The release of the book Flash Boys by Michael Lewis, is about a small group of Wall Street traders who believe the stock market is Rigged for the benefit of insiders. They create their own exchange for High Frequency Trading in an effort to reform the financial markets.
A great deal of controversy has been sparked with the release of Lewis’s 15th book. After a short stint as a Bonds salesman, Lewis began a career as a financial journalist and author, penning his first best seller Liar’s Poker, a book that captures the history of the bond market in the late 1980’s.
High Frequency Trading
Recent Flash Crash stock market events have made investors far more aware of High Frequency Trading (HFT). A Flash Crash is an extremely quick and deep market movement downwards, over a very short period of time. They have been touted as being driven by computer trading, or executed by trading systems run by computers without human intervention.
HFT is algorithmic trading operated by computers. Positions are bought and sold automatically based on a series of rules, and relies upon the speed of the computer and the connection between the computer and the stock exchange.
The Big Players
For years, Mum and Dad investors have feared that the stock market is Rigged by the big players – Institutions, Governments, the exceptionally wealthy. The recent Global Financial Crisis (GFC) in 2007/08 brought about the term “Too big to fail” with regards to leading Financial Institutions, where the Federal Reserve and government bailed out key firms to ‘save the economy’.
But is what we see as the Stock Exchange, really what is going on behind the scenes?
Lewis’s book claims that there is a real serious threat that the markets are Rigged as an increasing amount of trading occurs outside of the normal stock exchange floor. With potentially so much trading occurring on Dark Pool exchanges with HFT systems, prices for stocks on the exchange may no longer reflect where the stock price is actually at.
Stock Exchanges are operated by regulation. There are fees to buy and sell, and rules for all players to abide by. The purpose of having a regulated exchange is to ensure a fair playing field for all participants. Introduce off-exchange trading available only to key institutions, and you create a massive divide between “Us and Them”.
Dark Pool Exchange
The value of HFT may account for a mild cent here or there of the Mum and Dad transactions, which is estimated at around 40% of all US stock trades, but at the volume levels that are occurring, we are referring to billions of dollars. At what point is this allowed to continue?
You and I will never trade directly in a dark pool exchange. They are simply not available to the general public. But it does suggest that manipulation of the stock market could easily be made as large volumes of stock exchange at different prices to the regulated market.
And with the HFT transacting before the price even hits the exchange floor, the ‘insiders’ have made their money before you even know what has happened.
For now, the public is being stirred by a good book that is introducing them to activity that has been active for many years. If there is enough of an uproar, the regulators may be moved to take action. Until then, we are just going to have to give up that cent here and there until we make enough from trading to play in the deep end of the dark pool.
Matthew Brown – US Stocks & Options specialist
US Equity & Option Client Advisor
Halifax Investment Services
ASIC Australian Financial Services License Number – 225973
Matthew is an Authorised Representative of Halifax Investment Services (Halifax). Halifax provides broker services, including Full Service and Discount Services using multiple trading platforms.