The Traders Edge
One of the themes I have written about quite a bit is the huge benefits that are garnered from business cycles or reduced timeframes. In fact, probably the greatest ROI opportunities for existing companies lie in the ability to reduce the time it takes to get things done. But, can shaving milliseconds off a transaction time make a difference?
Milliseconds Make All the Difference for Stock Traders
I recently read the book “Flash Boys” by Michael Lewis, the same bestselling author who wrote, “Moneyball”. “Flash Boys” provides an insiders view into the world of online trading.
Many people have bought and sold stocks using an online investment account – some people are investors and some are traders. The difference comes down to how long you hold onto the stocks. If you buy and sell in the same day you are a Day Trader; and if you hold for the long term appreciation of a stock, you are a Long-term Investor. These two terms (Day Trader and Long-term Investor), define the two extremes of the timeline on which investments are held.
No matter where a buyer of stock falls on that scale, eventually he clicks “Buy” in his account. “Then what? He may think he knows what happens after he presses the key on his keyboard, but, trust me, he does not. If he did, he’d think twice before he pressed it,” Lewis explains.
Lewis then takes the reader on the equivalent of a ‘cloak and dagger’ mystery, but with real life Wall Street characters and their story. I couldn’t put the book down, and although I have a strong interest in both technology and investing, the story is still very compelling regardless.
Front-running – the Technology Has Taken Over
The Wikipedia definition of Front-running, “is an illegal practice of a stockbroker executing orders on a security for its own account while taking advantage of pending orders from its customers.” Front-running has been happening since stocks first started trading hundreds of years ago. But as the technology of how stocks were traded changed, front-running also had to change. When stock trading was automated, people figured that the opportunity to front-run a stock trade had disappeared. That is what the general public thought and it is what most of Wall Street thought, but something did not seem right to Brad Katsuyama, an RBC trader who had moved from the RBC Toronto office to New York.
Flash Boys revolves around the story of Brad and his search to explain what could not be explained. As Brad uncovers the truth, with a team of unlikely colleagues, he not only educates himself, but ends up exposing the workings of the high-frequency trading firms that had proliferated on Wall Street. This unlikely Canadian from a small Wall Street firm (RBC) ends up becoming the expert. The high-frequency trading firms had exploited technology to shave just a few milliseconds off of the time of a transaction, making them the front-runners in the world of electronic trading. No-one knew that they were doing this or how they were achieving this until Brad uncovered the truth.
Modern day front-runners had been, and still are compressing timeframes by a few milliseconds and this gives then a huge and illegal business advantage. Instead of shortening a business process, the high frequency traders used the time savings to short-circuit the trading process and create an advantage for themselves. These high frequency traders are using the same principal of shortening processing time, by milliseconds, to get an unfair advantage in an open market.
Brad Katsuyama, the Canadian RBC trader, took on an industry and exposed it when most people in the industry didn’t even know what was going on. Even as he shined a light on these practices he was ridiculed because it is almost impossible to prove that front-running was occuring. Lewis writes, “Brad Katsuyama explained to the world what he and his team learned about the inner workings of the stock market. The nation of investors was appalled – a poll of institutional investors in late April 2014, conducted by the brokerage firm ConvergEx, discovered that 70 percent of them thought that the U.S. stock market was unfair and 51 percent considered high-frequency trading “harmful or very harmful”. And the complaining investors were the big guys, the mutual funds and pension funds and hedge funds you might think could defend themselves in the market.”
“The narrow slice of the financial sector [high-frequency traders and the exchanges that support this practice] that makes money off the situation that this book [Flash Boys] describes felt the need to shape the public perception of it. … Then came the unfortunate episode on CNBC, during which Brad Katsuyama was verbally assaulted by the president of the BATS exchange. … He [the BATS President] hollered and ranted and waved and in general made such a spectacle of himself that half of Wall Street came to a halt, transfixed. … I was told by an CNBC producer that it was the most watched segment in CNBC’s history … His defining moment came when Katsuyama asked him a simple question: Did BATS sell a faster picture of the stock market to high-frequency traders, while using a slower picture to price the trades of investors? … The BATS president said no … It wasn’t true … Four months later, BATS parted ways with its president.”
If you are interested, here is a 4-minute compilation of the highlights of the CNBC segment.
I don’t think I have played spoiler by writing this blog. The unfolding of the Flash Boys story is fascinating and Lewis is at his best. I have to say that I felt a little patriotic reading about the Canadian, Brad Katsuyama, playing such a pivotal role in one of America’s biggest business stages.
Compressed Timelines – Business Processes Sped Up
Applying communication tools to compress timelines can give you huge advantages in your business. But anything in the wrong hands can be used in illegal ways as well. Brad ended up with a very creative approach to level the playing field, which ultimately involves an unlikely twist involving Goldman Sacks.
I hope you get a chance to enjoy the book!