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Tuesday, April 8, 2014

How Wall Street Is Turning Stolen Milliseconds Into Billions of Dollars

Posted by on Tue, Apr 8, 2014 at 10:21 AM

You know Michael Lewis is onto something with Flash Boys when a Forbes contributor writes a painfully sarcastic put-down of the book without even reading the book. Lewis managed to keep the subject of Flash Boys a secret pretty much up to its publication date—a rarity for the publishing industry. And when it was revealed that Flash Boys was going to rip the lid off the mechanics of high frequency trading, Wall Street lost its mind. ("Small investors benefit from the existence of HFT. So do large investors in fact," huffs the above linked Forbes piece. Well. If everybody wins, how can it be bad?)

Last night at a Town Hall reading hosted by University Book Store, Lewis discussed the immediate response to Flash Boys, which was far beyond what he expected. The book has sold 130,000 copies in its first week, he explained, and the FBI and New York's attorney general announced plans to investigate high frequency trading. The sold-out audience at Town Hall couldn't contain their excitement about some of Lewis's revelations. (Lewis explained, for example, that one of the characters in the book somehow secretly drilled a three hundred million dollar straight line from Chicago to New Jersey, in order to trim milliseconds off the arrival time of stock information via fiber optic cable. This line runs about three feet underground, and it somehow managed to be built without anyone noticing.)

Will anything change as a result of Flash Boys? Lewis said there was a possibility that nobody will be punished for abuses of high frequency trading. For one thing, the system is pretty much rigged from top to bottom. Lawmakers will do whatever Wall Street lobbyists ask, the SEC has an unbelievably cozy relationship with HFT organizations, and Wall Street is pretty good, Lewis said at running "in the direction in which they're not fucked." In an ideal world, Lewis said to an audience question, "we need more market forces on Wall Street, basically." He says that technology has enabled investors to pretty much take the middle-man out of the stock-buying equation, but that Wall street is "generating complexity" in the system "just to create an advantage for itself." By urging their mutual funds to not invest in HFTs, Lewis said, consumers can take some of the power away from these people who are rigging the system. In the last few days, he's seen quite a few large investment firms, including Charles Schwab, issue stern statements on the topic of HFTs. Lewis sounded surprised by his book's effect, and maybe even hopeful that HFT firms won't be able to get away with gaming the system any longer.


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Posted by wenchacha on April 8, 2014 at 10:29 AM · Report this
rob! 2
Like peeling back the skin of a cyborg, like understanding that private-equity firms and megabanks now control large percentages of the nation's housing, this book is a glimpse of the whirring machinery behind the massive UPWARD redistribution of wealth that has been going on for decades.
Posted by rob! on April 8, 2014 at 10:44 AM · Report this
Much of this was covered in another book, The Quants, from 2011.…

My question is why can't we all take advantage of instant trading.

That is, if someone were to set up a Fund that specialized in using technology to beat market trades, we could all buy shares (and take the required risks). Put it on ShareBuilder, etc.
Posted by Supreme Ruler Of The Universe http://_ on April 8, 2014 at 10:52 AM · Report this
I'm an average investor. I've been investing since the "old days," when you had to pay unconscionable commissions to a broker, who then called a "wire room," where a clerk wrote orders on tear slips which some time later went to an operator on a terminal to the market. The minimum "spreads" were typically an eighth, i.e. $0.125, the difference between where you would be allowed to buy versus where you could sell, a difference that chances are, the broker's company was mostly pocketing itself. If you bid between the buy and sell, the market would never see your order. The firm would just hold it until the market moved in its direction, and you'd still get screwed out of the spread.

I know the whole millisecond-pirate thing sounds bad, but the net result is so much fairer to the small, infrequent trader than the old system. Spreads are so much smaller, and with electronic trading, the commissions are tiny today.

Yeah, the millisecond boys are raking it in, exploiting tiny differences in price. But the people they're skimming money from are mostly other high-frequency traders. On a whole-second by whole-second basis, the rest of us are mostly getting pretty fair pricing. AND, if you enter a price between the bid and ask these days, the public market sees it right away. Someone might front-run your order to their advantage, but that doesn't affect you. You'll still get the limit price you set on your order, or possibly even better, but maybe just a millisecond later.

Would I like to have that extra tenth of a penny, sure! But considering all the ways we've always been robbed in the markets, it's never been fairer than today.

There's plenty of more important shit to worry about. While interesting, this is nothing to get excited about. Left alone, high frequency traders will invest more and more in their technology, and those spreads will get smaller and smaller. The only thing the SEC should be worrying about is shedding more light on "dark markets."
Posted by Brooklyn Reader on April 8, 2014 at 11:00 AM · Report this
fletc3her 5
At the level of day trading the market is a zero sum game. When somebody holds stock for a short period and then sells it at a high profit that represents a loss experienced by someone else. Some of the loss is borne by other fast traders, but most of it is extracted in a small profit loss among all the other traders in the market.

Nobody should be allowed to trade in the commodities market without demonstrating the ability to actually deal with the commodities being traded. If you can't take delivery of 30,000 barrels of oil you have no business "owning" it for even a millisecond.
Posted by fletc3her on April 8, 2014 at 11:01 AM · Report this
yelahneb 6
...and the guillotines get a little closer.
Posted by yelahneb on April 8, 2014 at 11:06 AM · Report this
rob! 7
@1, I like this version. (From an ad for the German newsmagazine Der Spiegel. The tagline basically means "The sharper the quill, the better you see.")
Posted by rob! on April 8, 2014 at 11:19 AM · Report this
It seems like a micro-tax on every stock transaction would take care of the problem.
Posted by BhamBrad on April 8, 2014 at 12:03 PM · Report this
NotSean 9
First heard of it on radioLab:…
Posted by NotSean on April 8, 2014 at 12:16 PM · Report this
JonnoN 10
@3 "why can't everyone on earth win a race only 1 person can win?"

God you're dumb. Read the article or book.
Posted by JonnoN on April 8, 2014 at 12:26 PM · Report this
AFinch 11
@4 - I started in the mid-80s and yes, in many respects, it's gotten much better, because technology has replaced human beings; back in that simpler system though, it wasn't rigged so badly. True enough, the worst victims for HFT are the big institutional purchasers, not small investors, but rather than getting all of the transparency and productivity gains delivered by technology, why should any of the institutional players get to rig and skim?

As Lewis says: it's a tax on the economy, and likely your retirement. It's a tax they wouldn't get if they were transparent about it.

Also: Lewis has said, after he came back to publish The Big Short, that he couldn't believe, after he'd written Liar's Poker that the whole thing hadn't collapsed already under it's own weight (corruption) but then he came back twenty years later and it was worse and going full steam. I suspect this time he figures he might not have much impact.

I haven't read the book yet (finishing Tropic of Cancer right now - jeez does Miller suck), but in the interview I heard Lewis suggested that IEX had been picked up by GS and that would likely lead to the demise of the HFT gaming.
Posted by AFinch on April 8, 2014 at 1:38 PM · Report this
Every trade should have a random mandatory delay of 1 to 5 seconds built in.
Posted by drshort on April 8, 2014 at 2:32 PM · Report this
@11 Yep, the mid-80s! Those are the bad old days I was talking about. That's when I started, too.

To a large extent, the rigging and skimming is taking place no so much because of the millisecond trading, but because of these "dark markets," which allow the players to hide big orders. Requiring all orders to be first transmitted to a public exchange, intact, would fix that.

The other thing that can get fixed is putting a stop to order "spoofing," where players place and cancel orders a couple of milliseconds later, with no intention of ever executing them, to confuse the market. Requiring them to leave the order up for 30 seconds would put a stop to that, or limiting the number of orders that could be cancelled by one player in one day, so they can cancel honest errors. Like 10 or 20. Make them eat the rest.

It's not the high speed, per se, it's the enabling shenanigans and tactics that are the problem.
Posted by Brooklyn Reader on April 8, 2014 at 4:00 PM · Report this

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