In Flash Boys, Michael Lewis explores the US stock market’s use and acceptance of high-frequency trading (HFT). Lewis—a best-selling author and journalist—argues that HFT exploits regular investors, creates unfairness in the stock market, and is a concern for any investor.
Published in 2014, Flash Boys devotes much of its attention to the experiences of Brad Katsuyama, a Canadian trader who investigated HFT tactics and was a key player in exposing the practice to the financial world. Lewis examines Katsuyama’s investigation in detail, using it as a lens through which to understand the history and effects of HFT on the market and economy.
In this guide, we’ll first discuss how the stock market adapted to technology and the new features of trading that resulted from these changes. Then we’ll explore HFT tactics that create problems for average traders and investors, as well as how Wall Street responded to HFT tactics. Finally, we’ll explain how Katsuyama and his team found solutions to the problems generated by these high-frequency trading tactics and their efforts to create a fairer stock market.
Along the way, we’ll look at how other experts have weighed in on the practice and some differing views on whether or not these changes have been beneficial. We’ll also provide updated information about trading research and regulations that have come into effect since the book’s publication.
Lewis describes high-frequency trading (HFT) as a type of electronic trading platform that uses automated computer algorithms to very quickly buy and sell large quantities of stocks. High-frequency (HF) traders and firms own these high-powered computers and algorithms. These HFT algorithms gather market data and use this information to buy and sell stocks, completing this process in microseconds, or one-millionth of a second, thus using a different strategy than long-term buy-and-hold investing positions. This speed advantage makes HFT algorithms faster than any human trader, giving them a powerful edge by enabling them to accrue billions of dollars in tiny profits from HFT trades that traditional investors and traders can’t.
(Shortform note: While Lewis doesn’t detail the history of high-frequency trading, who started it, or when it started, this may be because experts don’t agree on how it started. Experts have traced the practice back to the 1830s, 1930s, the 1970s, and 2005. Some researchers attribute HFT’s creation to former finance professor David Whitcomb, while others believe the SEC’s deregulation of the stock markets started the practice.)
As Lewis explains, a Canadian trader named Brad Katsuyama working for the Royal Bank of Canada (RBC) was one of the first people to raise the alarm about HFT. In the late 2000s, Katsuyama noticed changes in the stock market that clued him in to systemic problems caused by HFT, motivating him to build a team to investigate why he was losing money in his trades. While Katsuyama wasn’t the first person to learn about HFT and its tactics, he was one of the first to identify and raise awareness of how HFT was a problem. Lewis learned about HFT through Katsuyama’s findings and focuses much of the book on him.
(Shortform note: In 21 Lessons For The 21st Century, Yuval Noah Harari argues that as algorithms like HFT software provide increasingly accurate suggestions, their convenience is almost irresistible—but relying on algorithms to make your decisions denies you the freedom and ability to make your own choices, which may explain why Katsuyama felt he couldn’t trade successfully anymore. In addition to threatening jobs, technology threatens human liberty, as algorithms learn so much about people that they gain an immense power to influence and manipulate.)
Lewis outlines a few ways by which HFT uses its unique characteristics to unfairly disadvantage regular investors:
Speed is a crucial factor in stock trading. Traders who can lower their latency times, or the time between sending and receiving a signal about market data or a stock order, have an advantage over other traders.
Latency times can differ between exchanges and investors depending on how close to an exchange an investor physically is, since the further the electric signal has to travel through wiring, the longer it takes to execute an order. HF traders work so quickly that they can buy or sell orders in microseconds, so if a stock has changed its price on one exchange but there’s a lag of fractions of a second before it changes its price on another exchange, the HF trader can take advantage of that difference and make a risk-free profit.
Because of this almost-instantaneous purchasing power, HF traders can detect and act upon an order placed by a regular investor and profit off the market movements prompted by that order, lowering the profit for that regular investor.
(Shortform note: While Lewis asserts that speed is an important factor in high-frequency trading, critics argue that speed has always been an important factor in any trading. This may be one reason that [HFT has still gone...
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In Flash Boys, best-selling author Michael Lewis explores the US stock market’s use and acceptance of high-frequency trading (HFT). He argues that HFT exploits regular investors and creates unfairness in the stock market. Therefore, he believes any investor should be concerned about high-frequency trading.
Lewis focuses much of the book on the experiences of Brad Katsuyama, a Canadian trader who investigated HFT tactics and was a key player in exposing the practice to the financial world. Lewis examines Katsuyama’s investigation in detail, using it as a lens through which to understand the history and effects of HFT on the market and the economy.
In examining the role HFT plays in the investment world, Lewis explains six features of the stock market and how HFT algorithms exploit each of them to unfairly tilt the playing field in their favor. He explains how these tactics create problems for average traders and investors. Lewis also explores how Katsuyama and his team found solutions to these HFT tactics and their efforts to create a fairer stock market.
Michael Lewis is a financial journalist and best-selling...
In Flash Boys, Lewis exposes Wall Street and its use of high-frequency trading to exploit investors. He argues that high-frequency trading makes money using advantages that regular investors don’t have access to, meaning anyone with a retirement account, investments, or plans to invest is at a disadvantage.
Lewis focuses the narrative on a Canadian trader named Brad Katsuyama, who investigated high-frequency trading after noticing changes in his ability to trade. After learning about high-frequency trading, Katsuyama and his team used this knowledge to found the Investors Exchange (IEX), a new stock exchange designed specifically to prevent unfair high-frequency trading tactics and take action against Wall Street’s unfairness.
Lewis is a journalist and bestselling author of over 30 books, revealing unfair systems in finance, economics, and business. He wrote Flash Boys in response to the increase in high-frequency trading throughout the 2000s and 2010s.
In this guide, we’ll briefly explain what high-frequency trading is and how both Lewis and Katsuyama learned about it. Then we’ll discuss how changes to the stock market and electronic trading created the six conditions...
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To understand the HFT tactics Katsuyama and his team found, we should discuss the stock market characteristics—and the regulations that Schwall learned about—that set the stage for HF traders to exploit individual investors. First, we’ll provide a brief overview of stock market fundamentals. Then we’ll discuss the early phases of electronic trading that preceded high-frequency trading and how it changed the stock market. Then we’ll explain the six conditions of the electronically-based stock market that HFT exploited. (We’ll discuss how HFT exploited these precedents in Part 3.)
The stock market is where investors buy and sell stock, or partial ownership in companies. The stock market is composed of many different stock exchanges, which are individual marketplaces where stocks are traded. The National Association of Securities Dealers Automated Quotations (Nasdaq), the New York Stock Exchange (NYSE), and Better Alternative Trading System (BATS) are all examples of stock exchanges.
Traders and brokers trade stocks on behalf of an investor at a stock exchange, typically doing so as part of investment firms, brokerage firms, or banks. Traders...
Lewis argues that the above six characteristics of an electronic-based stock market allowed high-frequency traders to exploit individual investors. In Part 3, we’ll explore two of the main ways they do this: arbitrage and front-running. Within that discussion, we’ll describe six specific strategies that give HF traders an unfair advantage, allowing them to profit off the market in ways that are unavailable to regular investors.
Lewis explains that most HF firms make their money from different forms of arbitrage, which is when traders buy and sell a stock at two different prices at two different exchanges. Traders who can effectively time their purchases and sales profit from the temporary differences in stock prices.
Lewis notes that stock values are constantly changing—prices shift multiple times in a second. Every time a stock is bought or sold, its value changes slightly. Usually its value doesn’t change very much—by fractions of a cent—but this small difference in price is enough for HF traders to take advantage of arbitrage.
To illustrate the concept, imagine you buy an old typewriter at a local antique store for $35. You then go to a different...
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Reflect on all you’ve learned about high-frequency trading.
Do you find HFT to be an unfair presence in the stock market? Why or why not?
These six HFT tactics capitalized on the precedents set by electronic trading. Lewis explains that anyone involved in the stock market—brokers, investors, hedge fund managers, and so on—felt the effects of HFT. In this section, we’ll discuss how Wall Street responded to HFT, as well as the three strategies Wall Street firms adopted to keep up with their tactics. We’ll also describe the “flash crash” that caused investors to question what was happening with trading.
Lewis argues that the Wall Street firms and banks, who were supposed to help investors, adopted HFT techniques despite knowing that HFT made trading unfair for average investors. They did this because they were making so much money. One firm made over a billion dollars in one year from its HFT department alone.
(Shortform note: Lewis is no stranger to exposing Wall Street’s greed: In The Big Short, he argues that greed and short-sightedness were the prime drivers of the financial crisis. All major stakeholders in the ecosystem were fueled by...
This is the best summary of How to Win Friends and Influence People I've ever read. The way you explained the ideas and connected them to other books was amazing.
After discovering these HFT tactics and Wall Street’s greedy response to it, Katsuyama and his team decided to fight HFT rather than mimic its tactics to make money. In this section, we’ll discuss his team’s first attempt at fighting HFT: a trading program called Thor. Then we’ll explore their second attempt: a new stock exchange. We’ll also discuss the six features the team implemented to make trading fair against HF traders’ six tactics.
As their first step to addressing HFT techniques, Katsuyama’s team developed a trading software called Thor. Lewis explains that Thor slowed down a broker’s order so that it arrived at all exchanges simultaneously. While it may seem counterintuitive to go slower, this tactic actually helped Katsuyama’s team successfully fill their orders and saved them money. Slowing the orders down prevented an HF trader from front-running it to another exchange and changing the price of the stock.
For example, without Thor, a broker’s order arrived at BATS in three milliseconds and NYSE in six milliseconds. In the three milliseconds before his order got to NYSE, an HF trader saw his order at BATS, thus revealing that there was a known buyer for...
Reflect on all you’ve learned about the solutions to high-frequency trading.
Do you think HFT should be regulated? Why or why not?
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