Michael Lewis’ Flash Boys is a short (I read it on a Seattle-DC flight), well-written, exasperating and flawed look into the world of High Frequency Trading (HFT). HFT, for those not familiar with the acronym, is the term used to describe trading that has two principal features. First of all, HFT is executed primarily by computer algorithms following precisely detailed strategies, not traders making individual buy/sell decisions. Second, HFT trading algorithms depend on speed, extreme speed to be exact, in order to make money against all other HFT algorithms in the markets.
Perhaps the simplest HFT strategy, as Lewis points out, is a modern version of an age-old Wall Street scam called “front-running,” in which a broker who gets a large buy order from a client gets ahead of that order, buys the stock at the lower-pre order price, and then re-sells it at a profit to the original customer. HFT houses executive this time on maneuver thousands of times a day, each time virtually guaranteed to make money, exploiting, as they do so, the corruption of markets that look the other way in order to keep trades in their systems. As Philip Broughton noted in his Wall Street Journal review:
All in a matter of milliseconds, millions of times a day to millions of investors—your grandmother and hedge-fund titans alike. These tiny but profitable trades, Mr. Lewis writes, add up to big profits for firms like Getco and Citadel. He cannot put a hard number on the size of the industry, suggesting only that many billions are involved.
Bloomberg recently noted the success that HFT houses have had of late:
Share volume totals show the transformation that high-frequency firms have wrought in American equity markets. While combined trading on the NYSE and Nasdaq rarely exceeded 2 billion shares in the 1990s, today it is regularly three times that in the U.S. About 6.05 billion shares changed hands on all U.S. exchanges in the last session, data compiled by Bloomberg show.
For a reader unfamiliar with the workings of HFT networks, electronic front-running, dark pools, etc., Lewis’ book is an excellent (though completely one-sided) primer on the topic. Lewis not only exposes and explains HFT to a broad audience, he also tells the story of one banker, Brad Katsuyama at RBC, and his efforts to counter the rise of the secretive HFT houses.
Though praising Lewis’ story-telling abilities, several reviews have been critical of Flash Boys, because no one in the book speaks on behalf of the HFT traders and what they would surely argue is a perfectly legal, extremely clever, exploitation of the way stock markets work today. So they’re the 2014 equivalent of the smartest guys in the room. “So what?” they might have said to Lewis. Wall Street is a darwinian jungle, and if they’re the winning species for now, then their time will last until either that part of the jungle goes away or someone smarter/faster comes along. While this critique of Lewis’ story is fair, and while the case for the market efficiency improvements HFT (theoretically) brings are all worth considering, I think critiquing Lewis for this omission misses the point of this book.
Flash Boys is not really about HFT, when all is said and done. It’s about capitalism, and it continues the thread that runs through books such as George Packer’s The Unwinding and Lewis’ own (and better) The Big Short. That particular thread is the corruption of capitalism, which is supposed to be the mechanism for taking capital from investors and giving it to entrepreneurs, who then take chances in order to get wealthy individually and, in doing so, make society better off. HFT firms, by their own account, take little risk: they simply find ways to make money on the backs of others’ risk taking. The same could be said about the bankers who relied on a government bailout to save their skins. Wealth accumulation, without risk or responsibility, is not capitalism: it is a tax on capitalism at best and a terminal cancer on the system itself at worst.
Flash Boys, then, is yet another warning sign that the system that is supposed to underpin the American way of life has started to undermine it. HFT is the current symptom of this cancer. Trading at the speed of light is not the issue: making money without taking risk is.