as "rigged!"
The book should have been longer anyway. Not because "long" is intrinsically better, but because it feels rushed in a sloppy way. This was not a true effort to explore an interesting and important story (the rise of HFT) from multiple angles, as past Lewis books have been. This was more a flat-out bromance between an author looking for his next big hit and a Canadian entrepreneur who had all the quirky hallmarks of "hero" that Lewis picked up like a bloodhound on the scent. And he manages to insult real investors and traders in the process by calling us "dumb tourists" to boot. So lame.
16 of 21 people found the following review helpful
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.
16 of 21 people found the following review helpful
on April 22, 2014
Michael Lewis is a great story teller and I love his other books. Unfortunately, in Flash Boys he only tells a piece of the story rather than a complete story that views other perspectives. I get that he disdains high frequency trading, but it would have been helpful to provide color from HFT traders, regulators, specialists, small individual traders, and others in the industry. There is little discussion of how HFT evolved and the system that preceded it.
When Lewis talks about HFT being predators in the market, he totally ignores their impact on people like me, who make a few trades per month in relatively small quantities. With an order size between 100 and 1000 shares, I invariably am looking at a market with a $.01 bid-ask spread, and routinely get filled in that spread, sometimes better. That was not the case before the advent of HFT and personally saves me money. He intimates that the small investor has left the market because of market predators like HFT. I think that the great recession had more to do with altering people's risk tolerances and made individuals more leery of any market.
Lewis is concerned about how HFT makes profits by utilizing computer speed to front-run institutional orders. If HFT (computers?) were to suddenly disappear or be banned, would stock customers benefit? Would the bid-ask spread, the depth of book, and trading volume be the same as it is today? The obvious answer is no and the resulting change to all of these metrics would clearly have a negative effect on the profits of individual and institutional investors.
Lewis's hero in the story, Brad, is a bright guy who wants trading transparency for everyone. So what does he do? He starts a dark pool.
He does make good points when discussing payment-for-order flow.
93 of 129 people found the following review helpful
on April 1, 2014
That the book is non-fiction but reads like fiction (meaning you just can't put it down) is due to Michael Lewis and his writing style. I happen to be a Computer Engineer and the technology is both impressive and mind numbingly simple. Lewis explains frontrunning and how it works. Clearly the book will fan some flames and get people excited. It should. We're seeming a modern real-time version of the "The Sting" being performed. The bad guys don't have any of the style of Robert Shaw. Brad and the crew who worked at RBC could have kept quiet and made a ton of money. They were already very nicely compensated. That they took the risks they did to expose the system of stock trading and high frequency trading is really quite amazing.
I highly recommend the book.
67 of 93 people found the following review helpful
I would first like to say that this book, while reviewed a couple of times as fiction, in fact is true. The story of trades depending on the speed of data transfer less than a fraction of a blink of an eye can seem surreal. And of course those people who use this to their advantage preferred it that way. "Transparency was their enemy." The most "democratic market had become, in spirit, something more likea private viewing of a stolen art work." The story of Brad Katsuyama and his efforts to understand world of high frequency stock trading exchanges and the story of the creation of this network makes fascinating reading. It is an opportunity to see how the markets took knowledge, arbitrage techniques, and technology to make the actual market invisible to the uninitiated. Sometimes the unitiated were in powerful positions.
There are any number of reasons to read a work of this sort. Clearly from this title, I am an outsider of vast distance from this knowledge. But I think it behooves us to gather that information about our world as is accessable. Granted this book was obsolete before the presses began, but the motivations and the need for secret screening remains. This book is clearly written and easy to follow even for the previously confused. I recommend it.
10 of 13 people found the following review helpful
on December 30, 2014
* The book is basically an infomercial for IEX. The author gets basically all his information from employees of IEX. He made no effort to talk to proprietary trading firms, or exchanges.
* He does not define HTF. Instead he associates HTF with anything negative he sees in the market. Payment for order flow? HTF! Although payment for order flow has existed for almost 20 years. Dark pools? HTF! Interestingly dark pools were marketed to fend off HTF, just like IEX. Technology? Automation? NOT HTF! WTF!
* The author does not point out that the US equity markets are the highest quality markets in the world, as measured by accessible liquidity, tightness of markets, lowest transaction costs and regulatory control. This has being brought about by real competition among exchanges, replacing the corrupt oligopoly of NYSE and NASDAQ, and the replacement of providers of liquidity from specialists to proprietary trading firms. Gus Sauter of Vanguard, who has orders of magnitude more knowledge of the markets than the IEX folk (why didn't the author talk to him?) has pointed out that these changes have saved the average 401K saver about 30% of his investment over the average life of the investment. In fact the author does not give any historical narrative of the markets at all, which makes it look like the markets gotten worse for investors with the advent of competition and automation, instead of getting better.
* The author states that the main activity of proprietary trading firms is to front run institutional investors. He does not understand how prop firms create real liquidity by making markets based on pairs trading, leaning on index futures markets, basket trading, creation/redemption of ETF's. That is more likely the explanation of the high participation in trades by prop trading firms, which is a huge benefit to the market, and can only be done by automated algorithmic trading. That also explains why proprietary traders make markets in all exchange traded markets, e.g. futures and options, and these markets are more efficient, cheaper and more transparent than they have ever been. In fact, the author does not investigate any other exchange traded market, and does not even visit Chicago, the belly of the beast! A better name for HFT is algorithmic trading, whereby trading decisions are based on certain rules. By the way, this is also how a human trader trades, except a program does it better, and cheaper.
* The author makes the bald claim that prop firms are front running institutional traders. That may be happening. But the evidence he shows is less than convincing. When Brad tries to hit the market with a very large order (probably trying to take out a price level at each exchange). he is surprised that after he takes out the price level at the first exchange the orders at that price level at other exchanges disappear. He calls this front running. In fact it is more likely market makers adjusting their markets after seeing a large short term supply/demand discrepancy. They have invested money in making sure they can adjust their markets fast. This is not only legal, but completely ethical, transparent, and definitely not front running. When Brad develops Thor, a program to wipe out a price level at all exchanges simultaneously, he is gaming the system at least as much as anyone. Because of multiple platforms, market makers make sizeable markets in each of the platforms. They are doing so in the assumption that they will not be simultaneously hit on every exchange. That will probably lose them money, and discourage tight markets. Brad is not doing anything illegal with Thor, but Thor is not improving markets, and is not evidently more ethical than other practices alleged in the book, that are supposedly gaming the system.
* It is amazing how little Brad knows about the markets in 2009, and how they work, even though he is being paid $2 million a year to execute trades. Things that he is ignorant about were well known in the street, and well documented in the general and specialty press. When I spoke to a lot of money managers in 2009, I was struck by the wide range of understanding about the market, and different levels of competence. The top money managers expressed satisfaction with the changes in the equity market structure, because their transaction costs plummeted. However they pointed out that they had to change their trading approach to take advantage of these structural changes. Other money managers expressed anger at the the fact that they had to do some extra work to take advantage of these changes. Their transaction costs went down, but their relative performance (execution price executed vs, market price) reports showed what a bad job they were doing. Many do not understand the principle of "slippage", and feel entitled to execute a large percentage of average daily volume instantly at markets a tenth of a penny wide (in dark pools that can occur). They are outraged when their large order moves the the market. They are angry at the complexity of the market, because it makes them have to work harder. They do not acknowledge that competition and tighter markets have both made their transaction costs shrink by more than 60% in the last 10 years, at the cost of greater complexity. If they want simpler markets with thick buy/sell price levels, they should go back to the NYSE/NASDAQ duopoly, with minimum spreads of 6.25 cents.
* The author does not acknowledge the importance of a good regulator. The SEC has many faults, as does Reg NMS, but the SEC has done an awesome job introducing regulation which have made the equity markets fairer, and more efficient. If you want unregulated markets, go to Russia, or trade credit default swaps.
* The author complains about investments by trading firms and exchanges in making data communication faster, without explaining fully the good reasons for doing so. Market makers need to know as quickly as possible what is going on in each of their markets, in order to make as tight a market as possible. In doing so, they are competing with other market makers to make as tight a market for investors as possible. This investment is not to compete with the retail trader, or the institutional investor. In fact if an individual investor takes the trouble to directly access the exchanges, instead of letting their order be sold to a broker, their orders will hit the market without any prior notice to another party, and have exactly the same price/time priority. The possible exception to this is if the investor is trying to take out a price level across all exchanges. Then there will be a race for market makers to adjust their bids and offers before being run over by a cascade of orders.
* In general, the author makes no good recommendations on reforming the markets. Despite blaming regulation, he has no suggestions on reforming regulation. In fact, he sees no role for regulators at all. His solution is for IEX to succeed. This makes the book even more like an infomercial, and it makes no sense to me. Exactly how will IEX solve all the problems in the market? The author does not really tell us why. The reason is clear. The book is not an analysis of the market, it is a story, one that is engineered to portray a company, its employees and backers as heroes, and everyone else as criminals or buffoons. By the way, other reviews of this book have pointed out that IEX rules appear to give an unfair advantage to the type of investor that coincide with the backers of IEX.
* In general, the book really is two magazine articles cobbled together, supported by an astonishingly little amount of research. He gives credence to some people he happens to meet, who have a vested interest in the stock market being less automated, and whose interests often conflicts with small individual investors (many large financial institutions prefer markets with wider spreads, which results in thicker clusterings of bids and offers, which allow them to execute larger orders with less effort. This will penalize smaller investors). The HFT community is a very open one, with many participants willing to make the case for why their participation is healthy for the markets. Michael Lewis couldn't be bothered to talk to them. Perhaps his magazine article deadline was too tight. Or perhaps these people lay outside his circle of acquaintances. Of course, these are only speculations, But they are better supported by facts than the allegations he makes in his book.
To be fair, the author brings up a number of concerns which I share.
* Payment for order flow - this is a practice which is rife with conflicts of interest. My experience with trying to execute a trade with a broker who directs my order through a broker who has paid for my flow, has been that my order has been front run.
* Dark pools - These venues have advantages over public exchanges, are not transparent, invite conflict of interest, and are parasitic on the public market (e.g. they use the bid/offer spread for regulatory compliance, but do not contribute to it).
* Number of exchanges - I think exchanges should have greater obligations. They should be required to accept more liability to their customers (right now they demand extremely limited liability). They should pay penalties for lack of reliability, or slowness. They should be required to invest more in the SIP.
The author does not compare the stock market with the fx and precious metals markets, corporate bond market, or interest rate swap markets which are incredibly inefficient cartels controlled by banks, mainly because exchanges and algorithmic traders are prevented from operating due to cartel like behavior from the banks.
I also think a presentation of facts, no matter how true, can compete with a good story. And this book, although a lousy analysis, is a good story.
For a more informative read, get Dark Pools by Scott Patterson. I don't agree with all of his points, but at least he did the research work, to talk with some authority.
PS I have left out any critique about the part about Sergey Aleynikov since it bears very little relationship to the rest of the book. It was originally a Vanity Fair article that Michael Lewis wrote. It looks like he tacked it onto the thin Brad story to add more pages to the book, and because it had something to do with high frequency trading.