Flash Boys, by Michael Lewis, was my first Audible purchase. I listened to it during my commutes, and during some hours at work. It’s a fun book to casually listen to, especially while working in the trading industry.
The book was first brought to my attention when my roomate mentioned that a co-worker is a character featured in a best selling novel. It piqued my interest. I noticed that Michael Lewis is also the author of “The Big Short”; the movie adaptation of which I found incredibly entertaining. Finally, as an intern at a HFT firm, I wanted a description from an outside perspective.
The introduction is captivating, and sets the theme for the entire book: technology has transformed stock exchanges and financial institutions within the last two decades. The floors of the NYSE, once filled to the brim with loud and impatient traders, now exists only as a backdrop for reporters. The actual location of the exchange now resides within a data center, where market orders are sent and matched at unprecendented speeds. But most notably, the advantage of speed - specifically the ability to send and receive orders from the exchange quicker than other firms, has become critical to success. These changing circumstances gave rise to a new breed of financial institutions: High Frequency Traders, firms with access to a fast connection between exchanges, and capitalize on this advantage to turn a profit.
To what extent does speed matter? The first chapter describes a colossal undertaking: the construction of a almost perfectly straight fibre optic cabel channel spanning over 800 miles, connecting Chicago and New York, which required drilling through mountainous terrain and under rivers - all carried out quietly and covertly. The company behind this massive project, Spread Networks, invested over $300 million dollars into this operation; just to shave the round trip transmission speed from Chicago to New York from 18 microseconds, to 13 microseconds. High frequency firms pounced at a chance to use this channel. This should give you a good idea of the price of speed.
The book features many storylines. The central plot revolves around Brad Katsuyama, a trader from RBC (Royal Bank of Canada) who notices the disadvantages to investors that arise from the existence of high frequency traders, and forms a team of funny and talented people to try and combat the advantages of speed in the current market. Brad Katsuyama’s solution is to create his own exchange, IEX, where latency is artificially added to the network, such that the advantage of speed becomes greatly reduced.
Lewis is not subtle in framing Katsuyama as a hero from the start. In the introduction to Brad Katsuyama, Lewis returns time and time again to the fact that Brad is Canadian, RBC is the Royal Bank of Canada, and the Canadian “nice” culture is wholesome and innocent in comparison to America’s Wall Street culture. He even coins a term for this Canadianess: “RBC Nice”. It is absolutely hilarious to listen to Lewis describe RBC’s acquisition of a US trading firm; where the incoming American trading CEO is portrayed as bat carrying, loud, ignorant sexual harassers, in contrast to Brad’s reserved, polite, and Canadian self. When Brad Katsuyama leaves RBC to pursue the creation of IEX, Lewis constantly stresses how Katsuyama could have continued to make millions with RBC, but instead sacrificed his personal wealth to fight for fairer markets. Lewis goes so far as to say: no investor would give IEX money, until Brad and his team pretended to act greedy. I wouldn’t be surprised if Michael Lewis thinks Brad Katsuyama can also walk on water.
Furthermore, throughout the book, the high frequency trading firms are constantly portrayed as the “unknown evil”. Their methods were a mystery. Their algorithms were secret. Their security is more intense than the Pentagon’s. Lewis does not hesitate to say that the methods high frequency traders are unfair. Citadel was mentioned often, but the book never explores the details of the company; only that they were high frequency traders, they alledgedly had access to orders within dark pools, and they were surprisingly responsible for filling an extremely large volume of trades in the US (along with GETCO).
Lewis’s criticism against high frequency trading is due to the disadvantage to investors. Specifically, investors which do not have the speed of high frequency traders, can be taken advantage of by HFTs reaching the exchange before the investors orders, even though they start after learning the order investors want to place. In essense, he believes that in a fair market, speed should not be an advantage: and that in a fair market, all orders should be executed in order of the time of conception - not the time of arrival. Perhaps this is summarizing too far, and Lewis’s argument has more nuance. The defense against the criticism is that in such conditions, trades would execute slower as HFTs would be more reluctant to place orders, spreads would grow wider, and there would be less liquidity in the market. Is the loss in liquidity worth it for the investor, to be able to send orders without fear of being outsped? That’s a complex question, which I can’t presume to know the answer.
Flash Boys also features a dramatic depiction of the trial of Sergey Aleynikov. Sergey is a former software engineer for Goldman Sachs, accused of stealing Goldman’s proprietary HFT code. After leaving his job at Goldman, Sergey sent himself some code he worked on as reference material; but was subsequently arrested and convicted. It was difficult for the jury to understand what Sergey had done, and thus they found him guilty even though most of his peers couldn’t see any wrongdoing. Throughout Sergey’s story, Lewis emphasizes that in financial firms, there is a slow reversal of power: technologists and software engineers were slowly becoming extremely sought after, as companies, even Goldman Sachs, scramble to create systems that can trade quickly and efficiently. In the end, technology moved too fast, and the jury’s inability to understand the role of technology led to his conviction. Thankfully, he was subsequently acquitted and released.
It is hard to take Lewis’s words as facts, when he is so quick to glorify characters and demonize others. I noticed this in “The Big Short” as well - where we saw the 2008 financial bubble through the eyes of Hedge Funds, the good guys, who realized the bubble and capitalized. It offered almost no perspective from the other side of the housing crisis: no chapters were written from eyes of the big banks, Goldman Sachs, Morgan Stanley, or the institutions that certified the Mortgage-backed securities. Disclaimer: this is based only on the 2015 film and not on the book itself, although I hear the adaptation is quite faithful. When Lewis brashly states “The Market is Rigged”, I think it’s safe to assume he is simply being dramatic and superfluous.
I think Michael Lewis is a great storyteller, and I had a lot of fun listening to the audiobook. It made my job feel a lot cooler than it actually is. I think it’s a very entertaining book, but not to be taken too seriously.