I remember what a big deal Flash Boys (amazon) was when it was released in 2014. Everyone I knew was talking about it (I was working at an investment bank back then). I am two years late but I finally finished reading it and have to say, it’s a really interesting book.
There is no denying that Michael Lewis (author of Liar’s Poker and The Big Short among others) is probably the best financial author of our times. In this book, he does a great job explaining the inner workings of high frequency trading and how high frequency trading firms have been ‘stealing’ from investors for the last few years. He explains different ways through which high frequency traders make money at the expense of ‘slow’ investors.
What’s interesting is that all this started with SEC’s introduction of Reg NMS. Reg NMS is a regulation that requires brokers to route their clients’ orders to the exchange that is providing the NBBO (national best bid offer). The intention was that clients must get the best price available at a given time. However, unintentionally, Reg NMS makes it easier for high frequency traders to pry on investors. Consider an investor who wants to buy 1 million shares of Apple. At that time, the best price is offered by NASDAQ but only 50,000 shares are available whereas NYSE has 2 million shares available but at a worse price. Because of Reg NMS, the broker must send his client’s order to NASDAQ first and then route it to NYSE. In an ideal world, that works really well because the investor is getting as good a price as he can get. However, in the real world, you have high frequency traders who notice that someone is buying Apple’s shares on NASDAQ. They use their low latency networks to reach NYSE before the broker, buy rest of the shares of Apple and sell them to the broker for a higher price! All of this happens in milli-or-nanoseconds and the investor has no idea that he was tricked into paying higher price.
What’s more interesting is the role of exchanges in encouraging high frequency traders. You would think exchanges would be neutral but that’s not the case. Exchanges want to make money and the more trading that goes on their venue, the more money they make. Who executes more trades than anyone else? High frequency traders. In 2015, BATS had to pay $14 million fine for not disclosing specific order types to all of its clients. Two of the exchanges it acquired, EDGA and EDGX, had an order type called ‘hide not slide’ designed specifically for high frequency traders which allowed “the orders of some high-frequency traders to jump ahead of other orders.”
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To make the US stock market fair for investors, a former Global Head of Electronic Sales and Trading at RBC, Brad Katsuyama, decided to open his own exchange called IEX which would introduce a forced delay to all orders to level the playing field. This takes away any speed advantage that high frequency traders might have. Flash Boys is the story of Brad and his fight against high frequency traders!
The book also covers the high profile case of ex Goldman Sachs developer, Sergey Aleynikov, who was charged by Goldman for stealing their code and sentenced to jail. Here is an interesting quote from the book:
“Thus the only Goldman Sachs employee arrested by the FBI in the aftermath of a financial crisis Goldman had done so much to fuel was the employee Goldman asked the FBI to arrest.”
Finally, the book briefly touches the mysterious dark pools run by investment banks. Dark pools are private exchanges which don’t have to reveal information about their trades. That means that the investment banks running these dark pools can pretty much do anything they want with them…including revealing their investors’ trade information to high frequency traders. Scott Patterson’s Dark Pools is a great book on the topic.
Overall, Flash Boys is a both entertaining and educational book. The inner workings of the high frequency trading world are unknown to many. One thing I found a little annoying was the amount of repetition in the book. I have noticed that Michael Lewis really likes to repeat his messages through out the book. Besides that, this is a great book. I would definitely recommend reading this book! You can find the book on amazon.