Hi-Frequency Traders Ripping Off Investors, Michael Lewis Says
Comment of the Day

March 31 2014

Commentary by David Fuller

Hi-Frequency Traders Ripping Off Investors, Michael Lewis Says

Here is today’s initial article by Nick Baker and Sam Mamudi for Bloomberg, prior to the public release of Michael Lewis’ new book: Flash Boys: A Wall Street Revolt.  The original article is no longer available online but having sent it to my PC this morning, I make the PDF above.  The article was subsequently watered down and also diluted with rebuttals from the very powerful HFT industry, which has so far had the blessings of most exchanges, because their profits have increase dramatically as a consequence of all the additional volume created by high speed electronic orders.  Here is the opening from the original article:

March 31 (Bloomberg) -- The U.S. stock market is rigged when high-frequency traders with advanced computers make tens of billions of dollars by jumping in front of investors, according to author Michael Lewis, who spent the past year researching the topic for his new book “Flash Boys.”

While speed traders’ strategies, developed over the past decade with help from exchanges, are legal, “it’s just nuts” that they’re allowed, Lewis said during an interview televised yesterday on CBS Corp.’s “60 Minutes.” The tactics are too complicated for individual investors to understand, he said.

“The United States stock market, the most iconic market in global capitalism, is rigged,” Lewis, whose books “Liar’s Poker” and “The Big Short” highlighted Wall Street excesses, said during the interview. The new book comes out today. “It’s crazy that it’s legal for some people to get advance news on prices and what investors are doing,” he said.

Everyone who owns equities is victimized by the practices, in which the fastest traders figure out which stocks investors plan to buy, purchase them first and then sell them back at a higher price, said Lewis, a columnist for Bloomberg View. To show how lucrative the tactics are, Lewis said a technology firm spent $300 million to build a line that would shave three milliseconds off the time it takes to communicate between New Jersey and Chicago, then leased it out to securities companies for $10 million each.

David Fuller's view

Veteran subscribers are very familiar with the debate concerning high-frequency trading (HFT) because this service has been posting articles on the subject and writing about it throughout the last five years, as the historic Archive will confirm

Michael Lewis and others who have expressed criticisms of HFT today are rightly focussing on the fact that it is mainly a front-running system.  Therefore the ‘T’ in HFT is actually a misnomer because the normal definition of trading does not include front-running, which is supposed to be illegal. 

Moreover, normal trading has always carried a level of risk because the future is generally unknown.  Today’s HFT would be more accurately described as HFFR, for high-frequency front running.  HFFR virtually eliminates risk because it gets a clear look at the immediate future by seeing everyone else’s buy and sell orders, microseconds before they are excuted.

(Note: subscribers interested in this subject can review well over 100 previous articles and comments on this subject posted since 2010, by using the Search facility above. Please search under these three headings: the unhyphenated high frequency trading, high-frequency trading, and also HFT, to see them all.)       

I have commented so often on HFT over the last five years, when it was too often given an uncritical free ride, that I am happy to supply the latest informed comments of others on this subject.  Bloomberg columnist Barry Ritholtz describes it accurately in his column today: Speed Trading in a Rigged Market.  Here is the opening:  

"On ``60 Minutes'' last night, author Michael Lewis made a bland assertion: High-frequency traders, he said, working with U.S. stock exchanges and big banks, have rigged the markets in their own favor. The only surprising thing about Lewis’s assertion was that anyone could be even remotely surprised by it.

"The math on trading is simple: It is a zero-sum game. One trader’s gain is another trader’s loss. Only in the case of HFT, the losers are the investors -- by way of their pension funds, retirement accounts and institutional funds. The HFT’s take -- the “skim” -- comes out of these large institution’s trade executions.

"Trading on Speed

"The technology behind HFT may be complex, but the math is that simple. Once the Securities and Exchange Commission allowed stock exchanges to share with traders all of the unexecuted incoming orders, it was hard not to make money by skimming a few cents or fractions of a cent from each trade. Several years ago, the founder of Tradebot, one of the biggest high-frequency firms, had said that the firm had “not had a losing day of trading in four years.” The firm’s average holding period for stocks is 11 seconds.

"Any professional trader can tell you that his job is to manage risks. It is a statistical certainty that a percentage of trades will be losers. You are establishing a position with an unknown outcome. Sometimes they go your way, other times they go against you.

"How is it possible that one of the largest high-frequency trading firms executes millions and millions of orders for four years without ever having a down day? The short answer is what they do is not trading -- it is skimming. I call it legalized theft. High-frequency trading is a tax on investors, encouraged by the exchanges, allowed by the SEC. It is prima facie proof that something is amiss."

I look forward to reading Michael Lewis’ new book, finding him entertaining as well as accurate.  Meanwhile, I am certain that we have not seen or heard the last of HFT.  I am disappointed although not surprised by the slow response to HFT on Wall Street, although the link to 60 Minutes in the email below shows that this is beginning to change.  

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