The suddenly high-profile controversy over high-frequency trading seems to be focused as much on the literary and marketing techniques of best-selling author Michael Lewis as on the practice itself.
As the debate raged on last week in the wake of the release of Flash Boys, Lewis’ new book which depicts high-frequency trading as a scourge on U.S. securities markets, both supporters and detractors seemed to agree on a few points.
In no particular order, those points could start with the notion that Lewis failed to tell the whole story of the evolution of high-frequency trading and how that evolution has made stock trading more efficient and consequently cheaper for most investors.
That wider narrative apparently didn’t fit the ‘good guys versus bad guys’ story Lewis wanted to tell, and the one that would draw in as many readers as possible and sell the maximum number of books.
Lewis then doubled down on that narrative by telling an interviewer from CBS’ 60 Minutes that U.S. markets are “rigged,” an inflammatory statement he later attempted to soften by adding a bit more nuance to his explanations.
Another point that no one disputes is that the rise of electronic trading over the past 20 years, an evolution that has included the emergence of the sub-genre known as high-frequency trading, has benefited so-called mom and pop investors.
A whole generation of young Wall Street traders probably can’t imagine a time when the gap between stock prices for those looking to buy and sell was measured in fractions such as 1/4s, 1/8s and 1/16ths. Those kinds of spreads – 25 cents or 12 ½ cents – are unthinkable in today’s world of computerized decimal pricing, where price gaps are usually measured in pennies or fractions of a penny.
What that means is that investors ranging from Wall Street professionals to mom and pops managing their retirement accounts can buy stocks at prices much closer to their bids, which saves them a lot of money.
Thus mom and pop investors save when they buy or sell 100 or so shares and investors – like most of us – who own stocks through mutual funds managed by their retirement accounts or pensions all save because computerized markets tend to trade more efficiently than the specialist-dominated markets of yesteryear.
Investigations May Clarify Muddy HFT Regulations
Also indisputable is the reality that some elements of high-frequency trading have evolved faster than regulators can keep up with, and that those elements have been exploited, sometimes at the expense of those mom and pop investors.
For instance, high-frequency traders have been accused of using their sophisticated software and other technological advantages to move in front of large trades by mutual funds. In a nano-second, the HFT guys buy the same stock and then flip it to the mutual fund at a slightly higher price, taking money out of the pockets of the mutual fund investors.
While this may mean only fractions of a penny on the sale of each share, over the course of millions of shares and millions of trades, it starts to add up. That's the edge achieved by high-frequency trading -- unprecedented speed and massive volume.
Which brings us to the final undisputed point: Lewis’ book may be one-sided and a bit hyperbolic, but if it brings attention to rogue elements on Wall Street and leads to reforms that help level the playing field for all investors than the ends will have justified the means.
Since Lewis made his high-profile “U.S. markets are rigged” comment on television, no fewer than three federal agencies -- the FBI, the U.S. Justice Department and the Commodities Futures Trading Commission -- have announced they are looking into whether high-frequency traders are routinely skirting U.S. securities laws.
And New York State Attorney General Eric Schneiderman has made reform of some of the shadier tactics used by high-frequency traders a centerpiece of his overall Wall Street reform message. Specifically, Schneiderman has been looking into whether high-frequency traders have been buying access to information ahead of their competitors and then using their fancy software to trade on that information.
Apparently existing regulations are muddy when it comes to the advantages created by high-frequency trading. These investigations may help clear things up.
So if Lewis’ intentional focus on the bad elements of high-frequency trading helps eliminate some of the outlaws it will be worth Lewis’ neglect of the good elements of the practice.