I don't know what Michael Lewis or Philip Delves Broughton
are trying to do but the first wrote a book, and the second has reviewed it in
an article that seems to damn the High Frequency Traders (HFTs) as bandits, and
then exonerate them for not doing something illegal. The article has the title:
“'Flash Boys' by Michael Lewis” and the subtitle: “High-frequency traders use
dedicated data cables and specialized algorithms to trade milliseconds ahead of
the rest of the market.” It was published in the Wall Street Journal on April
1, 2014.
Broughton begins the article by telling the story of a
banker who tried to buy 10,000 shares of Intel at the offered price of 22
dollars, but the moment that he pushed the buy button, the offers vanished.
After a whole lot of meaningless talk that can only be called a big load of
hooey aimed at distracting the reader, Broughton tells what might have happened
in this case with the explanation that follows. Notice that he changes the name
of the stock from Intel to Microsoft, and the number of shares from 10,000 to
1,000 to avoid alerting the reader that there is a question to be asked and
responded to. Here is the explanation:
“If you place an order for 1,000 shares of Microsoft, it
pings from exchange to exchange claiming a few shares at each stop, seeking the
best price until the order is completed. But the moment that it hits the first
exchange, the HFTs see it, and they race ahead to the other exchanges, buy the
stock you want, and sell it back to you for fractionally more than you hoped to
pay.”
We now come to the pertinent question: In the case of the
10,000 Intel shares, what happened to the offered price of 22 dollars a share?
If the computer of the broker that ordered them pinged from exchange to
exchange claiming a few shares at each stop, like says the author, the order
should have been filled at a price lower than the 22 dollars, not a higher
price. In fact, there were occasions before the advent of the HFTs when I
ordered stocks on the Toronto Exchange and had my orders filled at a lower
price. But this never happened after the advent of those bandits where most of
the time, the orders vanished and I was expected to chase them up – which I
never did.
A similar thing happened when I tried to sell a stock,
except that in this case, the prices dropped, and I was expected to dump the
shares at a lower price – which I never did either. Eventually I discovered a
way to get around these schemes but they left a bitter taste in my mouth anyway.
It may also have happened that individual day traders discovered the method
that I did, but I am certain that no one trading through a broker would have
had this service extended to them.
Broughton admits: “this sounds like the old Wall Street scam
of front-running the market, that's because it is. Except in this case, it is
entirely legal.” No, it is not legal. Front-running used to happen mostly by a
specialist or a market maker who saw an order come for a specific stock, bought
it at the ask price then offered to sell it at a higher price to the would-be
original buyer. And this is exactly what is happening now with the HFTs except
that it is done automatically because the computer of the HFTs are linked to
the computers of the exchange or those of a broker that is a member of the
exchange.
But to make it sound that it is all legal, and happening
because of what came as a consequence of well-intentioned regulation, Broughton
lays the blame on the shoulders of the Securities and Exchange Commission which
ruled that brokers must find the “best price” for the client instead of
adhering to the rules of “best execution.” Well, best price does not mean
higher price which is what is happening not because the broker is looking for
the best price, but because the scammers and the bandits are seeing the
incoming orders and are front-running the market.
Front-running the market has always been considered a crime
at par with insider trading. Modern high frequency trading would not happen
without the conspiracy of those traders and the brokers who are members of the
exchange, and whose computers are linked to those of the exchange.