An inside baseball topic has certainly spilled over into the mainstream financial media. Michael Lewis’ latest book, Flash Boys, has opened the blinds on yet another shadowy corner of Wall Street — high-frequency trading.
Lewis’ Flash Boys central villains are a swarm of high-speed stock market traders and stock exchanges in search of quick profit. Their accomplices are the many brokerage firms willing to sell out their own customers — that is, investors like all of us.
Flash Boys’ main theme is that regulatory change inevitably awakens predators who constantly seek a loophole. Once found, they devise strategies to feast on their prey. Invariably, the scandal is exposed and yet another regulatory patch arrives.
In this story, about a decade ago new regulations helped to fragment the industry of stock exchanges.
What was once dominated by the NYSE and the NASDAQ, is now made up of dozens of new public and private exchanges. This created competition and lower trading commissions for investors — a notable and tangible benefit.
However, as a result, a new loophole was opened — tiny price discrepancies in identical assets trading across the many different exchanges. With a little help from others who lack business ethics, a new way to print money was born.
To explain, in today’s stock market, shares of a company trade on dozens of different exchanges simultaneously and high-frequency traders’ computers are almost connected like Siamese twins to an exchange’s own computers. Why is this?
High-frequency traders make money with their speed. Their competitive drive for computing speed led to their hell-bent pursuit to gain two key advantages; they want the proximity to an exchange’s computers in order to get access to the trade data feeding in from the other exchanges and they wanted exclusive access to other investors’ trade orders to see what’s about to happen in the market.