Lengthy but interesting.
I have thus far resisted writing anything about Michael Lewis’s book “Flash Boys”, in part because I typically don’t want to waste time on timely issues (instead focusing on topics that are of long-term interest), although it has been a real exercise in self-constraint because there have been few books published in my lifetime that have been as troubling to me (Piketty’s recent “Capital in the Twenty-First Century” is another recent example of flawed economic thinking).
I heard well before “Flash Boys” was published that Lewis was working on a book about high-frequency trading (HFT), and I was very excited; I loved all his other books. Then, a month or so before it became available, I saw something that made my jaw drop: the book was about IEX. This surprised me not because IEX is bad, but it is tiny and insignificant. There were many other exciting things to discuss on the topic of HFT: why would Lewis focus on IEX?
A few general observations about the book:
• It is not an objective account of reality. Lewis began writing the book having already decided in his mind that the markets are rigged. There is very little evidence that he made an effort to research for the book, short of talking to the IEX people.
• The book itself and subsequent promotion has been an exercise in sensationalism. When Lewis, Brad Katsuyama, and Bill O’Brien (President of BATS) squared off on CNBC, O’Brien started the conversation by declaring “shame on both of you for falsely accusing literally thousands of people and possibly scaring millions of investors in an effort to promote a business model.” There is an immense amount of truth in this sentiment. I am sure that both Lewis and Katsuyama believe what they’re saying to be true and they are looking to improve the markets, but there is no doubt that using the “rigged” word and emphasizing how the little guy is getting hurt has been unconscionable.
• For the most part, the “news” around Flash Boys is that Michael Lewis wrote a book. In other words, he has written an engaging story, although in this case, he has not uncovered anything that has not already been discussed at length by financial journalists such as Scott Patterson.
• One of my favorite parts of the book, which really highlights how little the author and the IEX protagonists understand market structure, was towards the end when IEX is reviewing the first trades that were executed in their dark pool. They were surprised to see very tiny orders coming through, which they concluded might be part of a conspiracy to make them look bad by competitors. This hypothesis, of course, completely ignores the fact that algorithmic trading uses small trade units in order to reduce market impact following Almgren and Chriss “Optimal Execution of Portfolio Transactions” and all common sense which dictates that you want to hide your orders.
More here – statalgo