What does Michael Lewis not understand in high-frequency trading?
Michael Lewis spent the first half of Tuesday promoting his book on high-frequency trading on NBC [ article dated April 1, 2014 - approx. trans.]. In the morning, I visited the show Today on NBC. By noon, he was on CNBC and took part in a heated debate about the advantages and disadvantages of high-frequency trading [High-Frequency Trading, HFT]. Lewis’s television tour began Sunday evening with his appearance on the 60 Minutes program.
Lewis's book “Fast Boys” draws enormous attention to the issue of high-frequency trading, it revived the debate about its impact on markets and investors. A new book written in a typical Lewis style. This is a fascinating story in which complex questions are successfully explained to non-professionals. Taking seemingly incomparable events - hidden attempts to build underground ultrafast fiber optic cable and arrest Goldman Sachs programmer in 2009 - Lewis brings them together in an unsurpassed narrative, driven by vivid characters of characters, to lead readers through the tremendous changes in financial markets over the past decade .
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And yet, with respect to some important points in the book, mistakes are made, primarily because of the desire of Lewis to simplify difficult things in an attempt to achieve bright plot twists and present the characters in black and white. Here are three things that Lewis interprets incorrectly:
1. High-frequency trading does not profit from non-professional investors. In the first two appearances of Lewis on TV, his story came down to the following: high-frequency traders are engaged in fraud in the stock markets, and first of all ordinary individual investors, middle-class investors lose their savings, namely the type of people who watch 60 Minutes and Today shows. Lewis called such people "guys who sit in front of their accounts in the ETrade ( ETFC ) system." From his point of view, high-frequency traders profit from such individual investors "trading against people who do not know how the market works."
The idea that small investors lose to the sophisticated experience of high-frequency traders is an old argument in a dispute about high-frequency trading, this idea was largely considered to be untenable. High-frequency traders do not play against the guys with ETrade, they play against each other for the right to execute orders of the guys with ETrade. And let Lewis in his book seriously delve into the details of an extremely complex system of redirecting orders, making such an assumption, he misses a lot.
Most retail orders will never appear on the stock exchange. Instead, they are likely to be executed at the expense of large "wholesale traders", the largest of which are UBS ( UBS ), Citadel, KCG ( KCG ) (formerly Knight Capital Group), and Citigroup ( C ). The algorithms of such firms compete with each other for the opportunity to receive these orders and execute them before they enter the stock exchange. Thus, they [wholesale traders] do not need to pay fees for sending a warrant to the stock exchange, which ultimately saves money to a single investor. To understand how market information flows go and how orders are executed, we recommend that you refer to the 2012 schedule from Bloomberg Businessweek.
Many single investors enter the market through “rich” players, such as pension and mutual funds [buy-side firms]. Lewis claims that these large, slow traders also suffer from HFT companies. Although it might well have been true ten years ago, this practice has been absent for several years. Talk to the investment directors of these large firms now, and you will probably hear how effective modern trading has become - compared to what it was 20 years ago, in an era when orders were redirected by market makers who stood in the middle of the stock pits.
Last year, I spoke with Gus Sauter, the former director of investments at Vanguard, one of the largest investment firms in the United States. By the time of his dismissal in 2012, he was operating on behalf of the business in the amount of $ 1.75 trillion. And instead of condemning high-frequency traders, Sauter extolled the advantages that HFT trading brought to him and his clients. According to his calculations, high-frequency traders helped him save up to a billion dollars a year.
2. High-frequency trading is not an incredibly profitable occupation. Lewis gives the impression that firms operating in the field of high-frequency trading, ride like cheese in butter. In reality, however, the best days of high-frequency trading were left behind , and many companies literally barely stay afloat. The company Getco, united with Knight and formerly a titan of HFT, in 2012 recorded a drop in profits by 90%. That year, according to Rosenblatt Securities estimates, the entire high-frequency trading industry earned a total of about $ 1 billion, while at the peak of its activity, in 2009, HFT companies earned $ 5 billion. This is a considerable amount, but the size will surprise you when you start to consider it in comparison with the achievements of competitors: JPMorgan Chase ( JPM ) received more than $ 5 billion profit in the last quarter alone.
Somewhere in the middle of the book "Fast Boys" Lewis writes that "financial intermediaries" earn from $ 10 to $ 22 billion a year. Although he doesn’t specify this term, Lewis lets us know what he means by high-frequency traders, electronic market makers, bringing buyers and sellers together, and earning a spread that today is hardly more than a penny per share. In the pre-HFT era, this amount averaged about 12 cents.
Lewis does not report where he got these numbers. From the point of view of companies that track the profits of HFT firms, these values ​​are seriously overestimated. In particular, the Tabb Group is accounting for the profits of high-frequency traders, and according to its latest estimates, profits for the entire industry are approximately $ 1.3 billion, compared with $ 7.9 billion in 2009.
3. High-frequency traders are not Wall Street insiders. One of the storytelling centers in the book of Michael Lewis is a story about outsiders going against the system and destroying traditional ways of doing business [ this part of the story in Michael Lewis’s adaptation was published as an article in The New York Times, which we translated in our blog: 1 , 2 , 3 , 4 - approx. trans.]. In the book "MoneyBall. How mathematics has changed the world's most popular sports league "such an outsider is Billie Bean, general manager of Oakland Athletics baseball team. In the book "The big game on the slide. The secret springs of financial catastrophe "like a hero - investor Michael Barry. In “Fast Boys,” this is a group of former traders from the Royal Bank of Canada ( RY: CN ) who create their own stock exchange.
Focusing on this story, Lewis overlooks the story of much more serious violations that high-frequency trading companies have committed in the last 15 years. A company from a typical ex-trader from Wall Street, representatives of large banks and HFT firms can hardly be considered this group of outsiders. Companies such as Tower, Hudson River Trading and ATD were founded by techies who found a better, more efficient way to trade on the exchange. Their first victims were not non-professional investors - they were large, reputable market-makers, which formed the basis of a group of insiders from the stock market specialists.
It cannot be said that the Lewis book is bad, or that peace and justice reigns in the marketplace. Lewis points to many negative qualities of the modern market: over the past 10 years, the system of state regulation of competition in the hope of stimulating the market through the emergence of new rules has led to an increase in market fragmentation, an increase in unseemly trade incentives and an increase in the complexity of market processes. High-frequency traders definitely benefited from the emergence of this new ecosystem, and no doubt there were dishonest players among them. But it would still be wrong to assume that all HFT companies conduct fraudulent activities in the market. To make villains out of high-frequency traders is to lose sight of the real picture of what is happening.
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Source: https://habr.com/ru/post/227315/
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