January 18, 2018
Just last week, I finished reading Flash Boys, written by Michael Lewis. This book can be summarized pretty easily by a single statement: "High Frequency Trading".
For those of you who have been averting your eyes from finance and Wall Street since 2008's mortgage derivative crisis, high frequency trading basically boils down to a bunch of guys with really fast computers, really fast internet connections, and a bunch of money who basically sniff stock exchanges for arbitrage opportunities. If that doesn't make sense: high frequency traders buy and sell shares really fast to make profits when they're sure the market is moving in a particular direction. If they know that shares of a company are going to rise in the next few seconds because breaking news just revealed a huge previously-unknown product brewing inside the company, they can buy the stock and then sell it to somebody at a higher price extremely quickly, making a neat profit in fractions of a second and taking on next to no risk. As Lewis writes in Flash Boys, they can also watch for big stock orders -- buys or sells -- arriving at an exchange. When one of these big stock orders comes in, the exchange doesn't have nearly enough buyers or sellers to complete the transaction, so that exchange will send messages to other exchanges, who of course have more buyers and sellers, thus allowing the exchanges to pool their resources to keep the transaction from stalling. Unfortunately, exchanges don't really care how fast their messages get to each other, giving high frequency traders a chance to, as Lewis calls it, "frontrun" a large order from one exchange to another exchange, where they'll quickly snap up all of that stock's buy/sell orders and then post their own, making a neat profit (again with no risk). This is all very interesting, and I initially thought that Flash Boys was going to go into a lot more detail on this subject, much like Lewis' The Big Short takes a deep dive into the complex market of CDOs, CDSs, and other esoteric derivatives.
Unfortunately, I was wrong.
All in all, I had a lot of issues with Flash Boys. But instead of nitpicking every little thing that bothered me, I'll just mention my top three problems:
1) Lack of focus. This is the largest issue I took with Lewis' writing: unlike The Big Short, where every single isolated story converges nicely on the 2008 financial crisis (typically on the small number of people who saw it coming), Flash Boys spends a lot of time diving into irrelevant details of completely unrelated things. One of the most egregious examples is Lewis' intro to the book, which discusses the top-secret construction of a fiber-optic cable between NY and Chicago for the sole purpose of sending messages quickly (a la high frequency trading) between the two locations. This gives some impression of the stakes involved in high frequency trading, where mere milliseconds or even microseconds can make the difference between making a surefire profit or losing money on transaction fees. Unfortunately, Lewis' use of the story fell flat for me: it's obvious that high frequency traders (or even big banks delving into high frequency trading) would pay a premium for such a connection. What wasn't obvious -- and what I was hoping Lewis would demonstrate in Flash Boys -- was the way that they did it.
2) Depth/Agent Motivation. Lewis mentions many times how several high frequency trading startups made a profit every single day, without fail, but upon finishing the book I couldn't tell you how. Lewis discusses at length how high frequency traders "rigged" the market when more exchanges cropped up, many with special kinds of offers useful only to high frequency traders. He talks about how they convinced big banks to share their client's buy and sell information, and how big banks eventually allowed high frequency traders to frontrun their own "dark pools"... but I never understood the motivation the big banks had to do these kinds of things. About half of the novel focuses on IEX ("investors exchange", of www.investorsexchange.com notoriety) and the plan to "fix the market", but at the end of the novel I couldn't say if IEX accomplished any of their goal. The last couple of chapters oscillates oddly between labelling Goldman Sachs as one of the best behaved banks who largely refused to sell out their client transaction data to high frequency traders... and a horrible, evil corporation who sued a Russian programmer for taking some mostly-open source code with him when he switched jobs. Is this Lewis' attempt to demonstrate the fact that the big banks are so large they don't even behave consistently? That their business is so incomprehensibly large -- easily in the many many billions of dollars -- that neither they nor their regulators understand their role or how they ought to behave? Maybe Lewis knows; I sure don't after reading Flash Boys.
3) Derision of technology (maybe). Throughout Flash Boys I detected a lot of negative feelings toward technologists in general. Perhaps this is due to Lewis' origins in finance, a domain that at this point has been dominated by technology moreso than any other sector I can think of. But that doesn't make it excusable. This manifests in many ways -- the aforementioned Russian programmer who Lewis seems to regard as something of a simpleton, his remarks that the tech side of finance doesn't understand what they're doing (both in the big banks and in high frequency trading, which seems odd, because how could high frequency traders possibly figure out how to make money from high frequency trading if they don't understand what they're doing?), and even his subtler derision, like when he describes a group of techies who fail to make a dent in a massive buffet-style meal.
What bothered me the most, however, was the lack of any kind of chapters focusing on high frequency traders themselves. Especially in a book titled Flash Boys (which I have to interpret as either a book about the folks who perform high frequency trades or some kind of weird focus piece on enthusiasts of the comic book hero Flash Gordon) this feels strange. Why don't we hear their perspective? Are they truly a cancer on the market, as Lewis seems to imply? Or did they improve the market in any measurable way? Surely they must have contributed to the market in some positive way, but Lewis never points out a single positive thing about high frequency traders. Even the heroes of the NY->Chicago fiber-optic cable story didn't seem to be high frequency trading experts: they even admit that they don't understand the real uses of their creation.
At the end of a book that I'd hoped would inform me about high frequency trading, I'm forced to admit that I know nothing more about high frequency trading than I did last year. Or the year before. Or the year before that. Or essentially since I'd first heard the term "high frequency trading" and inferred some details about what the term meant. My next read for the year is Flash Boys: Not So Fast: An Insider's Perspective on High-Frequency Trading by Peter Kovac. I hope it'll teach me more than Lewis' useless piece of pulp.