Book Review: Flash Boys

Book Review: Flash Boys

I am a huge Michael Lewis fan.  I’ve read all of his books (or at least listened to them), and was thrilled to find out that his latest was coming out on the very day I had a four hour drive.

The book centers around a former RBC trader who noticed that the market was increasingly moving out from under him.  He would want to buy 100,000 shares of a particular stock only to find that as soon as he indicated his intention (by buying all of the shares available on one particular exchange), the rest of the shares on other exchanges vanished.  This happened because of a new (well, relatively new), high-tech version of the oldest trick in the book, Front Running.  Essentially, a computer in some High Frequency Trading (HFT) firm would notice the initial buy and then would, leveraging their faster connection to the next exchange, purchase all the remaining shares in the market.  The HFT firm could then raise the price and sell them to the “conventional trader” at more than they should have had to pay.

As usual the story is well crafted and follows our heroes as they recognize the problem, unravel the truths behind it, and then create a solution.  The solution comes in the form of the new Stock Exchange IEX.  It’s a surprisingly easy read given the weight and technical nature of the subject matter.  As a technologist who works in banking and has been asked how I can reduce latency from 5 microseconds to 3 microseconds and whether or not a particular exchange will actually put our servers in there datacenter so the signals don’t have to travel the 2 microseconds through NJ, I already knew much of what’s in the book.  I wasn’t aware of IEX and how they were going about trying to stop the HFT firms from doing this, but I am glad to see that the market is reacting to this latest form of Front Running.  The more efficient the market the better the economy.

Bottom Line:  I highly recommend the book if you are interested in Finance but don’t know much about HFT, but it’s a worthwhile read for just about anyone.

If you’re a Wall Street person you can stop reading now.  However, since most of the people who read this blog (or at least used to when I posted a lot) aren’t, I thought I would spend a minute on “How Pissed Should I Be?”  Lewis paints these HFT guys as horrible people and points to the billions that they are literally skimming off the market.  I can see how a lot of people would read this book and be thoroughly outraged.  I think it’s worth tempering that outrage for 2 reasons:

  1. This isn’t THAT much different than making a lot of money in the market because you can speed read the WSJ and discover which stocks are going to benefit from positive press and which ones are going to suffer from negative faster than most people can.  All HFT firms do is act on publicly available information faster than anyone else in the market.  Synthesizing information quickly and reacting before the market does is always going to be a way to make money.  Clearly, the HFT version of this is adding nothing to the value of the market, and consequently is worth stopping, but you can’t blame the HFT traders for coming up with a way to beat the market.
  2. It’s not REALLY effecting you.  HFT takes an unfair cut of big transactions.  Chances are you neither make enough transactions nor big enough transactions to be seriously effected.  Let’s say you’re in a 401k for work and that you dabble on your own from time to time in individual stocks.  The 401k is probably invested in big mutual funds.  These funds, even the most active of them, don’t make a ton of trades.  Their goal is stability.  They may get hit by HFTs a little when they do make their big trades, but your net impact is likely small fractions of a percent.  Your individual trades are even less likely to be effected.  In fact, you might actually benefit from HFT.  Let’s say you buy 150 shares of IBM (can’t recommend that, but let’s say).  That’s about a $19,000 investment… pretty good chunk of change for you and me.  If the HFT’s react at all to your little 150 share purchase it will be because they anticipate that you actually want another 10,000.  As long as you don’t decide immediately after your $19,000 investment that you actually want $19M in IBM, HFT can’t really get any of your money.
All of that said, an efficient allocation of capital benefits all of us so you’re right to encourage your legislators to pressure the SEC to figure out a way to stop this.