Book review: Flash Boys, by Michael Lewis

originally posted elsewhere: September 1, 2014

tl;dr: Not the largest Wall Street heist Michael Lewis has ever uncovered, but an important one nonetheless...

If you’ve heard the term “high frequency trading” and wondered exactly what it is, or wondered why one of your recent stock transactions was priced one ten-thousandth of a cent from a round figure, then you should find Flash Boys educational and entertaining. Michael Lewis cites various sources to claim that high frequency trading is a low tens-of-billions of dollars industry which takes money from investors without performing any real value-added service to the market or capitalism. Yes, arbitrage has been around for centuries, but the nearly risk-free arbitrage performed by high frequency traders is only possible because various firms and system conspire to prevent investors from directly accessing the entire stock market nearly simultaneously.

There’s a truism in the design world that can help maximize the chances of a system functioning properly and reliably, namely the KISS principle: Keep It Simple, Stupid. A stock market is necessarily complex, but it is dangerous to make it any more complex than it absolutely needs to be. Lewis builds a persuasive case that the complexity which has been added to the stock market over the past decade serves the interests not of long-term buy-and-hold investors, but rather the high frequency traders looking to make a few risk-free pennies by standing in the middle of every single stock trade.

The growing complexity Lewis enumerates includes a fragmentation of the stock market into many smaller, geographically dispersed markets; Wall Street firms’ own private stock markets, called “dark pools”; a vast array of new stock order types; regulations that make the system worse instead of better; a variety of new commission schemes; and speed-optimized network and computer design, with special access rights granted to those who fork over the most money.

The result is a system that no one fully understands, is more volatile than a simpler system would be, and may be susceptible to crashes, as demonstrated by the recent “flash crash”. In fact, one of the minor failings of Flash Boys is that Lewis cannot offer a precise step-by-step explanation of how the flash crash occurred. But perhaps no one can, given the complexity of the system and the lack of detailed record-keeping down to the nanosecond.

Although it is fully computerized, the stock market is ultimately created and shaped by people. Lewis does an admirable job showing how the motivations of the high frequency trading firms and the traditional Wall Street banks are aligned against investors to keep the game going, as everyone profits at the expense of the investor. Fortunately Lewis describes a few hardy souls who refuse to play the game, and instead are taking action to protect investors from high frequency traders. One hopes they will ultimately succeed, and reshape the stock market from within.

Flash Boys is not quite as good as Michael Lewis’ best works, but it is a very worthwhile read if you have an interest in learning more about high frequency trading, Wall Street, and the structure of today’s computerized stock market. I for one am glad that Lewis remains on the job, surfacing more of the dastardly deeds of Wall Street.