Because technology was old and outdated, high frequency traders set up their own, much faster computers in their exchanges, and a gap was created between an HFT’s view of the market and an average investor’s. That was why Katsuyama’s trades in 2007 became an illusion; his computer wasn’t fast enough to compete with the new technology paid for by HTFs.
Intended to create equality of opportunity in the market, Reg NMs created “a more pernicious inequality’’: “A small class of insiders with the resources to create speed were now allowed to preview the market and trade on what they had seen.’’
Lewis provides numerous examples of how faster technology can be exploited to hurt investors, including big institutional investment funds.
Katsuyama’s team decides that their new exchange, Investors Exchange, must be extremely fast -- much faster than any other exchange, “thus preventing investors’ orders from being abused by changes in that market. In the bargain, it (IEX) prevented high frequency traders from submitting their orders onto IEX more quickly than everyone else.’’
IEX opened on Oct. 25, 2013, with 32 employees. On Dec. 19, 2013, they traded 40 million shares, with Goldman Sachs placing the biggest order. The ramifications were momentous. Brian Levine and Ron Morgan of Goldman Sachs are credited with instilling a new sense of order and fair play.
“Goldman Sachs was insisting that the U.S. stock market needed to change, and that IEX was the place to change it. The market felt fair: 92 percent of those orders traded at the midpoint -- the fair price -- compared to 17 percent that traded at the midpoint in Wall Street’s dark pools.’’
But while reading Lewis’s account, keep in mind this cautionary note from Floyd Norris in his April 11, 2014, High & Low Finance column in The New York Times: “The solution his (Lewis’s) heroes advocate -- more computerization to drive out middlemen -- risks making the market even more vulnerable to disruption as it becomes less attractive for anyone to provide liquidity.’’
'Flash Boys: A Wall Street Revolt' by Michael Lewis. W.W. Norton & Company. 274 pages. $27.95.
Eleanor O'Sullivan is an award-winning freelance journalist who has written for USA Today and Gannett newspapers. She has covered alternative and green investing, estate planning and family offices for Financial Advisor and Private Wealth magazines, and reviews new business books of interest to financial advisors. She can be reached at [email protected].