Flash Boys | Michael Lewis

Summary of: Flash Boys: A Wall Street Revolt
By: Michael Lewis

Introduction

In ‘Flash Boys: A Wall Street Revolt’, Michael Lewis investigates the world of high-frequency trading (HFT) and its impact on the US stock market. The book focuses on Canadian Brad Katsuyama, who, after discovering irregularities in the trading process, assembles a team of industry experts to uncover how HFT affects ordinary investors. By demystifying the manipulation and exploitation within the stock market that remains hidden to most, the book highlights flaws in regulations and raises fundamental questions about the fairness and ethics of modern financial markets. The introduction of Katsuyama’s solution, the Investors Exchange (IEX), sets the stage for a potential revolution in the world of trading.

The 1987 Stock Market Crash

In 1987, the US stock market crashed unexpectedly, leaving experts baffled. Regulatory changes that followed led to an increase in computer trading and a decrease in human involvement.

Flash Boys: The Speeding Traders

Canadian Brad Katsuyama learns how high-frequency traders exploit the time some stock market orders use arriving at different exchanges to front-run. This unsettling discovery propels him to start a new exchange that eliminates this predatory tactic.

Brad Katsuyama never aspired to be a stock trader but quickly climbed the career ladder at the Royal Bank of Canada’s trading desk. However, he began to notice oddities affecting his work while working in New York City. He could no longer buy or sell stocks at the exact prices he saw on his trading screen, and the market prices shifted as he tried to make trades. His team eventually discovered high-frequency traders exploiting the time differential between different stock exchanges to take advantage of edge orders.

This discovery motivated Katsuyama to create a fairer exchange that did away with high-frequency trading. Katsuyama’s venture, IEX, a novel exchange with a 350-microsecond delay in trading, set out to eliminate this shady high-frequency trading technique. Since its inception, IEX has garnered considerable attention, and investors have praised its efforts to level the playing field for all investors.

Unexpectedly, Katsuyama’s book, Flash Boys, sparked significant controversy and debate in the financial industry by bringing to light an issue where Wall Street insiders used electronic loopholes to win over investors to keep profits high. Katsuyama’s story is an account of a disruptor who instigated concrete change in the finance world.

The Mad War for Speed

Ronan Ryan, who lacked Wall Street contacts, ended up at a big telecom company where he became a sought-after expert in technology, helping firms transmit signals at incredible speeds. Brad Katsuyama, a trader who trusted the system, discovered that the markets were rigged and decided to fight back against high-frequency trading (HFT) and its grip on the exchanges. Trading firms battled for microsecond advantages in signal speed, demanded co-location, and the latest materials. Katsuyama assembled a team, including Ryan, to learn about HFT’s impact on the markets and to fight it. Ryan took a considerable pay cut to join RBC, where his job was to explain to Katsuyama, in technical terms, what was happening in the markets. Katsuyama hoped to enlighten and educate other investors and put enough pressure on the system to change it.

Unintended Consequences of Regulation

John Schwall, a product manager at Bank of America, discovered that the Regulation National Market System (Reg NMS) unintentionally opened a loophole for high-frequency traders. Reg NMS required brokers to buy at the exchange offering the lowest prices, which enabled HFT experts to profit from a sneak preview of the market by calculating the National Best Bid and Offer (NBBO) faster. This created a trading delay favoring HFT experts. Schwall saw that improvement in market behavior led to new opportunities for profit and Reg NMS did not close the gap.

The Deceptive Aspects of HFT

Katsuyama exposes how High-frequency trading (HFT) did not create liquidity and, instead, profited by hijacking trades without assuming any risk, thus undermining trade liquidity. HFT’s volatile and fragmented markets encouraged new exchanges to open, adding to the problem. Katsuyama advocates for providing liquidity in trading instead of assuming risks without market information.

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