Michael Lewis: The Wolf Hunters of Wall Street
nytimes.com
nytimes.com
Having read the book and most of the coverage of "flash boys", I'm surprised and disappointed by the complete lack of any statistics to prove the assertion that the market is rigged, or even statistics that show how investor orders are disadvantaged.
Describing certain aspects of the market that appear to be unfair and then making it seem as if the entire market is "rigged" is a big leap.
I'm amazed that they have gotten such a free pass from the press on this. I guess people are suckers for stories that play on people's fears about malfeasance by the wealthy and powerful.
To even call it "high frequency trading" is not fair - this implied large volumes throughout the day by continuously providing quotes on both sides of a given security. Their PnL comes from the bid/ask spread and rebates for providing liquidity. They are primarily market makers. This is 99.99% of the HFT industry.
Instead, ML and IEX are talking about "speed trading" or, as the press has coined it, "latency arbitrage" - they take advantage of their speed to reach exchanges (2 milliseconds vs. 20 milliseconds) to front-run orders and react quicker to new information. These types of trades only happen at points during the day when signals are met, and they do not provide liquidity but rather cross existing orders (often times before the exchange receives the cancel message from the participant) and TAKE OUT liquidity. I would say less than 1% of HFT firms engage in this type of unethical activity.
An example: Imagine it's 9:29am and the Dept of Labor Statistics is going to release the monthly unemployment numbers. There is a positive expectation, and so before market open there are a lot of buy SPY (S&P 500 ETF) orders queued. The report comes out at 9:30am as the markets open, and the numbers are bad. Now, a rational investor would immediately attempt to cancel his order for SPX as the market is going to move downward. Imagine at the same EXACT time, a speed trader see's this investors buy order on the book and decided to cross him and sell. Due to his speed advantage, the exchange receives his message to cross before the investors message to cancel. The investor loses out, SPX invariably moves down, and the speed trader then buys everything he just sold for an essentially risk-less profit.
A final point is this: for any buy-side market participant (anything from a mutual fund to a "Average joe"), transaction costs are much lower due to the much higher liquidity and tightened spreads that high frequency trading has brought to the markets. HFT is making the markets more efficient. Cliff Asness (Founder, AQR Capital Mgmt) wrote a piece in WSJ talking about this: http://online.wsj.com/news/articles/SB1000142405270230397830...
If you took away exchange colocation, you'd just have a boom in property values around the exchange as automated traders would still try to get on the shortest network path to the exchange. Exchange colocation is actually a way to level that playing field. Everyone who is colocated has exactly the same network delay to the matching engine as everyone else who is colocated.
Millions of Americans invest a large percentage of their retirement money in 401ks because they believe that the US Stock Market is a relatively good place to make long term investments.
When we see examples of people skimming money off of the market it makes us lose faith in the market. That is why this practice should be banned.
It is Heisenberg morality. Once you look at it, there is nothing wrong with it. They are just updating prices to reflect demand, but at the same time they are extracting money from the market just because their data center is physically closer to the exchange.
Computers have made this process extremely fast and efficient to the benefit of nearly every market participant.
Which practice, exactly? You described one party having a faster connection than another. That's not exactly something you can "ban". Lewis even acknowledged that relative inequality of this nature will always exist.
How do you "ban" a fast connection? How do you even define a fast(er) connection?
If I'm the CFO of company X I have an unfair advantage when it comes to making trades minutes before the quarterly results are release for my company.
This would be very similar to insider trading in that there is going to be a grey area where it would be hard to prove that the intent was to undercut someone else but having the regulation there would at least curtail this practice somewhat.
A technological solution to this problem is to either execute on alternative venues such as dark pools where the price and possibly quantity are hidden from all participants, or use an algorithm such as VWAP to hide your intentions. Smart money already does both of these. If you submit block orders to a public exchange now a days you're considered foolish and are getting a bad deal. The reason why this keeps coming up is because the rubes are finally starting to realize what wall street already knows: they are getting screwed.
You do make a cogent point about discussion of automated trading being laughably imprecise, but your argument doesn't really debunk the immorality of the behavior that is occurring.
And finally, your point about non-farm payroll is a non starter for me. What you are talking about is informed order flow (wall street), VS. uninformed order flow (you and me). When non-farm payroll is released designated market makers have been known withdraw from the market because the price is being corrected by the informed order flow. When volatility quiets down they re-engage their market making activities.
Your understanding of what is going on in latency arbitrage is incorrect and implies that a latency arbitrage trader can see your order before it executes on an exchange. This is not true.
Further, the only people who think independent price synchronization provides worse execution are large block liquidity takers. That is large institutional investors who have the intention to remove all the liquidity from a group of exchanges. They have always tried to hide their intentions so that the market cannot take those intentions into the account. They are now using scare tactics to make it seem like this is a problem when in fact it is the markets behaving as they should.
Market segmentation & correct price discovery help small retail investors not hurt them.
One of the central themes of Flash Boys is that this (sweeping multiple market centers) is somehow a hard thing to do. I think to most practitioners it seems like Brad Katsuyama and RBC were just exceptionally bad at it. Yes you have to invest a little bit in technology and network connectivity, but the big sell-side banks have the money to make those sorts of investments. Given that they got paid to competently execute these big trades, it seems almost inexcusable that their excuse was like "We didn't actually understand what was going on."
My favourite one is a section where Lewis starts naming HFT algos and they invariably have names like Dagger, Viper, etc. yet he never seems to point out the HFT Brad Katsuyama created was named Thor.
And I think it is closer to reality