There was a time ages ago when I was enamored with the idea of finance. Just out of university, finance was the in thing. It was during this phase that I picked Michael Lewis’s Liar’s Poker. The author describes his bond trading experience in the late-1980s and early 1990s. He has written other books over the years: Moneyball and The Big Short among them. But it took me roughly 10 years after picking up Liar’s Poker to return to Lewis. Sometime in the mid-2010s, I bought The Flash Boys from Kinokuniya Kuala Lumpur.
But it would take me another 10 years to read and finish it. I have a bad habit of buying multiple books and later forgetting about them completely. On my shelves, I think between a fifth and a tenth of books there are unread. I am glad to say there is one more book out of the unread list.
The market has changed over the past 20-30 years and the contextual contrast between Liar’s Poker and The Flash Boys is huge. The former was set in a world where there were people on the trading floors taking bids and making offers for all kinds of financial instruments. By the 2010s, the floors were empty, the financial instruments had increased in complexity beyond the comprehension of most finance-people and computers had taken over buying and selling activities. Now, the most advanced markets are driven by algorithmic trading (before everything was labelled as AI), computing power and ultimately, super high-speed internet. That is the context of The Flash Boys: it is about high-frequency trading or HFT.
The greatest lesson I get from The Flash Boys is something that I already know: not all competition is good and for the financial markets, fragmentation (including multiple listings) largely creates room for inefficiencies.
The proliferation of stock exchanges has created unfair arbitrage opportunities for those with access to the most computing power and the fastest speed. That room for arbitrage exist in less than a tenth or even a hundredth of a microsecond, a window too small for a human to notice but a lifetime for computers. Here, having competing stock exchanges means having lags introduced into the whole financial system and that lag will be manipulated by high-frequency traders that thrive on delays too small for the human senses to detect. That manipulation comes in the form of frontrunning legitimate transactions which raises the cost a great majority in the market with HFT firms pocketing the additional charges.
This is just one example where competition is counterproductive to the market. For stock exchanges, we really do want to create a deep, one-location transparent market. Anything else creates information asymmetry.