Saturday, May 31, 2014

How the flash boys have corrupted financial markets

John Lanchester reviews Flash Boys: Cracking the Money Code by Michael Lewis in the current London Review of Books.

Lewis, he says, shows how computer technology and the ability it gives traders to exploit price differences that exist only for microseconds have made the traditional picture of financial markets laughable.

Lanchester writes:
We want a market to be people buying and selling to and from each other, in a specific physical location, ideally with visible prices. In this new market, the principal actors are not human beings, but algorithms; the real action happens inside computers at the exchanges, and the old market is now nothing more than a stage set whose main function is to be a backdrop for news stories about the stock market. As for the prices, they move when you try to act on them, and anyway, as Lewis says, there’s the problem of the ‘dark pools’, which are in effect private stock markets, owned for the most part by big investment banks, whose entire function is to execute trades out of sight of the wider public: nobody knows who’s buying, nobody knows who’s selling, and nobody knows the prices paid.
As so often, it seems that those who defend "the market" are, in reality, defending the exercise of naked corporate power.

Lanchester waxes lyrical on the waste it all represents:
After finishing Flash Boys, I found it hard not to think about those missing oceanographers, the computer geniuses and engineers and physicists and entrepreneurs, all those brilliant minds, all that passion and energy disappearing into the black hole of money, lost to all the more productive and interesting things that we humans can do. It’s hard not to feel a sense of loss when you think of what these people would have done, if they hadn’t been sucked into the enterprise of making money out of money. If we ever get enough distance to look back with some sense of perspective on the delirium of modern finance, I think this is what will stand out clearly: that sense of human and intellectual waste.


Phil Beesley said...

The very first companies to adopt high frequency trading would have made a lot of money. Followers would have made less money, and where they are heading there is even less money to be made. The arms race is very expensive and the return is falling.

It's all down to the speed of light which determines how quickly data travels along a fibre optic cable, through switches and processors. The speed of light is fixed so as other factors are optimised, no team can win the race. The laws of physics mean that high frequency trading is not viable for very long.

Brad Katsuyama changed things by artificially lengthening the cable entering a data centre running an exchange. By adding a few hundred milliseconds to data transfers, the exchange modified trading behaviour in one location.

The tech wizardry used by high frequency traders may be useful in other circumstances. I assume that they are moving some intelligence from the trading system onto network interfaces and switches in order to make snappier decisions. Presumably spooks use similar techniques to separate data which interests them immediately from cat videos. There are less sinister applications however.

Iain Coleman said...

The next step being when some genius, forever lost to science, figures out a way to use a modulated neutrino signal to send market information from Tokyo to London directly through the interior of the Earth, beating the light-speed signal running across the surface and gaining a crucial competitive advantage.