BOOK REVIEW: FLASH BOYS: A WALL STREET REVOLT

FLASH BOYS: A WALL STREET REVOLT

By Michael Lewis

 

I just finished reading Michael Lewis’ new book Flash Boys: A Wall Street Revolt.

Recently we emailed the web link of the 60 Minutes interview with Michael Lewis titled “Is the U. S. Stock Market Rigged”, that many of you watched. The interview and the book have captured investors’ and regulators’ attention. Last week both the SEC and FBI began investigating High Frequency Trading (HFT). Could this be a coincidence? Not Likely.

Lewis tells the story of the development of HFT by following the lives of an honest stock trader from the Royal Bank of Scotland and a Russian computer technician as they stumble into the bewildering and dishonest world of HFT.

They encounter three levels of players in this world:

  • The CEO’s and upper management of our major banks such as Goldman, Morgan Stanley, BOA, who have no idea what HFT is nor do they seem to care.
  • The technicians who are charged with making the trading arena as fast as possible but have no idea what their computer programs actually do.
  • The traders who know what they are doing but not how they are doing it (i.e. they don’t understand the computer programming), they just know they are making $ BILLIONS.

These three layers of personnel are kept very separate from one another. The traders do not want anyone to know what is going on.

Until a few years ago there were two stock exchanges; NYSE and NASDAQ. Now there are 45. The reason for this explosion is that the more places stocks can be traded, the harder it is for the broker and investor to know whether they got the best price.

How exactly does this work?

Say you or your mutual fund or pension plan want to buy 50,000 shares in Marks & Spencer. You place your order — either electronically or over the phone — to a broker or bank, which then tries to find the best price by getting its computer to search the various stock exchanges.

But the computer request from the broker or bank takes a small amount of time to reach those exchanges electronically. In that small time delay, the HFTs pounce, buying 50,000 M&S shares, which push up the market price very slightly, and then selling them to you for a profit at the higher price.

The extra money going to the HFT firms is estimated to be $ Billions per year coming directly out of the investors’ pocket.

There is no documentation on these trades. Remember the “no doc” (no documentation) loans that contributed to the mortgage crisis? We asked: “how can a bank give a loan without documentation”? We should now be asking: “how are trillions of dollars of trades done without documentation”?

Bottom line, the stock market is no longer about value, it is about speed. It is no longer about building capital by giving investors shares in companies; it is about gaming the system for the benefit of a few savvy players. The stock market is now one large poker game with shares of stocks as chips. Whoever gets their trade in first by milliseconds, wins.

I have known about HFT for some years now, and it is one of many reasons I do not have your money in stocks.

I was optimistic that the book would end with the good guys establishing a new, honest exchange and putting the bad guys out of business. In a way that happens, but as of today the new exchange accounts for 1% of the trades being placed in the U. S.   Remember HFT occurs worldwide.

As an investor, you need to read the book. This is not your father’s or even your stock market.

There is, however, somewhat of a light at the end of the tunnel. While HFT now accounts for 75% of trades, trading volume is down by 50% in the last three years. Are investors figuring out the stock market is not where their savings should be?

 

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