Monday, March 31, 2014

The Nonsense Surrounding Michael Lewis's Contention That the Stock Market is Rigged

Michael Lewis is out with a new book, Flash Boys: A Wall Street Revolt, in which, according to 60 Minutes, he contends "the stock market is rigged."

I am going to make a claim that will be very unpopular among many. Lewis is talking bs.

What his book is  about is front running of institutional trades by high frequency traders. That is all. For small long-term investors this type of trading, in many cases will provide an edge. Just use limit orders and wait for a high frequency trader to take a stock to where your limit order is and get the trade executed, you win.

There are many very smart people on Wall Street who spend time thinking of every possible angle to take your money. There are, also, very smart people who will try and counteract those people. Indeed, the 60 Minutes story ends by discussing a trader who has formed an exchange, the IEX, that will nullify the high frequency trader edge. That's how markets work. But more importantly, if you don't understand the game, don't play.

As for high frequency trading being some big news story that Lewis has broken, puhleez. ZeroHedge has been screaming about it for years.

Here's Ron Insana  in 2009 writing in Portfolio Manager about high frequency trading:
The New York Times and The Wall Street Journal are taking aim at a new form of computerized trading known as "High Frequency" trading. The algorithm-based trading is allegedly an illegal form of front-running, as high-frequency traders hook into exchange computers and use "flash trades" to suss out incoming order flow and use the lightning speed of their own programs to jump ahead of customer orders.
The real scam here is Lewis pretending he has discovered some new overall rigged market. HFT should be of zero concern to long-term investors.

As Barry Ritholz notes:
The only surprising thing about Lewis’s assertion was that anyone could be even remotely surprised by it.
To be sure, it is a rigged game, but it is not about the stock market overall. As Ritholz points out, the SEC allowed stock exchanges to share with traders all of the unexecuted incoming orders, it was hard not to make money by skimming a few cents or fractions of a cent from each trade.  The real evil one here is the SEC, a wholly owned subsidiary of the elite Wall Street establishment.

It is outrageous, though, that 60 Minutes will spend so much time on claiming "the market is rigged" because of high frequency trading, when it really plays a very small role in the big picture of the U.S. stock market and doesn't come anywhere near the Federal Reserve manipulations of the economy and interest rates. That's rigging that people should be aware of and which should be of general concern. It hurts many, including many who don't want to play the Fed induced roller coaster game but are forced to because the Fed rigs the entire economy.


  1. REALLY????.....

    Bubbleberg News LP

    One of the evils of massive over-financialization is that it enables Wall Street to scalp vast “rents” from the Main Street economy. These zero sum extractions not only bloat the paper wealth of the 1% but also fund a parasitic bubble finance infrastructure that would largely not exist in a world of free market finance and honest money.

    The infrastructure of bubble finance can be likened to the illegal drug cartels. In that dystopic world, the immense revenue “surplus” from the 1000-fold elevation of drug prices owing to government enforced scarcity finances a giant but uneconomic apparatus of sourcing, transportation, wholesaling, distribution, corruption, coercion, murder and mayhem that would not even exist in a free market. The latter would only need LTL trucking lines and $900 vending machines.

    In this context, the sprawling empire known as Bloomberg LP is the Juarez Cartel of bubble finance. Its lucrative 320,000 terminals and profit-rich $10 billion in revenue are not purely a testament to the extraordinary inventive genius of Michael Bloomberg The Younger. In fact, Bloomberg’s 1981 invention owed a huge debt of gratitude to Richard Nixon and Milton Friedman. It was they who destroyed the Bretton Woods regime of anchored money and global financial discipline that made “Bloombergs” necessary.
    And, in fact, so are all the other distincitive features of the modern equity gambling halls—index baskets, cash-settled options, ETFs, OTCs, HFTs. None of these arose from the free market; they were enabled by central bank promotion of one-way markets—that is, the Greenspan/Bernanke/Yellen “put”. The latter, in turn, is a product of the hoary doctrine called “wealth effects” which would have been laughed out of court by officials like William McChesney Martin who operated in the old world of sound money.
    Needless to say, the parabolic rise in financial sector profits from about 1.25% of GDP prior to Camp David to 4.25% of GDP today—call it a round $500 billion per year—is only the tip of the ice-berg. What lies beneath, according to the Commerce Department numbers crunchers, is some $3.75 trillion of FIRE sector (finance, insurance and real estate) “value-added” which generates the aforementioned accounting profits and consists primarily of compensation.

  2. Yves Smith has deconstructed some of Lewis' bs on other issues.
    A good writer, but not to be taken too seriously on these things. He spins it the way the establishment wants it spun.

  3. Your analysis is pure nonsense. By your reasoning, if a thief of one kind of another, steals just $5 from your bank account every month, or even just every quarter, you would say to ignore it, because in the long run, it would not significantly impact your retirement.

    First, the money does add it. And your recommendation to place limit orders, ignore the fact that HFT front runs orders, and will outbid you limit by a penny. True most of the time you will get your limit, but there will be at least one time when by that 1 penny, you miss a major move.

    But more basic, one always prefers dealing in an area that is based on fairness. That has not been possible in the mkts for several years, due to HFT.

    1. It is totally absurd to think your individual trade is going to be impacted by HFT. You have no clue. They are not front running odd lots.

      Use limits properly and HFT even provides the small investor with an important edge.

    2. I never assumed anyone reading this site was trading in odd lots. But still, the principles remains: HFT front-runs orders. If there are enough orders at the same price that your odd-lotter placed his bid, HFT will buy 1 cent higher. At some point, that will make a significant difference.

      But why all of a sudden are you favoring major banks & brokers, as well as billion dollar hedge funds, who borrow at ZIRP. Exchanges income are maybe 12-15% from commissions; the balance from data feeds, etc., and very impt, fees for placing HFT computers closer to exchange floors, permitting them to front-run orders. Why encourage such behavior?

  4. Comment on this?

    1. OK, my final comment on this subject today. Forbes claims HFT benefits BOTH the small investor, AND the large investor. Presumably EVERYONE benefits, except it would seem logical to conclude,
      but the HFT.

      Forbes explains the paradox by claiming liquidity is so improved that everyone benefits. Fortunately, a market expert just commented on this issue on CNBC. Art Cashin said that HFT increase volume (no question, as they do about 70% of exchange volume,) but Art said that does not mean it is increasing liquidity.

      And Forbes only mentions in passing, but I would emphasize, that just 1 flash crash every so often, caused largely by HFTs, will wipe any previously assumed benefits to the small or large investor.

      But were you surprised that Forbes came to the defense of the brokers, etc., that are their subscribers, and buy the products of their advertisers?

    2. Innuendo and special pleading are not arguments. If you are not going to refute or modify the argument that HFT's reduce the spreads and therefore provide benefit then you haven't addressed the argument. Noting the nature of Forbes' clientele does not necessarily invalidate the argument made in the article. The completely ignorant on the topic are making plenty enough heat to go around. If you want to be taken seriously, shed some light.

      Also with respect to the assertion that: "1 flash crash every so often, caused largely by HFTs, will wipe any previously assumed benefits to the small or large investor," do you have any documentable evidence or logic that will back up that assertion? Are you presuming a perfect, frictionless, crash-proof market that somehow can be achieved? Glib denials are not arguments. I am way more than willing to entertain the idea that the HFT phenomena are merely the warped creatures spawned out of the phony, over-regulated, fiat currency, and fractional reserve system we have now, but to me that says that people should be striking at the root of the problems, not hacking at the HFT leaves.

  5. There are problems with HFT, problems that ought to concern the general public (even people with no money in stocks at all).

    And yes, like most of the world's problems, this can be traced to the government's efforts to "help." I have no idea whether Lewis recognizes this -- I'd have to read the book to know. I don't especially care whetrher he recognizes this.

    Arnuk and Saluzzi, in their very well-informed book on market structure two years ago [BROKEN MARKETS], traced the problems to order handling rules, Reg ATS, and decimalization, all reforms of the US markets by the SEC in the late 1990s.

    These changes, and HFT itself which they facilitated, slimmed almost to the point of disappearance the size of the spreads in that system.

    So: are narrower spreads a good thing? No. Just as in other markets, lower prices aren't necessarily a good thing. For those fatter spreads of earlier days paid for something. They did valuable work. The higher spreads won in large part from the fractional nature of minimal ticks in the old days paid for a whole professional network or infrastructure that was essential to the launch of once private companies into the public waters.

    David Weild and Edward Kim, who contributed a chapter to the Arnuk-Saluzzi book, have discussed the some of the numbers involved in a presentation I find compelling. The US stock market is shrinking. The number of companies that have left it each year since 1997 has exceeded the number who have entered. That stock market has been a critical component of the over-all growth of the economy. The SEC is killing the goose and looking for the gold in its interior.

    1. Your arguing that wider spreads are better because they "paid for a whole professional network or infrastructure that was [once upon a time] essential to the launch of once private companies into the public waters" is akin to saying that horse-based transportation is better because it once supported a whole industry of buggy whip makers. If you want your argument to make a point, you need to explain how that horse-based transportation was somehow better. I think you're implying that a gold system with free, non-fractional banking would not have the HFT phenomenon present, and if so the horse-and-buggy analogy is not good one, on my part, but from what I see in what you've presented, you've not clearly made and supported that point here.

    2. This comment has been removed by the author.

    3. Your analogy does seem a bit skewed. But yes, I do think that an economy where the stock market has a central role and private equity has a lesser role is a better over-all model for growth. And the higher spreads made the greater relative role of the former possible, the lower spreads seem to be pushing us toward a greater role for the latter. HFT and the government regulations that empower it have been part of that push. Are you saying that you agree with me about what is happening in this respect but you find it desirable because you get to drive an internal combustion engine this way?

  6. Traders these days all know what high frequency trading is but very few actually understand some of the strategies they’ve used to pinch pennies from everyone’s pockets since 2007.

    In this episode, Haim & I speak about a practice called Latency Arbitrage. Speed is at the forefront of many HFT strategies and this predatory practice uses speed to take advantage of slower feeds.
    - See more at:

  7. HFT Trading As Applied To Comex Gold Futures

    Everyone is discussing the Sixty-Minutes segment on HFT trading. I’ll know that real change is coming to our system when the Government allows Sixty Minutes to discuss the manipulation of the gold market.

  8. > But more importantly, if you don't understand the game, don't play.

    Would that were the case. The sad state of affairs is that the Fed, in effect, requires that everyone play the game by pushing interest rates to near zero.

    Obviously, this is an argument to end the Fed's manipulation of interest rates rather than somehow regulating every nuance of the game that is beyond the ken of unsophisticated players.

  9. Market participants react to the circumstances under which they find themselves operating. In the crash of 1987, market-makers reacted to the one-sided order flow by walking away from their telephones. When the balance of risk vs. reward favors one group of market participants over another, this is exactly what we would expect to occur. It was that day in October 1987 and another similar day in October 1989 or 1990 (I cannot recall which) that sparked the imaginations of a handful of tech savvy traders and brought about the beginning of what was to become high-frequency trading. The thought was simple: if Wall Street is going to walk away from one-sided markets, there is going to be an opportunity and technology will likely be at the forefront.

    Since those early days of trial and error experimentation, the markets have evolved from bid offer spreads measured in 1/16ths and 1/8ths to fractions of a cent thanks to HFT. And with spreads that tight, the role of the human market-maker in heavily traded stocks has diminished to nearly nothing. In recent years, the algo traders have spread their exposure to include FX and futures markets and have even begun to make an impact in the options markets.

    I've spent the majority of my adult life making markets in commodity options on three of the domestic futures exchanges and I've watched as the markets gradually evolved from favoring the market-maker to favoring the outside trader due entirely to the narrowing of the bid/offer spread. This past year I left the floor as the floor-based trader is no longer in an advantageous position.

    This is progress. It is disruptive. It is creating losers from former winners and winners from entirely new market participants. And, to be clear, there is no one more opposed to change than former winners. Muckraking journalists are always looking for a story that aligns with their point of view and populist politicians will always side with the aggrieved -- even when the so-called victim is a member of the 1% that they vilify with impunity.

    For those not up on early 20th century history of financial markets, floor traders at the NYSE (or room traders as they were known at the time) so opposed the introduction of telephones on the floor of the exchange that they went to Congress looking for relief. Progress sucks if you are not on the leading edge.

    1. CFTC Investigates The "Secret" HFT-Exchange Incentive Programs

      The CFTC probe is focusing on contracts tied to high-volume commodities such as crude oil, among other trading, and whether exchanges are pressuring some clients to trade such contracts exclusively on their venue, according to the people familiar with the probe. It also is targeting deals struck privately between exchanges and trading firms that aren't disclosed to other trading outfits.

      "There shouldn't be secret deals," said Mark Gorton, chief executive of Tower Research Capital, a U.S. high-frequency trading firm. "The big players shouldn't have better rates than the little players."