Flash Boys – A Review

Is the stock market rigged? And what does “rigged” mean, anyway?

Some people say that the market is controlled by a few shadowy individuals who manipulate news and world events so they can buy low and sell high. Some do actually rig the market by trading on inside information or illegally manipulating company financials – very occasionally getting caught. And there are a few penny stocks that are largely traded as part of pump and dump scams.

Michael Lewis’s “Flash Boys” says that the market is rigged, in that high frequency traders (HFT) learn what you want to buy or sell a few milliseconds before the rest of the market. Armed with this information, they can cut in front of everyone else, change the price, and play you (or your mutual fund) for a sucker. It’s like insider trading, but completely legal and riskless.

Flash Boys tells the story of HFT, from the point of view of its victims.

The hero of the book is Brad Katsuyama, a nice guy at the nice Royal Bank of Canada who makes a nice living (a couple of million a year) trading stock for large clients. Let’s say Fidelity wants to buy 10,000 shares of AT&T. If they try to buy it all at once, then the market will react, and they’ll have to pay a premium. Brad’s job is to spread the trades out so Fidelity pays a more reasonable price. It’s not clear why this couldn’t be done by a computer program, saving a couple of million dollars a year, but that’s another book.

Brad runs into problems, though. To do his job, he needs to know what the market price is. But whenever he tries to trade a stock, the price changes before he can do it – the market price doesn’t exist. Brad investigates, and ends up going down the rabbit hole of HFT, eventually putting together a team that builds an exchange that can’t be front-run by the HFTers and will give fair prices for all. Hurrah!

That’s the main story, at least. There are a couple of other bits on someone building a straight-line data route from the Midwest to the East Coast, and a computer programmer who’s sent to jail by Goldman Sachs for taking code when he leaves. Both work well.

How important is HFT? The heroes think it’s a major threat to capitalism and a massive swindle on the ordinary American investor. The book isn’t quite clear on how big an effect it has, but people who work in finance tell me it’s more like the man who takes a penny from everyone’s bank account – he can get rich, but you as an individual don’t notice much. In fact, maybe it’s beneficial in that it provides liquidity. And besides, competition among HFTers should drive arbitrage profits down to near zero. And you can minimize loss to HFT by not trading a lot, which is probably a good idea anyway.

So is there nothing to worry about? Not quite. The strongest point against HFT is the flash crash, when many shares traded at ridiculously high or low prices for fractions of a second. If everything is for the best in this best of all possible markets, then why did the flash crash happen?

Looked at a different way, is it a good thing that so much effort is being devoted to shaving an extra millisecond off the time for orders to reach market? It seems hard to imagine that we couldn’t put our best and brightest to use in some more socially productive fashion. But under our current system, what would that be? These days, if not finance, all the mathematicians are busy figuring out which ads to show you on the Internet, and how much companies should pay for them. On the other hand, in previous years, they were figuring out how to find enemy submarines, or calculate how many tractors Donetsk should produce, so perhaps we are better off now. And at least creating the straight-line routes needed led to some construction jobs in the depth of the recession.

How is the book as a story? Good, but not Lewis’s best. One of the problems is that the main character does not have much depth. Brad is portrayed as a Dudley Do-Right – a minority who doesn’t think of himself as a minority, who works hard and sails into a job at the RBC, and whose main concern in life is making sure that investors can trade at a fair price. His steadfastness to his principles is admirable, but the lack of character development does not make for the best story. Even Jesus got angry, tempted, and despaired. Brad works with an Irish tech guy, Ronan, who has the same single-minded devotion to the cause, but with more swearing.

Overall, the book moves along nicely, though, and does a reasonable job of making the dry subject matter interesting.

Should you buy this book? As far as I can tell, it doesn’t lie, but it does give the anti-HFT viewpoint an extremely uncritical platform. Maybe we should be encouraging Lewis to try harder, but you can buy it with a clear conscience.

Will you enjoy this book? Are you interested in how HFT works, and how a stock exchange might try to stop it? If so, then you will find this book interesting. If those details seem kind of technical, then this is not the book for you.

Flash Boys ends happily for all concerned. On the page, Katsuyama’s fair IEX exchange is a success. In the world, Lewis’s book is a best-seller and being cited approvingly in Congress. And if you’re in the market, then perhaps you’ve noticed a few pennies more in your account.


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