Flash Boys

originally published April 7, 2014 on MichaelLutin.com

Speed has become a way of life, a way of thinking, a way of doing business. Thirty plus years ago when the personal computer became accessible to us the thought was that it would give us  more time, because the computer was going to do all those time consuming details, like writing your bills in a ledger, writing letters or thesis’ on a typewriter, or keeping track of your contacts in those old fashioned address books.  However, to the contrary, speed has not only created the reverse of this idea, but has cost us more money in postage, equipment and slick, digitalized equipment. Speed seduces us into thinking we will think better, look better, get things done faster, be more to more people we can access our groceries, our machines, our clothes and anything else on the internet. We can also buy and sell our stocks on the internet.

When companies like Charles Schwab, Ameritrade, and E trade to name a few formed platforms upon which we, the individual, could bypass our brokers and buy and sell either stocks and equities by day or by the year, we all jumped on board. Whether or not the markets were affected by a bunch of people who really didn’t understand trading, price earnings ratios, or volatility, I think they were. If you get someone going in and out of the market without any type of true understanding, it seems that it would increase the volatility or the improbability of positive outcomes. However, the need for speed has entered an entirely new dimension in the form of High Frequency Trading.

High Frequency Trading has increased markedly in the last ten years. At this writing, there is no real regulation although it has been proposed in the past and is in the news again as one book, Michael Lewis’ “Flash Boys: A Wall Street Revolt” gains traction in publicity. High Frequency Trading (HFT) has been around for a while, but it is really unchartered territory on so many levels, particularly with regular folks who need to understand the concept. Flash crashes, as they are called, have occurred more and more frequently. Some of the more publicized ones were the one on May 6, 2010. Another one resulted from a fictional tweet stating the White House had been assaulted, shutting down the market and losing millions in just a matter of minutes, and then there was the three hour shutdown of the NASDAQ occurring on August 22, 2013. This last shutdown was  because of an outage or some technical problem and the wisdom of shutting it down for three hours (without rushing to open it again) was wise. Whether flash crashes are caused because of outages, tweets, false information or algorithms gone awry, the fact remains that we are not in Kansas anymore!

HFT is computerized, algorithmic trading, which now accounts for about half of all U.S. equity-trading volume on some of the large exchanges. Billions of dollars are invested to set up these computer banks and there is a lot of debate about whether or not without realizing it, they are actually rigging the market. It isn’t done consciously, but the fact is that the machines to thinking and analysis that no human brain can do and therein lies the rub. The everyday buys and the sells either with our brokers or directly online (bypassing the agent or broker) cannot possibly match the speed at which these calculations occur or the orders can be processed. HFT programs run to front of the line, before our everyday brokers, or our trades on some of the above mentioned sites even get to the desk.

On Friday April 4, US Attorney General Eric Holder stated that it is possible that HFT falls in the category of scams and insider trading. However, because this is considerably new and like any other technology all the things that could go wrong have not been examined because all the issues have not been revealed – because it is so new.  When they bombed the World Trade Center on 9/11 we had not had that experience. When one doesn’t have the experience, one learns as the experience unfolds. This is all pretty new, but it bears watching. In March New York Attorney General Eric Schneiderman, for one, likened high-frequency traders’ speed advantage to insider trading. He repeated the same thing just a few days ago stating it was insider trading 2.0.

However, this isn’t the only problem, the other problem is the fact that these are machines calculating at speeds faster than anyone can imagine and machines can burn out, short out, or shut down. If a high percentage of market trades are occurring using this technology, then more than ever markets are at risk.  Certain jobs are at risk too. Can it be the stock broker, the day trader, the investment consultant can soon be jobs of the past going into extinction like the dinosaurs after the ice age. I mean, how much speed do we really need? Mahatma Gandhi very wisely stated, “There is more to life than increasing its speed.” In the age of Red Bull, Instagram, and massive texts that replace conversations and discussions, and smartphones and tablets that give instant answers that may provide information contains loose relationships with the truth, you really have to wonder. Do we have such a need to get to the head of the line that we forget the process or the journey?

Below are three charts for the above mentioned charts. The first is the Flash Crash of May 6, 2010 which started at 2:42 pm and ended at 3:07 pm prompting a suggestion by the then SEC Chairperson Mary Schapiro that perhaps there should be some sort of regulation with this unfamiliar new entity entering the marketplace. The second chart is the Flash Crash that resulted from a fictional tweet hoax stating that the White House had been attacked and that the President was injured. It occurred at 1:07 pm when all hell broke loose and in a matter of minutes millions were lost until it was revealed it was a hoax. In just a few minutes life returned to normal. And, finally, is the chart of the three hour shutdown of the NASDAQ on August 22, 2013 due to an outage, but who really knows?  This caused that exchange to shut down for three hours. It shut down at 12:14:03 pm and then went back online at 3:25 pm. The decision was a wise one, perhaps the result of past crises where the markets went right back on line causing huge losses.  I include these charts for your perusal, but, in the end, the question still remains…where are we going that we need to get there that fast?

3 astrological charts

click to enlarge