Friday, April 4, 2014

Flash Boys is an eye-opening reveal of the highway robbery taking place on Wall Street every day

It's amazing how quickly technology changed how Americans do business. I had assumed prior to picking up Flash Boys: A Wall Street Revolt by Michael Lewis, that computers had taken over trading with algorithms going back to at least year 2000. However, the change was more recent than that. It happened in and around 2007-2008. Mr. Lewis conjured an image of a trading floor full of screaming brokers slamming telephones along with a hysteria-infused ticker tape like you see in the movie Trading Places, and all of that ended less than a decade ago. It's now pretty quiet at the exchanges and much of what gets done happens in secretive black boxes.

The New York Stock exchange and the Nasdaq are two "for profit" businesses that provide a platform for the buying and selling of stock. Because they are "for profit", high frequency traders have been able to get an edge on everyone else. One company (calling itself Spread Network and under stealth conditions reminiscent of Cold War espionage) built an absolutely straight tunnel to run fiber-optic cable through the mountains of Pennsylvania. This involved drilling, getting permission from every small town along the way, making sure that no one ever figured out what the tunnel was for, and spending hundreds of millions of dollars. When completed, Spread Network sold access to their "cable" for $14 million each...access that gave a .00008 second advantage on the buying and selling of stock.

What does this mean? Well with the right algorithm (and they did have the right algorithm) a high-frequency trader could identify a big order coming in from say Pershing Square (hedge fund controlled by Bill Ackman) for scooping up a million shares of a company, buy all that available stock on the open market a micro-second before the order hit, and then turn around and resell those stocks to Pershing for more money because they were no longer available.

If you don't understand how this works imagine this: you are at a supermarket and there are a limited number of bananas on the shelf (as there always are) and you need to buy some. As you reach for the bananas, someone pushes you out of the way, buys all the bananas, and then offers to resell them to you for five cents more.

Is this at all capitalism? Is this what America is about these days? Or is this just highway robbery?
As you can see from this graph, high-frequency trading happens in bursts.
The line at the bottom is the stock market activity involving General Electric
shares over 100 milliseconds (one-tenth of a second) at 12:44 p.m. on Dec 19th.
So these 44 trades basically happened during that time (source: New York Times).
There are two camps of thought on this subject and they've been raging ever since Michael Lewis' book came out earlier this week (I started reading it on Monday).

The first train of thought goes like this: It is capitalism because high-frequency traders provide liquidity to the market. Additionally, Spread Network paid to have the tunnel built and the exchanges (which are "for profit" businesses) gave their blessing, and if you wanted to they would do the same for you (the only problem being that the average Joe like you and me doesn't have hundreds of millions of dollars to spend on a cable).

The second train of thought (mine) goes like this: These people are crooks. They are pirates and need to be stopped. Forcefully making yourself a middleman in a two entity transaction is criminal. Sure, these high-frequency traders are making a very small margin of profit per share, but the thing is, when mutual fund managers of 401K's and retirement plans are moving assets around that total billions of dollars, these mosquitoes ravage the common person's money (essentially adding hidden fees on top of what you're already getting screwed out of by taxes and regular fees). In other words: it's bullshit.

It's going to be interesting to see the fallout from this book and whether or not the heroes, one is named Bradley Katsuyama, are vindicated or vilified for daring to come out and say that the markets are rigged (high-frequency traders have been attacking him publicly ever since the release of the book). For me, Katsuyama is a hero, pointing out what I'd suspected about Wall Street but never had any proof. I'm not a day trader but a long-term investor, so the impact on what I do personally is minimal (outside of my retirement plan). But because my retirement plan is getting bigger and more significant, it pisses me off that these swarming insects will scalp further profit from a pile of money that should rightfully be mine.

Consider this fact: In early 2013, one of the largest high-frequency traders, Virtu Financial, publicly boasted that in five and a half years of trading it had experienced just one day when it hadn't made money. Goldman Sachs and Morgan Stanley can't do this, so how is HFT even allowed to happen? The more I think about it, the more it really starts to make my blood boil.

Do any of you have an opinion? Or has apathy at how unfair life is finally taken its toll and beaten you into the ground? I look forward to reading your comments.


  1. Ultimately it will come down as to whether it's legal or not. Fair? Not at all, even though it is capitalism.

  2. Ha, I saw an article on this book last week I think and I was going to ask if you'd read it.

    What these people sound like are ticket scalpers, the type who buy up all the tickets they can to a popular event and then resell those to the public for more money. Only because they're on Wall Street, some people will think these scalpers are OK.

  3. Is this high-frequency trading where bitcoins come into play? BTW, did you notice my review?

  4. I didn't understand how it worked though I've seen the controversy going on. Thanks for explaining it so clearly. So the guys with the best technology wins? The guys who have lots of money to start with make more money? Another example of laws unable to keep up with technology.

  5. Hmm...I'll have to check that book out.

  6. @Desert: Review? I didn't notice a review but now you got me excited! I'll have to read it :) And no, this isn't bitcoin, which my mind still struggles to understand the point to.

  7. When I see stuff like this, I think: This is why the French Revolution had to happen.

    When people are so fixated on "winning the game" that they play like this... When money is the game...

  8. In spite of the fact that many people deride socialism, unfettered capitalism can never work. A combination of both is required. Unfortunately we learned this week through a Supreme Court decision that we no longer live in a democracy. We now live in an oligarchy--rule by the rich.

  9. I saw the 60 Minutes piece on this story, and though I wasn't shocked (Really? Wall Street is crooked?), I was delightfully surprised by the two youngish guys who were so appalled by the injustice of the situation they left cushy jobs to open their own exchange and fight the bad guys.

    The New York Times followed that up with an excerpt from the book, which I just started, and it turns out there's a third youngish hero.

    The good news is, the book is at least causing shock waves through Wall Street and some rat bastards are getting worried. While I'm not holding my breath for the SEC to grow a pair and start regulating the hell out these crooks (as you rightly call them) and their insider use of technology, I am hopeful that Hollywood might make a movie lionizing the heroes. Maybe that'll educate a few more Americans who don't even realize their retirement funds are being ripped off.

  10. Definitely unfair, truly the dark side of capitalism.

  11. 802,082… You know I check in every couple weeks to see where your page views are at… ;-)

    I think you might be the most popular person I know. :)

  12. I've known about this sort of stuff for a long time because I'm a Matt Taibbi fan. I'm not surprised and I've been outraged by it but it seems like the greater American public is apathetic or feels helpless about the corruption. I think mostly they feel helpless??? Especially given that protests these days seem to wind up with arrest or violence (i.e. NM shooting of a homeless man which then led to protests here which led to more arrests of protesters) and the news reporting it as though protesters are always the aggressors.

    Speaking of Wall Street: If you want to make it rich on Wall Street, there was a recent article in Bloomberg View (a review of a book called WINDFALL) called "Profit from Global Warming or Get Left Behind" The book details many ways that Wall Street has been planning on making their millions on increase as the waters rise. Here's a quote "iMany people consider water a necessity, a basic human right, but investment advisers and their well-heeled clients view water as blue gold, the "petroleum of the next century" whose value as an asset class will surpass all other physical commodities. Money is pouring into "hydrocommerce" including water rights and water asset hedge funds."

    Gotta love Wall Street. I predict nothing will ever change whether what they do is legal or illegal.