Did anyone follow the development of the stock exchange IEX? I see they landed their first publicly traded company in October. I also see that Wall Street is building its own stock exchange, explicitly rejecting the IEX complaints.
I thought this was a very interesting story when it broke, because it is about how to do things better than the stock market does. If anyone with more financial background could comment, I’d be very interested to hear it.
For those completely unfamiliar, this exchange was built specifically to mitigate High Frequency Trading. There’s some more details of the kinds of things that were happening in this article about the year after Flash Boys was published. Naturally, the people who employ high frequency algorithms insist it is all hokum.
Everything I’ve ever heard attributed to Michael Lewis on this topic was false. Good ideas shouldn’t require lies to sell them. And I can tell it’s false because I carefully read the quoted passages. In particular, you conclude from his claim that “the richest people on Wall Street” are angry that they employ HFT algorithms. But that’s not at all true. HFT is tiny. If the biggest players on Wall Street are angry, it’s because they’d rather trade with HFT than with Brad Katsuyama.*
Is IEX listing a stock a significant milestone? I doubt it. IEX has been selling other stocks for 4 years, first as a dark pool and then for 2 years as an exchange. (But aren’t “dark pools” evil incarnate?) IEX claims to be 2.7% of the total volume. I never looked at that number before today. I’ve previously claimed that IEX was a failure, and I was surprised to see that the number was so high. I welcome experimentation and I’m happy that they’ve found a niche. But if you thought it was a much better product that would quickly win in the marketplace, maybe you should reconsider this, 2-4 years on.** But the future is long. Maybe IEX listing individual stocks will matter, though you should be suspicious if no one can explain why. And it’s hard to rule out the possibility that’s it’s a much better product that will take a long time to win.
* It was probably a bad idea to use Brad K as metonymy, because he plays two roles. I meant the kind of trader he was at the beginning of the book, who was outcompeted by HFT. I don’t mean IEX, the market he now runs. In as much as IEX exists as a place to trade with people like him, it seems like most people wouldn’t want to trade there, either, but it has a lot of room to evolve.
** To put the 2.7% in context, there are 12 exchanges, so I think IEX is the smallest, but I don’t know. There are dozens of dark pools, so the 1.5+% market share IEX had when it transitioned to exchange was pretty big for a dark pool.
If the biggest players on Wall Street are angry, it’s because they’d rather trade with HFT than with Brad Katsuyama.
I’m confused by this. That is almost exactly the claim that Lewis and Katsuyama are making: the large exchanges are preferring HFT. The reason this is a problem is because it unilaterally disadvantages everyone who lacks similar trading speed, like individual investors or retirement funds. The exchanges seem to benefit by the increased volume and direct payments from the HFT people for routing privileges.
Do you have a better source to recommend for how they operate in the market? I’m happy to dump this guy if I can get more reliable information.
I haven’t read it, but Vanguard wrote about how it loves HFT. A lot of what I know is from Matt Levine, but he is such a fragmentary blogger that he probably doesn’t say much in one place and it’s hard to find any particular thing he’s written.
Your abstractions like “benefit” seem confused to me. Where is money flowing? How?
By the biggest players, I mean investment firms. I thought that the biggest investors are bigger than the exchanges, but maybe they’re only equally big. For example, BATS and Fidelity both have a market cap of $60 billion (NASDAQ $14B, NYSE $6B).* HFT firm Virtu has a market cap of $5B. That is, the net present value of the profits Fidelity extracts from its retirement accounts is $60B, while the NPV of the profits BATS extracts from all retirement accounts in the US is about the same. BATS allows (and subsidizes) HFT because it thinks that Fidelity wants it. That’s what BATS says and that’s what Fidelity says. Maybe they’re lying and actually BATS has market power to extract money from Fidelity, but I’ll get to that later. [And why would Fidelity go along with such a lie?] [* looking up these numbers again, I find completely different numbers. But they’re roughly right if we swap NYSE and BATS.]
Transaction costs are way down. This is easily and objectively measured in terms of bid-ask spreads and trading fees. This is money that is not going to the middlemen, neither exchanges nor market makers, but is saved by the investment firms, which is why they love HFT. There is a more subtle argument that market liquidity is an illusion that will go away “when it matters” and produce flash crashes. I think that this is also false, both painting too rosy a view of the past and exaggerating the damage caused by flash crashes, but it is much harder to argue about rare events.
HFT and running exchanges are not terribly lucrative businesses, not by the standards of Wall Street. HFT makes orders of magnitude less money than market makers made (in aggregate) even 20 years ago. Individual HFT firms make a lot of money, but there used to be a huge number of market makers who specialized in very small numbers of stocks. When HFT first appeared and drove out these people, they reduced the aggregate money going to market makers and the small number of HFT firms have continued to compete away their own profit. This is a pretty simple metric that is exactly opposed to many common stories. It’s not that simple because many of the market makers were vertically integrated into firms that did other things, so it’s not that easy to aggregate the market makers. In particular, I claim that’s what Brad K’s old job was (understanding market structure and making money off of the difference between markets, allowing the rest of the firm to think in terms of stocks, not markets). If you buy that, it makes the old market makers look even more bloated and thus the new HFT look even more efficient, but I don’t claim that it is obvious.
But are you saying that Lewis is saying that the exchanges are sucking all the profits out of the HFT? I don’t think that exchanges are very lucrative (see numbers in beginning). Does he give any numbers? I think that there are only about 4 companies running exchanges in the US (including IEX), which doesn’t sound very competitive. But that’s because they keep buying out new exchanges, so it can’t be that hard to enter the market. And they keep the exchanges around, so they do see value in diversity. IEX being the 12th exchange and the 4th company does make the market more diverse and competitive, but they’re probably only fill a small niche. Whereas the dozens of dark pools are already very competitive.
Katsuyama asked him a simple question: Did BATS sell a faster picture of the stock market to high-frequency traders while using a slower picture to price the trades of investors? That is, did it allow high-frequency traders, who knew current market prices, to trade unfairly against investors at old prices? The BATS president said it didn’t, which surprised me. On the other hand, he didn’t look happy to have been asked. Two days later it was clear why: it wasn’t true. The New York attorney general had called the BATS exchange to let them know it was a problem when its president went on TV and got it wrong about this very important aspect of its business. BATS issued a correction and, four months later, parted ways with its president.
Emphasis mine. I interpret Lewis’ claim to be that BATS was helping HFTs extract money from non-HFT investors. The benefit to which I referred is the fee BATS was paid for the faster market picture and the increased trading volume generated as a consequence.
More broadly and aside from allegations of specific wrongdoing, the claim is that HFT is just shaving the margins of everyone who makes trades more slowly. This argument makes sense to me; I can see no added value in giving preferential information to one market participant over others. It isn’t as though HFT is providing a service by helping disseminate information faster—most of the action taken by regulators on the subject was because of exchanges not informing investors about whatever they were doing. My naive guess is their only real impact on the market is to slightly amplify the noise.
That being said, I can easily imagine HFT competing to a profit margin of zero and thereby solving itself, and I can also imagine that there would be other uses for the technology once other types of algorithms were introduced. I can also imagine that the regulatory burden would be greater than the damage they do so it wouldn’t be worth it to ban them.
Which is why IEX was the focus of my interest. They are competing on the basis of countering this specific practice, and they seem to be doing alright.
I’ve asserted a lot of things. Should you believe me? You don’t know that I’m disinterested (though you should damn well know that 300 pages of advertising copy is very, very interested). But I can provide a different perspective; you can’t imagine that anything good is going on, but I can try to widen your imagination.
More broadly and aside from allegations of specific wrongdoing, the claim is that HFT is just shaving the margins of everyone who makes trades more slowly.
The main difference in perspective I want to promote is how you carve up the market. You’re carving it into HFT and Everyone. I say that you should carve it into market makers and investors. HFT makes money. It makes money by shaving the margins off of someone. But why think that it’s shaving “everyone”? It’s competing with market makers and shaving their margins. The market makers are mad about that. That’s enough to explain everything that is observed. Maybe something bad is going on beyond that, but no one says what, no one except liars.
I could say more, but I think it would distract from that one point. (Indeed, I think my prior comments made that mistake.)
Did anyone follow the development of the stock exchange IEX? I see they landed their first publicly traded company in October. I also see that Wall Street is building its own stock exchange, explicitly rejecting the IEX complaints.
I thought this was a very interesting story when it broke, because it is about how to do things better than the stock market does. If anyone with more financial background could comment, I’d be very interested to hear it.
For those completely unfamiliar, this exchange was built specifically to mitigate High Frequency Trading. There’s some more details of the kinds of things that were happening in this article about the year after Flash Boys was published. Naturally, the people who employ high frequency algorithms insist it is all hokum.
Everything I’ve ever heard attributed to Michael Lewis on this topic was false. Good ideas shouldn’t require lies to sell them. And I can tell it’s false because I carefully read the quoted passages. In particular, you conclude from his claim that “the richest people on Wall Street” are angry that they employ HFT algorithms. But that’s not at all true. HFT is tiny. If the biggest players on Wall Street are angry, it’s because they’d rather trade with HFT than with Brad Katsuyama.*
Is IEX listing a stock a significant milestone? I doubt it. IEX has been selling other stocks for 4 years, first as a dark pool and then for 2 years as an exchange. (But aren’t “dark pools” evil incarnate?) IEX claims to be 2.7% of the total volume. I never looked at that number before today. I’ve previously claimed that IEX was a failure, and I was surprised to see that the number was so high. I welcome experimentation and I’m happy that they’ve found a niche. But if you thought it was a much better product that would quickly win in the marketplace, maybe you should reconsider this, 2-4 years on.** But the future is long. Maybe IEX listing individual stocks will matter, though you should be suspicious if no one can explain why. And it’s hard to rule out the possibility that’s it’s a much better product that will take a long time to win.
* It was probably a bad idea to use Brad K as metonymy, because he plays two roles. I meant the kind of trader he was at the beginning of the book, who was outcompeted by HFT. I don’t mean IEX, the market he now runs. In as much as IEX exists as a place to trade with people like him, it seems like most people wouldn’t want to trade there, either, but it has a lot of room to evolve.
** To put the 2.7% in context, there are 12 exchanges, so I think IEX is the smallest, but I don’t know. There are dozens of dark pools, so the 1.5+% market share IEX had when it transitioned to exchange was pretty big for a dark pool.
I’m confused by this. That is almost exactly the claim that Lewis and Katsuyama are making: the large exchanges are preferring HFT. The reason this is a problem is because it unilaterally disadvantages everyone who lacks similar trading speed, like individual investors or retirement funds. The exchanges seem to benefit by the increased volume and direct payments from the HFT people for routing privileges.
Do you have a better source to recommend for how they operate in the market? I’m happy to dump this guy if I can get more reliable information.
I haven’t read it, but Vanguard wrote about how it loves HFT. A lot of what I know is from Matt Levine, but he is such a fragmentary blogger that he probably doesn’t say much in one place and it’s hard to find any particular thing he’s written.
Your abstractions like “benefit” seem confused to me. Where is money flowing? How?
By the biggest players, I mean investment firms. I thought that the biggest investors are bigger than the exchanges, but maybe they’re only equally big. For example, BATS and Fidelity both have a market cap of $60 billion (NASDAQ $14B, NYSE $6B).* HFT firm Virtu has a market cap of $5B. That is, the net present value of the profits Fidelity extracts from its retirement accounts is $60B, while the NPV of the profits BATS extracts from all retirement accounts in the US is about the same. BATS allows (and subsidizes) HFT because it thinks that Fidelity wants it. That’s what BATS says and that’s what Fidelity says. Maybe they’re lying and actually BATS has market power to extract money from Fidelity, but I’ll get to that later. [And why would Fidelity go along with such a lie?] [* looking up these numbers again, I find completely different numbers. But they’re roughly right if we swap NYSE and BATS.]
Transaction costs are way down. This is easily and objectively measured in terms of bid-ask spreads and trading fees. This is money that is not going to the middlemen, neither exchanges nor market makers, but is saved by the investment firms, which is why they love HFT. There is a more subtle argument that market liquidity is an illusion that will go away “when it matters” and produce flash crashes. I think that this is also false, both painting too rosy a view of the past and exaggerating the damage caused by flash crashes, but it is much harder to argue about rare events.
HFT and running exchanges are not terribly lucrative businesses, not by the standards of Wall Street. HFT makes orders of magnitude less money than market makers made (in aggregate) even 20 years ago. Individual HFT firms make a lot of money, but there used to be a huge number of market makers who specialized in very small numbers of stocks. When HFT first appeared and drove out these people, they reduced the aggregate money going to market makers and the small number of HFT firms have continued to compete away their own profit. This is a pretty simple metric that is exactly opposed to many common stories. It’s not that simple because many of the market makers were vertically integrated into firms that did other things, so it’s not that easy to aggregate the market makers. In particular, I claim that’s what Brad K’s old job was (understanding market structure and making money off of the difference between markets, allowing the rest of the firm to think in terms of stocks, not markets). If you buy that, it makes the old market makers look even more bloated and thus the new HFT look even more efficient, but I don’t claim that it is obvious.
But are you saying that Lewis is saying that the exchanges are sucking all the profits out of the HFT? I don’t think that exchanges are very lucrative (see numbers in beginning). Does he give any numbers? I think that there are only about 4 companies running exchanges in the US (including IEX), which doesn’t sound very competitive. But that’s because they keep buying out new exchanges, so it can’t be that hard to enter the market. And they keep the exchanges around, so they do see value in diversity. IEX being the 12th exchange and the 4th company does make the market more diverse and competitive, but they’re probably only fill a small niche. Whereas the dozens of dark pools are already very competitive.
From Lewis:
Emphasis mine. I interpret Lewis’ claim to be that BATS was helping HFTs extract money from non-HFT investors. The benefit to which I referred is the fee BATS was paid for the faster market picture and the increased trading volume generated as a consequence.
More broadly and aside from allegations of specific wrongdoing, the claim is that HFT is just shaving the margins of everyone who makes trades more slowly. This argument makes sense to me; I can see no added value in giving preferential information to one market participant over others. It isn’t as though HFT is providing a service by helping disseminate information faster—most of the action taken by regulators on the subject was because of exchanges not informing investors about whatever they were doing. My naive guess is their only real impact on the market is to slightly amplify the noise.
That being said, I can easily imagine HFT competing to a profit margin of zero and thereby solving itself, and I can also imagine that there would be other uses for the technology once other types of algorithms were introduced. I can also imagine that the regulatory burden would be greater than the damage they do so it wouldn’t be worth it to ban them.
Which is why IEX was the focus of my interest. They are competing on the basis of countering this specific practice, and they seem to be doing alright.
I’ve asserted a lot of things. Should you believe me? You don’t know that I’m disinterested (though you should damn well know that 300 pages of advertising copy is very, very interested). But I can provide a different perspective; you can’t imagine that anything good is going on, but I can try to widen your imagination.
The main difference in perspective I want to promote is how you carve up the market. You’re carving it into HFT and Everyone. I say that you should carve it into market makers and investors. HFT makes money. It makes money by shaving the margins off of someone. But why think that it’s shaving “everyone”? It’s competing with market makers and shaving their margins. The market makers are mad about that. That’s enough to explain everything that is observed. Maybe something bad is going on beyond that, but no one says what, no one except liars.
I could say more, but I think it would distract from that one point. (Indeed, I think my prior comments made that mistake.)