Michael Lewis: shilling for the buyside?

http://scottlocklin.wordpress.com/2014/04/04/michael-lewis-shilling-for-the-buyside/

by nbouscal • 12 years ago

197 204 12 years ago

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drcode5• 12 years ago

Yeah, Michael Lewis' recent interviews do seem a bit suspect. He is yelling "Hey joe sixpack, Wall Street is eating your lunch!" and then when you hear the details of the supposed "fraud" it all revolves around companies like Goldman Sachs (who work with Katsuyama) whining that they're not getting a fair shake in the world. (Oh right, Goldman Sachs is managing Joe Sixpack's pension fund via two levels of indirection- Oh noes, poor Goldman Sachs!)

Plus, the interviews he's given on 60 minutes and Fresh Air never once mention the terms "market order" or "limit order". If you don't explain those two basic terms at the heart of the HFT controversy, you're not giving people information, you're only giving them disinformation.

That said, there's obviously lots of shady ass shit happening on Wall Street every day, but Michael Lewis is not helping the situation one iota, from the looks of it.

ryandrake2• 12 years ago

The way I (as a lay person) read this is:

One side: "HFT hurts the little guy and helps billionaires! Boo HFT!"

The other side: "HFT helps the little guy and hurts billionaires! Yea HTF!"

Reality: "HFT is pretty much irrelevant to the little guy. It helps some billionaires and hurts other billionaires, and this is only a story because billionaires are all talking about it."

mylons• 12 years ago

HFT seems cancerous regardless of who it helps and who it hurts. Sure it might provide liquidity, but so do traders and the market at large. HFT making money doesn't really service anyone except the people making money, and more importantly it doesn't create anything or provide a service to society at large.

tootie• 12 years ago

It affects mutual fund managers who many joe sixpack types do have a stake in.

throwaway13qf85• 12 years ago

"Joe Sixpack" is a terrible name for the average US stock investor. The median number of shares owned by the adult US public is exactly zero. Most people who own (publicly traded) stocks are already wealthy. "Joe Chateau Lafite" would be a better name.

Source: some Matt Levine article.

drcode5• 12 years ago

If Wendy's raises the price of their chili because they use an overpriced supplier of beef, nobody would argue Joe Sixpack's stake in Wendy's was hurt.

Instead, Joe Sixpack eats his chilli at another store that is more competent in managing their supply chain, and the Wendy's Corporate takes a hit.

tptacek16• 12 years ago

If you think it harms mutual fund managers, can you account for Vanguard saying that it's helped them?

tptacek16• 12 years ago

Two other concepts you really want to understand before forming an opinion about HFT: "large block trades" and "bid-ask spread".

Lewis has a drive-by mention of bid-ask spreads in the book (he concedes that they've been decimated, while asserting without evidence that HFT has created a new "shadow spread"), and, thus far, no mention whatsoever of the mechanics of large-block trades. In Lewis' universe, a hedge fund can unload 100,000 shares of XYZ just as easily as you can sell 10 shares of AAPL.

apaprocki3• 12 years ago

And just in case it isn't entirely clear, one example of 'algo' trading (algo != HFT) is developing an algorithm to sell smaller blocks of shares over a period of time to "hide" the fact that one participant is unloading 100,000 shares so the the price is not driven down too hard, thereby reducing the overall return from selling the shares.

001sky7• 12 years ago

tptacek -- Not to nitpick but isn't this comment is like someone accusing you of having a "drive by" understanding of computer security? He knows what a block trade is, and how to quote a market. Lewis worked on a bond trading desk, and coined the phrase "equities in dallas". So it's not CFA 1 here for him.

To your point: what's missing is the hedging costs. The reason block trades trade out of the market is not just that they are "bespoke", but that there is the inventory hedge risk. It may take some time to build up a position (during which prices can move adversely). And this may or may not need a hedge to protect the holding period (which someone needs to pay for).

Various types of trading strategies have very different risk profiles when compared to required inventory hold/periods etc. And this is a hidden source of economics or cost. Hedging doesn't always scale well, either.

So its very hard (especially as a lay-person) to make inferences about many things unless you are taking into account both profits and risk. As I'm sure you know.

robterrell• 12 years ago

I found his interviews really compelling and thought about getting the book. But I had this nagging thought the whole time -- you know, I've been hearing about HFT for years, could it really be some super-secret cabal? The linked article does itself no favors with its pissy tone. I almost didn't read through it, but I'm glad I did, because I learned quite a bit. As always, the truth is somewhere in the middle.

Michael Lewis is a master of taking something complicated and turning it into a clever narrative. However, this narrative is simpler than, say, Moneyball: bad guys are "stealing" from good guys, there's a detective story about figuring out how it's happening, and there's a build-a-better-mousetrap montage at the end. It's too perfect. Odds are there's a screenwriter crunching this sucker down into three acts right at this moment.

jokoon• 12 years ago

but Michael Lewis is not helping the situation one iota, from the looks of it.

Hasn't the FBI been recently investigating this ?

nbouscal• 12 years ago

An interesting study on the topic concluded that HFT helps retail investors and hurts institutional investors: http://qed.econ.queensu.ca/pub/faculty/milne/322/IIROC_FeeCh...

lmg6432• 12 years ago

This was a great article. I started reading the book. Early on, one of the examples given was "Brad talked to a friend of his at SAC Capital" about how HFT firms were taking advantage of information in the markets.

That is the kind of unintentionally ridiculous anecdote which undermines the moral center of this book. SAC Capital, after all, is the same fund which ran into one of the largest insider trading cases in history, which is also about taking advantage of information in a, let's say, special kind of way.

I know a lot about this subject, probably too much to let the judgment fall cleanly in one camp or another on HFT, but with all the hubub right now, I find it might be useful to get biblical for a second - let the person who is without sin cast the first stone.

matthewmcg2• 12 years ago

Is the anecdote really unintentionally ridiculous? Lewis acknowledges SAC's later infamy in a parenthetical (quotation below). And the point of the anecdote is that even a party that went to great (and illegal) lengths to gain an informational edge didn't understand the new phenomenon of latency arbitrage by the HFTs.

Quotation: "He had a good friend who traded stocks at a big-time hedge fund in Greenwhich, Connecticut, called SAC Capital. SAC Capital was famous (AND SOON TO BE INFAMOUS) for being one step ahead of the U.S. stock market. If anyone was going to know something about the market that Brad didn't know, he figured, it would be them."

lmg6432• 12 years ago

Of course it's ridiculous. The book makes no actual mention of what SAC did, to avoid cognitive dissonance. Perhaps SAC was infamous for dwarf tossing - not illegal but in poor taste. I don't think the 60 minutes audience would have SAC's transgressions on instant recall. Lewis declines to specify anywhere in the book that SAC was engaged in criminal violations of established securities laws, while he writes an entire book about the evils of HFT, which in large part is mostly an issue of what types of trading we want to permit and not widespread illegal activity.

And did Brad "figure" SAC would know because he knew that SAC pursued informational advantages to the extreme? Did he think that was unethical, crossed a line, so they would know about other activity that crossed the line? That seems like a really strange line of thinking.

It also seems strange that this super ethical guy would attack activity which is legal, but turn a blind eye towards known unethical or suspected illegal business. Did he know about the rumors of insider trading? Did he knowingly solicit business from a firm which he had reason to suspect was engaged in insider trading?

cwisecarver• 12 years ago

It seems this guy isn't the intended audience for the book. I, for instance, know that Netflix performance is bad on certain ISPs because of throttling and peering agreements but if someone wrote a narrative about this I wouldn't berate them for telling the public at large about it in words they would understand.

falsestprophet• 12 years ago

Obviously he isn't the intended audience of the book because he knows its thesis is false.

fr0sty4• 12 years ago

There is a real and meaningful difference between popularizing and fictionalizing though. Some amount of gloss is needed to keep things tidy but if/when that crosses the line then the author is doing a disservice to his audience. This is doubly bad when the book in question is an indictment of the status quo with what amounts to a "call to action" in favor of some new business venture.

If the book was presented as non-fiction "based on a true story" that's one thing, but If the b

elecengin• 12 years ago

I think "shilling for the buyside" is a bit strong. Lewis aggressively pursued a compelling and simple narrative in a market that doesnt have an easy story. I get the impression he didnt even recognize that the field he decided to plow was a minefield. The HFT debate is complicated and has serious implications: his treatment didn't respect it.

From acquaintances that knew Katsuyama personally, he was described as a genius marketer, not a technologist. Before even Lewis came along, he had crafted a large part of this narrative: the Thor matching technology succeeded on a compelling story. Lewis got sucked in.

The personal reactions you may have seen (William O'Brian on CNBC) are authentic: HFT participants (and those who deal with them) have been villified in an industry already viewed in a negative light. There are some bad apples, but there are also many who genuinely believe that they are doing a service for the market.

I don't blame Lewis for this. I just hope that there is an author that can create a compelling story that doesnt fall for the tired trope of the evil HFT trader. The story exists - it is just very technical and nuanced at times. Unfortunately, many HFT participants have been shamed away from standing for what they believe in so there are very few left to tell the story.

If you want to read a rebuttal and learn more about the markets at the same time, check out this analysis by Larry Tabb - a market research consultant prominent in the US execution technology market: http://www.scribd.com/doc/215693938/No-Michael-Lewis

nova22033• 12 years ago

Bill O'Brien may not be the best person to quote. http://blogs.wsj.com/moneybeat/2014/04/03/bats-forced-to-cor...

BATS Global Markets Inc., under pressure from the New York Attorney General’s office, corrected statements made by a senior executive during a televised interview this week about how its exchanges work.

BATS President William O’Brien, during a CNBC interview Tuesday, said BATS’s Direct Edge exchanges use high-speed data feeds to price stock trades. Thursday, the exchange operator said two of its exchanges, EDGA and EGX, use a slower feed, known as the Securities Information Processor, to price trades.

The distinction matters because high-speed traders can use powerful computers and superfast links between markets to outpace traders and trading venues that rely on slower market data, such as the SIP.

tptacek16• 12 years ago

That's a particularly uncharitable way to put it. Another way to put it is this:

Regulations encouraged a fragmentation in exchanges (a good thing, since they used to be monopolies).

For multiple exchanges to trade in the same instrument, some force needs to synchronize the prices between the markets.

The regulations specify a mechanism by which this might work: quotation feeds for different products replicate the NBBO ("current" best bid-ask) across the markets.

But the NBBO feed is only an approximation of the best feed --- and it has to be, as anyone who has ever built a distributed system must know.

Fast electronic trading can synthesize a BETTER NBBO. If you know what the better NBBO is, you can trade against it, in effect forcing prices to synchronize through arbitrage trades.

The net effect is that the markets synchronize on a more accurate BBO, and electronic trading systems get compensated for doing this based on the profits from the arbitrage trades.

In the ABSENCE of that trading, the delta between the SIP NBBO and the "real" NBBO still exists; it's just money in the pockets of a different set of entities.

In neither case was this money likely to be helping firms that hold long-term positions and make money by allocating capital; the previous crappy NBBO profits were just going to a different set of sell-side firms, who are now angry that they'd been obsoleted.

To me, an extremely telling fact here is that Vanguard's Chief Investment Officer went on the record and said that HFT trading, and latency arbitrage in particular, had been helpful to their trading costs. If that doesn't mean anything to you, do some research into how Vanguard works and is structured.

graedus• 12 years ago

For those that didn't click through, the (very entertaining) CNBC interview can be found here:

http://video.cnbc.com/gallery/?video=3000263252

erichocean2• 12 years ago

there are also many who genuinely believe that they are doing a service for the market

You make it sounds like HFT is some sort of non-profit, community service vocation, like teaching, or fire fighters. Do people actually think this?

Regardless of the merits of HFT, that kind of argument seems very disingenuous. I haven't met a single person engaged in HFT who is doing it to smooth the function of the market or "provide liquidity". They may think it has that effect, but no one is in it for that reason. If anything, it's what they tell themselves to justify skimming money from the other market participants.

tptacek16• 12 years ago

You can replace the letters "HFT" in your comment with "any market maker" and come to exactly the same conclusion.

Liquidity has always, always been subsidized by "skimming". The rake market makers take from trades is the cost of liquidity: ie, of being able to buy shares immediately without getting shafted because the only orders on the market are from large traders who are holding out for very high prices.

Have you ever tried to sell a house? That's what crappy liquidity looks like: there are buyers and there are sellers, but nobody is anywhere near agreeing about the price of the goods being traded, and so it takes months to get in or out of a position, and you sometimes have to do it at extremely unfavorable prices.

sseveran• 12 years ago

If teaching were as competitive as market making major cities might graduate more than half their students from high school while simultaneously driving down costs. Non profit is not a badge of honor.

pash• 12 years ago

"It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest."

Adam Smith's insight helped launched the enterprise of modern economics because it turned out attention to what matters: results. Benevolence, like self-interest, is neither necessary nor sufficient to produce a social benefit.

So you're right: the motivations of high-frequency traders are irrelevant, except insofar as we can change their behavior by changing the incentives they respond to.

lmm• 12 years ago

You make it sounds like HFT is some sort of non-profit, community service vocation, like teaching, or fire fighters. Do people actually think this?

They're doing it to make money, but that doesn't mean they're not helping other people out. My uncle is an importer; most of his time is spent finding something that's cheaper in Korea than it is here and drawing up a contract with a supplier there and a buyer here. Does he do it as a community service? No. Does he take his cut? Yes. But every deal he makes benefits both the supplier and the buyer.

dpierce9• 12 years ago

Lewis's book examines one kind of HFT, argues that it is objectionable, and takes a look at one method of mitigation. Where this bites is that this HFT method is super common and relatively common knowledge to insiders but not outsiders.

This criticism, that Lewis doesn't take a comprehensive view, is inapt since Lewis's book is not a treatise on HFT and its implications. It is like criticizing a scientist for publishing an article on a narrow topic rather than describing everything in the world in one giant book.

You can say that this method of HFT isn't front-running or that front-running shouldn't be illegal (and back up your case with arguments) but you can't say this criticism of one HFT method is wrong because HFT does other stuff too.

Edit: Source: actually read the book

nissimk• 12 years ago

This is a complicated issue and not very well understood as you can see in some of the replies to this comment. The term HFT is used to describe a lot of strategies, and many of them are overall good for the market. Elimination of human specialists and market makers and subsequent tightening of spreads is definitely a good thing. Also, arbing prices between different markets is also a good thing and those with the best technology will succeed there.

But there are HFT strategies that are bad for the market where the HFT algorithms are enriching themselves while providing no benefit to anyone else and actually causing the market harm.

Take a look here for more details on "quote stuffing" and other malicious HFT practices:

http://www.nanex.net/aqck2/4022.html

dpcheng20032• 12 years ago

I think it's disingenuous to project motivations for Michael Lewis. Is he shilling for the buyside the same way he was shilling for the Oakland A's? In my opinion, the only thing we know based on facts is that Michael Lewis, the author, has one objective in mind: To sell more books.

In order to sell books, the story and narrative has to be compelling. Is the story of a Canadian guy making millions of dollars at his trading desk quitting his job and starting a company (we love startups!) that may undermine a controversial trading tactic a compelling story? Absolutely. Is the story of Einhorn or Cohen or Icahn doing things like insider trading or activist investing equally compelling? Probably not, since it's on the cover of the WSJ or on CNBC every week.

Michael Lewis does not have a responsibility to educate main street about the nuances of HFT, although as a secondary benefit of his noble pursuit to sell more books, he does shine a light on the topic. In this regard, Lewis is exceptionally successful. He's sparked a debate, he's created controversy, he's made smart people discuss a topic they had previously less interest in.

Think about what Moneyball did for professional sports? Lewis was hardly the first (e.g, Bill James) but he popularized it so we, the general population, could discuss the topic with some conviction and knowledge. If he can do the same for HFT and trading in general, then good job. And he sells more books.

drited• 12 years ago

"Is the story of Einhorn or Cohen or Icahn doing things like insider trading or activist investing equally compelling"

Why do you put activism in this sentence along with insider trading? Are you implying that it is morally reprehensible in the same way that insider trading is? Activism is in no way illegal and many consider it a counter against corporate cronyism that can infect public corporations due to the principal/agent problem.

alexqgb• 12 years ago

"There are some bad apples, but there are also many who genuinely believe that they are doing a service for the market."

Believing they are doing a service and actually doing a service are two different things. I agree it's important not to tar the latter of your two cases with the brush reserved for the former, but that doesn't mean sparing them entirely. It simply means selecting a more appropriate brush.

While malicious intent and clueless idiocy may be different from a moral perspective, they're indistinguishable in terms of effect. In either case, it falls to the law to limit these effects. Between the lack of ethics and the general ignorance, both types lack the ability to restrain themselves from harming others, not to mention the institutions we all rely on.

pron• 12 years ago

HFT participants (and those who deal with them) have been villified in an industry already viewed in a negative light. There are some bad apples, but there are also many who genuinely believe that they are doing a service for the market.

Without discussing this particular issue, doing evil and feeling evil are two very different things. People who do evil almost never see themselves as evil people, and they almost always justify their actions to themselves. There are no Bond-villains in real life, and if you look for them to find evil you miss its actual manifestations. Those are often quite elusive.

stygiansonic• 12 years ago

Seems like this book is causing quite the ruckus with certain brokerages: http://pressroom.aboutschwab.com/press-release/corporate-and...

Yet they are more than happy to sell their order flow to market makers who use HFT. (To allow them to trade against it before going to the exchange - as is customary - nothing wrong with that) http://www.schwab.com/public/schwab/nn/legal_compliance/impo...

Seems like they are jumping on the populist bandwagon by claiming "HFT bad!" but I think what they mean is "HFT bad - unless it's from one of the firms we sold our order flow to!"

AustinScript• 12 years ago

I would disagree that this would be considered jumping on the populous band wagon, if you've read the article, you'll see that Schwab originally released an Op-Ed in the summer of 2103 echoing similar concerns.

He took a public stance on HFT a full year before the book was released.

Taken directly from the release you linked-> As we noted in an opinion piece in the Wall Street Journal last summer.

http://blog.themistrading.com/talk-to-chuck-about-hft/ http://online.wsj.com/article/SB1000142412788732358290457848...

001sky7• 12 years ago

If your ISP packet sniffed your network and traded against your positions in advance of them coming to market would you have a problem with it? How about if they put up an MITM to get your credntials and then installed a key-logger to make it more effective and faster? One could argue that once you hit "sell" or "buy" your electrons are public information. But others might consider them NPI. I don't think that the issue is completely cut and dry, at least no just yet.

matthewmcg2• 12 years ago

I am still reading the book, but it seems like Lewis' main criticism in the book (vs. interviews) is against the so-called HFT front-running of orders that get routed to multiple exchanges. He is careful to distinguish market-making/liquidity providing functions from the multi-market latency arbitrage and spends a good part of Chapter 4 exploring this distinction.

Perhaps his public statements in interviews haven't been so nuanced.

Also, these rebuttals to the book don't really address the front-running issue. Is it simply an unavoidable consequence of the physical reality of separate markets? Should anything be done about it? Is it even still occurring or has competition among HFTs and savvier buy-side order routing eliminated it? I would like to read a rebuttal that discusses this.

minimax2• 12 years ago

He is careful to distinguish market-making/liquidity providing functions from the multi-market latency arbitrage

I don't think the distinction is as clear as you think. If I'm making markets on several of the US equity exchanges, and I see my entire order on one side of the market at one exchange get taken, I will adjust my quotes at the other exchanges. That's not front running. It's a reasonable market making strategy.

tpeng12• 12 years ago

The argument from IEX is that the exchanges intentionally price trades using slower data than what they (the exchanges) have access to. We can call it whatever we want, but natural traders would prefer an exchange that doesn't price match in this way, and have every right to move to such an exchange.

http://www.zerohedge.com/news/2014-04-03/bats-admits-ceo-lie...

tptacek16• 12 years ago

One of the more disingenuous things about Lewis' book (caveat: I'm only halfway through, because I'm listening to the audiobook and, on the advice of another reviewer, switched to the book _Dark Pools_ in midstream) is the rhetorical sleight of hand he plays with the term "front-running".

In Lewis' universe, the price movement that happens when an informed trader tries to piecemeal-fill a 100,000 share order is "front-running".

But in Larry Harris' universe†, not only is price movement during block shopping not "front-running", it is the fundamental reason for the existence of sell-side firms; in other words, the challenge of stealthily shopping 100,000 shares of thinly-traded product XYZ is the reason that Katsuyama made $2MM/yr.

Lewis posits that the natural state of affairs is that there's an NBBO for XYZ, and that Katsuyama should expect his equities desk to collect fat fees simply by accepting a block order from a client, pushing a button, and unloading it at the current best bid, whereupon at the completion of this order the price will change to reflect the altered supply/demand condition of XYZ.

But that is crazy. The presence of a 100,000 order changes the supply/demand conditions for XYZ. For RBC to expect to sell 100,000 shares at the current bid, it must expect to get something for nothing: to take the price hit for the increased demand of XYZ out of the hide of whoever is holding it right now.

Before HFT mania, "front-running" meant something very specific: it was a problem of agency. A client/broker relationship existed, and the broker exploited it by trading in front of their client's order. The client had a right to expect the broker to act in their best interests. But the markets as a whole aren't a positive-sum system; in the absence of a contractual relationship, nobody has an obligation to act in the interests of anyone else. A dollar you make on the market is a dollar someone else didn't make.

† https://news.ycombinator.com/item?id=7526783

tpeng12• 12 years ago

The specific example given in the book is that an existing ask sized at 100,000 is already sitting on the order book when the buy order goes in at the ask price. The ask then disappears before the order executes. This is very different from the market moving in response to an order that has no market fill.

kcmarshall• 12 years ago

Interesting side note: Here's a link to an Amazon review of _Dark Pools_. The review claims the name Brad Katsuyama and opens the review with "As an insider in the world of electronic trading..."

http://www.amazon.com/review/R2HRZNW5661QVR/ref=cm_cr_dp_tit...

aasarava• 12 years ago

Can someone explain how HFT would "provide liquidity", which seems to always be the pro-HFT response? To use an analogy, if I want to buy a house and someone is selling a house, how does a third-party buying the house first and selling it to me a slightly higher price provide liquidity?

patmcc• 12 years ago

If a third-party is always willing to buy houses (or sell houses it owns), then you don't have the awkward case where I want to buy your house today but you really really wanted to sell it a month ago.

Mikeb852• 12 years ago

Because they'd be buying and selling when there isn't a buyer or seller.

Imagine if you could have the house off your hands, at market price, in a day instead of listing it for months. That's b what liquidity does for you. Almost all HFT is market making, there's plenty of information about what that means...

pkinsky• 12 years ago

I thought the whole point of HFT was to wait for a buyer to signal interest in buying X, and then buy X before that buyer and sell it to him at a slightly higher price. If this is true, then in your scenario you would still have your house listed for months, but a high frequency trader would buy it just slightly before it would be brought without any high frequency traders in the loop.

aet3• 12 years ago

k, I'll bite. Lets say you want to sell your house in 1935. Luckily, there is a buyer, but he won't be ready until 1946 when he gets back from fighting WW2. Luckily, there is a real estate investor who is willing to step in an buy from you and sell to him. He'll hold the property from 1935 to 1946. During that time he takes the risk that housing prices may go down. He also has to pay operating costs in the form of his office and assistant. This is essentially what HFTs do. They intermediate markets.They have cost and risks. Some of them take advantage of special knowledge of market organization. They know the hot neighborhood. The real question is: Are market intermediaries being compensated fairly for the risk they take? i.e. do HFTs make too much money for the risk and expense they incur while intermediating markets.

erichocean2• 12 years ago

I get all that, but does that really apply when the time interval is sub-second? It's hard to imagine the discounted value of the trade changing in a sub-second interval, whereas it obviously does selling 11 years later.

In other words, sure, definitionally it's liquidity, but since the trade would have gone through a sub-second later anyway, it's not meaningful liquidity: the liquidity was already there on a reasonable timespan (again, sub-second) for the seller. Thus, nothing has been gained.

What am I missing here? Do sellers really need additional sub-second liquidity beyond what the market would provide without HFT?

reverend_gonzo• 12 years ago

Saying Alice wants to sell a house, but she needs to sell the house now, and is willing to take slightly less money to get it sold. That's when the HFT comes in says, "Okay we'll buy your house for slightly less than market value, since we're taking the risk that we can resell it." That's Alice crossing the bid-ask spread, and paying for liquidity.

Suppose Alice doesn't want to pay for liquidity. She can just as well say, I'm going to wait for a buyer willing to pay the ask price. She doesn't trade with an HFT and instead takes the risk that a buyer never shows up or that the market moves against her. This is equivalent to an add-liquidity-only order. She won't be crossing the spread, and she therefore she won't pay the bid-ask spread.

It's the same thing if you're buying. If you don't want to pay for liquidity you don't have to. You state your price, say you'll only add liquidity, and when a seller comes along who's willing to give it to you at that price, you'll be matched.

AnthonyMouse7• 12 years ago

Let's unpack that a little. For most publicly traded stocks, there are always going to be willing buyers and willing sellers, for the right price. Those prices, respectively, are the bid and ask prices. So for example, if you want to trade shares of some stock, the bid might be $100.00 and the ask might be $100.10, i.e. someone will buy from you at $100.00 and someone will sell to you at $100.10.

Obviously if the buyers and sellers hold fast then no trades get made: The buyers are offering less than the sellers are willing to accept. If you want to make a trade then someone has to cross the spread -- either the buyer has to pay $100.10 or the seller has to accept $100.00. This leaves room for speculators: When a seller decides they want to trade right now and they cross the spread, the speculator can buy the shares and then hold them until a buyer comes who is willing to cross the spread, and then the speculator profits by buying at the bid price and selling at the ask price. The speculator is taking the risk that in the meantime the price of the stock may go down and they'll lose money, and that risk is what earns the profit.

But HFT isn't that. HFT is having fast computers sitting in Chicago and New York, so that when a buyer crosses the spread in Chicago at the same time as a seller crosses the spread in New York, the HFTer can arbitrage the transactions with the foreknowledge that both trades will clear immediately. The HFTer is not taking a risk proportional to the profit but rather is profiting from trading with superior information. Moreover, the HFTer is only holding the shares for milliseconds. How does that provide any useful amount of liquidity? Why can't we arrange the exchanges so that if a buyer and seller both cross the spread at approximately the same time, they split the difference and no third party takes anything?

harryh23• 12 years ago

Market makers provide liquidity because a lot of the time when you want to buy a house no one is actually selling one. Rather than waiting around for someone else to show up to sell you a house the market maker is always there with one to sell.

KVFinn• 12 years ago

Can someone explain how HFT would "provide liquidity", which seems to always be the pro-HFT response?

You should narrow your question to how the latency arms race provides liquidity, and if it would be different it latency was capped at some amount.

snowwrestler• 12 years ago

Let's use an example that everyone is already familiar with.

Everyone knows you can get more for a used car if you sell it yourself instead of trading it in. Yet millions of people trade in their cars. Why? Because it's easier and faster.

The difference in price they get from the dealer vs Craigslist is the price they are paying for liquidity in the transaction.

mcguire• 12 years ago

You have to understand that the definition of "providing liquidity" is to always supply a buyer for a security, with the minor qualification that the buyer so provided should be able to immediately turn the security around for a profit.

HFT's are very good at providing liquidity (and obviously so), under that definition.

tpeng12• 12 years ago

People ITT are not making a distinction between different types of HFT. Katsuyama and Lewis do not criticize all forms of computerized trading, but specifically computerized scalping that is aided and abetted by exchanges. Their chief complaint is that HFT uses more current prices than the exchanges themselves and they use this to scalp other traders.

http://www.zerohedge.com/news/2014-04-03/bats-admits-ceo-lie...

This is actually very simple. Natural buyers and sellers do not need intermediaries, but intermediaries do need the natural traders. So if the natural traders can coordinate, they should be able to set rules that favor themselves and disfavor intermediaries. I won't say that what HFT does is "unfair" (capitalism does not contemplate fairness), but I think it's highly ironic that HFT and their supporters are complaining how "unfair" it is that natural traders are working together, and yes, marketing their new exchange.

msandford2• 12 years ago

Very nicely put. Yes it's a bit hilarious.

The HFT folks seem to be saying "you don't have a right to add up all the total amount of asks at a certain price across all the exchanges and expect to get execution at that price" and with a bit of thought I might agree with them. But it is very counter-intuitive. If you see 10,000 shares for sale across 10 exchanges at $54.00 your VERY next thought probably isn't "oh that's actually 1,000 shares, but advertised on all the exchanges so it only LOOKS like 10,000" Once you understand how things works, sure fine.

The counter to that, though, is that the HFT folks don't have any right to have access to order flow. If market participants want to route their orders to a particular dark pool or exchange they have every right to. The "markets are always right" sword cuts both ways.

auntienomen• 12 years ago

They do have every right to route their orders where they will. It's telling that most of the buy side prefers to route their orders to public exchanges rather than dark pools like IEX.

consz• 12 years ago

It isn't only 1000 shares, there is indeed 1000 unique shares on each of those ten exchanges. The problem is that, as soon as the first exchange that you trade on processes your trade of the 1000 shares on that exchange and publicly disseminates that information, that is public information -- and an HFT is totally within their right to pull their remaining 1000 shares on each of the nine remaining exchanges if they so choose. That's why Lewis explains that once they wrote a program to stagger the submission of their orders so they arrive simultaneously to all ten exchanges, they were able to pick off all 10000 shares instead of only the 1000 on the first exchange.

lotsofmangos2• 12 years ago

I stopped reading at 'potato-wog'.

tpeng12• 12 years ago

Why is this downvoted? There are multiple comments in the article based on racial stereotypes which are not only completely unnecessary but reflect negatively upon the author's judgment and credibility. Very ironic considering the article seeks to suppress Mr Lewis's speech.

brymaster• 12 years ago

To quote te_chris:

"On most articles like this it just feels like a bunch of doe-eyed, aspirational men who really want to be rich one day, so don't want to spoil the fun for their future selves."

https://news.ycombinator.com/item?id=7257140

kasey_junk13• 12 years ago

I also found the racial commentaries problematic and unnecessary. That said, the author is in no way trying to suppress Mr. Lewis's speech.

Disagreement is not censorship.

lotsofmangos2• 12 years ago

I did an actual double take at 'potato-wog'. The only people I have run into who use that term for the Irish in normal speech are BNP.

RockyMcNuts4• 12 years ago

The market exists the benefit for the 'buyside' e.g. people who own stock, not for the benefit of the middlemen like exchanges and HFT marketmakers.

You may not like homeowners and think some of them are or should be convicted, but it's ridiculous to say someone is 'shilling for homeowners' when they point out that real estate brokers are overpaid and skimming.

Some more balanced discussion - http://streetwiseprofessor.com/?p=8333

http://blogmaverick.com/2014/04/03/the-idiots-guide-to-high-...

http://blogs.hbr.org/2014/04/high-frequency-trading-threat-o...

In a nutshell, people who run big portfolios don't want to give away information about what they're doing, and they don't want HFT types to be able to pay exchanges to get first crack at front-running them.

On the other hand there is a legitimate market-making function, and there's a tradeoff between transparent markets and forcing people to share info that lets other people trade against them.

drcode5• 12 years ago

people who run big portfolios don't want to give away information about what they're doing...

Then people shouldn't be investing in these poorly-performing portfolios and use other portfolio managers who are more savvy.

These people act like this stuff is MP (my problem, as an average person) whereas it's obviously YP (your problem, Mr. portfolio manager)

harryh23• 12 years ago

Yes, some big portfolio guy wants to be able to sell 50M worth of some stock without the price dropping.

But what if you were buying stock at the same time? Wouldn't you want that information about that rise in supply to be detected and priced into the market as fast as possible?

tptacek16• 12 years ago

The buy-side is buying liquidity. The sell-side is selling it. That's basically what the terms mean.

It's not particularly meaningful to say that the market exists "for" the buy-side. The real estate market exists for the real estate buy-side, too. But it takes 5 months to sell a house, because nobody is selling liquidity; instead, you have to work through an ineffectual sell-side agent who takes tens of thousands of dollars out of your hide for the privilege.

RockyMcNuts4• 12 years ago

no, the buy side is long. the sell side is selling things like IPOs, etc. that the buy side might want to buy. sometimes they provide liquidity, sometimes they're just an agent and rent-seeker.

markets, trades, liquidity are a means to an end, not an end in themselves. every trade is a friction and a cost, and only happens because the two sides aren't happy with their portfolio.

"more friction in your machine is generally bad and just creates heat."

"oh, but that's not meaningful, people who make sandpaper and grippy tires are needed to create friction"

"..."

RockyMcNuts4• 12 years ago

this guy said it better than me -

https://news.ycombinator.com/item?id=7546768

forgotAgain• 12 years ago

This article seems like nothing more than an overly long ad hominem attack.

The only critique that matters is whether or not front running of buy orders by HFT traders is real or bull. Anything more is just an attempt to cloud the waters.

aet3• 12 years ago

Yes, I was also dissapointed by the name calling.

Guvante• 12 years ago

It was especially disappointing when he dismissed the front running as always having been there.

harryh23• 12 years ago

He didn't say front running has always been there. He said market making has always been there. Market making is a valuable service and it's great that it's cheaper than ever.

NkVczPkybiXICG• 12 years ago

There is no front-running: http://clarkgaebel.com/you-are-not-being-front-run/

whyme• 12 years ago

I haven't read the book, but I've followed the chatter and have been listening to Lewis on Bloomberg. I get the impression that many justify HFT by comparing current or past alternatives, however his argument is that HFT is corrupting an otherwise fairer market place. In other words the market should improve and lessen these side businesses that victimize participants and add to the discredit of the exchanges.

If anyone thinks that these side business do not victimize participants you should look back to examples like Knight Capitals glitch that most certainly caused retail investors to lose trust and pull their money from the market, taking a loss. The introduction of non-relevant code is an unnecessary risk that does corrupt the system and does victimize your average investor.

1. http://www.telegraph.co.uk/finance/newsbysector/banksandfina...

joosters• 12 years ago

I wonder how many people commenting here have actually read the book? Or have they just been reading articles about it?

kasey_junk13• 12 years ago

This is a very good point. I finished the book today. The most interesting thing to me is that the book pretty clearly (from the perspective of an HFT engineer) comes down on the side that HFT is not actually a villain and that the large banks (especially Goldman Sachs & Credit Suisse) are pretty much the devil (giving Goldman a pass for their last year of non-deviltry).

Yet all the interviews, press junkets, and face time on the Daily Show are saying the exact opposite (to the point that Jon Stewart of all people is extolling the virtues of Goldman).

It says way more about the book selling/exchange building business than it does about HFT.

anonu• 12 years ago

My concern is that Michael Lewis and his books have great popular appeal. Furthermore, he is jumping on the popular bandwagon of bashing HFT. They lay person will look at these facts and simply conclude that he's right. The problem can easily extend to other buy-siders who dont really full understand (or care to understand) how market microstructure works in the US.

JackFr• 12 years ago

I suppose one could add this book to

The Blind Side -- the story of how one of Michael Lewis's classmates as an Ole Miss booster, gave impermissible benefits to a high school recruit and got away with it.

Moneyball -- the story of a GM with 0 World Series appearances and a .530 WP.

scottlocklin• 12 years ago

If you think I'm a dork, or too much of a Michael Lewis hater, I encourage people to read this Amazon review, which gets into a lot of interesting small details Lewis got wrong:

http://www.amazon.com/review/R3PJO6KJGRMWUE/ref=cm_cr_pr_vie...

kasey_junk13• 12 years ago

This is very close to the blog post I would write if I were going to write a critic of Flash Boys. I'd add the following:

IEXT has a few main selling points. 1 transparency, 2 simplicity, 3 looking out for "investors". The problem is that they aren't any of those things and it is obvious from a simple reading of their technical documents.

First transparency. Their marketing pitch is that as opposed to other dark pools, they are transparent about what is happening on their markets. Yet the first thing they say in their technical documents is "IEX will commence operation as a fully NON- ---DISPLAYED venue." What this means is that their order books is not available for outside audit. They are meeting the lowest hurdle to regulatory compliance by providing best bid/offer and no more. If you think that is ok, let me ask you. If I told you that there was 1 buyer willing to buy at 10.00 and 1 seller willing to sell at 11.00 what would you think the "real" price for that instrument is? What if I told you that there was 1 buyer at 10, 1 seller at 11, 100 million buyers at 9.99 and zero sellers at 11.01? If you think those markets should be priced the same way, IETX is for you. If not, realize that IETX would tell you those markets are the same thing.

As far as simplicity, Flash Boys and the IETX marketing materials make a big deal about all of the order types that provide advantages to market makers, yet they remain silent on those order types that are explicitly there for large institutional investors. Lewis rages against ALO orders yet doesn't even mention iceberg orders which the sole point of is to hide the amount of shares a participant wants to sell. Then he extols the virtue of IETX for only offering 3 order types (which has since risen to 4), yet doesn't explain that in those 3 order types are many variants that only benefit large investors. IETX has literally removed all of the order types that allow market makers to do their jobs, while leaving all the order types that allow large institutions to hide their order flow. One of the most controversial order types out there is an ISO order, which is literally a legislative exemption for large block buyers that allows them to circumvent regulation about the national ticker. IETX offers those sorts of orders, but you will be happy to know they don't support "esoteric" orders.

The most egregious problem in Flash Boys is Lewis' use of the term "investor". He uses this term to make his readers think he is talking about them, after all anyone who is not an HFT, who is long holding a stock is an "investor". Yet the practices he describes as predatory, are really simple market dynamics. If an "investor" wants to buy or sell an extremely large block of shares, that should move the market price. No other marketplace would think differently. If McDonalds buys all the cows in America, beef should cost more. We all understand that. But the giant hedge funds of the world hate this. They want to use their privileged information of demand to make money, and not change the prices of the things in demand. They used to be able to accomplish this because the markets were dumb. They aren't anymore. Price discovery is an extremely efficient (and cut throat business). IETX does its gosh darn Canadian best to undercut that. Literally every rule they have is an attempt to hide demand and undermine price discovery. It's possible that bad pricing is an overall societal good. I'm not smart enough to weigh in on that. I will ask, if they are looking out for the little guy though, why do they have a special order type that insures that big investors don't trade with them (min. qty orders)? They will respond that it is protection against predatory HFT. I ask you though, if the huge hedge funds of the world don't want to trade in small volume with the rest of the informed markets, at the lowest prices conceivable, who do they want to trade with? The answer is large dumb funds, who don't care about trading at inflated costs. I.E. pension funds.

harryh23• 12 years ago

As much as there are a lot of people in the world (many of them right here on Hacker News!) who don't care about the mechanics of how liquidity is provisioned in markets and consequently have kind of backwards views of HFT most of these people aren't, you know, trading stocks.

So here's my question: since the people that are trading do tend to understand these things (if for no other reason that they'll go bust if they don't), won't liquidity providers run away from IEX as fast as they can? How do Brad Katsuyama and his partners think they'll actually scare up enough liquidity to get maintain a functioning market?

I'm a little befuddled by this.

blue112• 12 years ago

You don't have to agree with Michael Lewis' views or buy into the story line 100% in order to enjoy the book. The fact is that this is a well-written book that is full of mini-stories and anecdotes that present very realistic descriptions of how electronic markets and Wall Street in general work. Statements like "the market is rigged" are obviously over the top but that doesn't mean that the book on average is not true to reality. Most books about electronic trading suffer from extreme sensationalism, poor writing, and the inability of the authors to understand the subject matter that they are writing about. Michael Lewis does a better job than everyone else. He is a great writer and he is a smart guy who has some financial background and has a pretty good understanding of financial markets. Yes, there is some sensationalism here (he has to sell a good story after all) and there are many errors in the book, and, yes, the author's biases are quite evident, he's picked a side and he's sticking to his story. On aggregate, though, this is probably the best book about the world of electronic trading that I've read.

(Some people mentioned "Dark Pools" by Scott Patterson. Although also interesting, that books was often quite painful to read because it was quite clear that the author did not understand basic financial and programming concepts. "Flash Boys" is much better, in my opinion. Although if you are really interested in the subject, you should read both.)

harryh23• 12 years ago

You basically just said that people should read the book because, even though it's mostly wrong, it's well written.

Isn't that kind of crazy?

blue112• 12 years ago

I'm not saying that it's mostly wrong. I am saying that it's a biased perspective, but most of the contents is factual. You can learn interesting things about the markets, and about the individuals and the companies involved. However, this is one side of the story. Michael Lewis' facts were gathered from people that were close to him and the people that he could get to speak to him. It's one circle of people with their own agenda. But there are many other views out there. So he is presenting the facts that he knows about and that he thinks are important. But there are things that he is perhaps omitting on purpose, and things that perhaps he just doesn't know or understand. The book is not the whole truth. As with any good book or article, you can learn a lot without having to agree with the author's conclusions or his personal views.

skywhopper• 12 years ago

Always good to start out an article critiquing the argument in a new book by showing a picture of the author and making a snide remark about his appearance. Immediately gives you credibility.

stevewilhelm• 12 years ago

As an aside; I have been thinking it would be useful to have two new levels of capital gains taxes.

In addition to long term capital gains, and short term capital gains, there would be "intra-day" capital gains and "sub-second" capital gains.

I was thinking the intra-day gains Federal tax rate would be 50% and sub-second capital gains Federal rate would be 90%, but these values are arbitrary.

For both new types of capital gains, LIFO trade accounting would be used.

Michael Lewis: shilling for the buyside?

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