When Michael Lewis’ best selling book, Flash Boys, went on sale last year, it sent a shockwave through the financial industry. Lewis’ premise is simple: the stock market is rigged. One year later, the topic of high speed trading (HFT) is still raging on as lawmakers and the public try to understand and untangle this very complex web. The bottom line is that the stock market has quickly evolved and is dominated highly sophisticated, high-speed computer technology. The question that needs to be answered is whether or not this is benefitting the few at the expense of the many.
HFT utilizes sophisticated technology and algorithmic tools to rapidly trade securities. Flash trading is a type of HFT and involves sending an order to a market center that is not quoting the industry’s best price or one that cannot entirely fill that order. This order is then flashed to those who have access to that market center’s data feed to see if anyone wants to take the other side of that order. This is great news for the market center since they can facilitate the buying and selling of stocks before they reach the rest of the market. This is also referred to as a “dark pool.” It is in these dark pools where Michael Lewis argues that predatory trading occurs and fortunes are being made by a privileged few.
As one can imagine, Wall Street did not take kindly to Michael Lewis’ claim that the stock market is fixed. Many experts say that he is nothing more than a novelist looking to peddle his story to the world. More specifically, critics say that retail investors only use HFT so they can execute orders on behalf of small investors in the quickest and most cost effective manner. It is also pointed out that profits from HFT are currently about $1.3 billion, down significantly from its peak of $7.9 billion in 2009. Finally, they say that Lewis widely criticizes Wall Street, but fails to adequately acknowledge that the real disruption caused by speed trading has come from outsiders and not insiders. While most experts agree that the system of trading securities needs to be improved, they think that it is ridiculous to believe that the stock market has been rigged.
I do not agree with Michael Lewis that insiders have deliberately fixed today’s markets. This is not to say, however, that today’s stock market operates in a way that benefits everyone equally. I think technology has evolved so quickly that regulators cannot keep pace with the innovations and ambitions of the marketplace. This gap creates windows of opportunities for those who have the brains and resources to exploit them and it does sometimes come at the expense of the small investor. Still, the ability of investors to cost effectively access stock markets all around the world for a reasonable price far outweighs the damage done by those looking to exploit the system. Let’s hope this balance can remain.
For more information on High Speed Trading (HFT), please refer to the following articles:
What Michael Lewis Gets Wrong About High-Frequency Trading, Bloomberg, Matthew Phillips, April 1st, 2014
Michael Lewis Reflects on His Book Flash Boys, a Year After It Shook Wall Street to Its Core, Vanity Fair Magazine, Michael Lewis, April 2015 http://www.vanityfair.com/news/2015/03/michael-lewis-flash-boys-one-year-later
You’d Better Know Your High-Speed Trading Terminology, Investopedia, Elvis Picardo, http://www.investopedia.com/articles/active-trading/042414/youd-better-know-your-highfrequency-trading-terminology.asp
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