I’m convinced that ever since humans have invented this idea of trade, that there soon followed people, with the idea that they can profit as middlemen, even if they have nothing to buy or sell directly. This concept is easily applicable to settings beyond real world economies: players in games stumble upon viable business models in virtual economies (that turn into real money); the trendy “sharing economy” makes its money by matching supply and demand and taking a sizable cut.
In the financial world, exchanges serve as the intermediary between willing buyers and sellers, with various banks and finance companies making money on commission. However, if the book Flash Boys is to be believed, they’re being disrupted – unfairly displaced – by a dangerous phenomenon known as High Frequency Trading (HFT), and it’s about time to exercise some indignation.
HFT is software eating the world, finance edition. The idea is to use computers and algorithms to look for patterns in stock trades, and once they identify trades that are profitable, these machines execute trades both faster than any human, but also faster than other machines as well. That is, HFTs trade so fast that they edge out the original buyers and sellers, inserting themselves as another, faster middleman. The other characteristic of the HFTs are how often these trades happen; even if each individual trade is tiny, the speed plus the volume of trading accumulates to substantial profit for HFT firms.
There are a good number of arguments for and against HFT in general, particularly after this book landed on the NY Times Bestseller list. Of all the points made though, the one that resonates with me is the acknowledgement of trading based on pure numeric and statistical patterns in the market is far divorced from what the stocks and securities represent. The underlying value is completely abstract, similar to instruments like mortgage-backed securities (MBS) and collateralized debt obligations (CBO) in the lead up to the housing crash only a few years ago. If there is a role that finance can play to create value for society, HFT is far from realizing that function.
Unfortunately, the book reads to me a bit like Hatching Twitter, in that the story has been dramatized beyond the point of believability, and thus loses its effectiveness by inviting questions on its credibility. Sometimes, it falls into a trap of reading like a commercial for the main characters and the new exchange they’ve dreamt up to rid the world of evil HFTs.
Other times, the author sets up a bunch of scenarios where, if we take him at face value, many of the top Wall Street firms and their executives and top traders had no idea what was happening and have been sitting around for years just impotently losing money. The story makes everybody who is not designated a hero look like an incompetent moron, and while it’s certainly embellished with a literary license, the protagonists end up looking suspiciously good.