The US stock market is rigged in favour of high-frequency trading (HFT) firms, which use their nanosecond advantages to extract billions of dollars from investors claims financial journalist and acclaimed author Michael Lewis.
Speaking to the CBS news programme 60 Minutes about his new book ‘Flash Boys: A Wall Street Revolt’, Lewis alleged that HFT traders are able to “front run” orders, which means they are able to buy in front of you and sell them back to you at a higher price when you want to buy.
The author, whose books include Liar’s Poker and Moneyball, said:
“This speed advantage that the faster traders have is milliseconds, some of it is fractions of milliseconds”
Front running was spotted in 2008 by Brad Katsuyama, former head trader in New York for the Royal Bank of Canada, who found that every time he looked to buy a volume of stock for a client, it would only be partially filled before the price would go up.
With the help of telecoms engineer Ronan Ryan, Katsuyama found that as his buy orders travelled along fibre-optic lines from the closest exchange to those further away, but HFT traders had access to shorter, and therefore faster, cables. This meant that the HFT traders could catch a glimpse of the buy order to one exchange, but then beat the order reaching the other exchanges, allowing them to front run the orders.
To beat the HFC traders, Katsuyama and his team developed new software to make orders hit the furthest exchanges first, making the buy orders hit all exchanges at exactly the same moment.
Katsuyama and his team then left Bank of Canada to start a new trading platform, Investors’ Exchange (IEX), which is designed to exclude the advantages of high-frequency trading. It does this using a huge coil of 60km of wire dubbed the “magic shoebox”, which is put in between HFT firms and the exchange, essentially removing their advantage.
Explaining that the success of IEX is down to trust in the platform, Katsuyama told the programme:
“We are selling trust, we are selling transparency, and to think that trust is actually a differentiator in a service business, is actually a crazy thought, right?”