High-frequency trading is back in the spotlight, which could lead to improvements or knee-jerk catastrophes.
Anytime Michael Lewis writes a book, it’s a good time to be a reader. He’s a great storyteller. And he’s always provocative. His latest book, “Flash Boys”—which I have on order but have not read—will likely be no different. But good stories need stark lines in the sand, and so far, it’s pretty clear that Lewis’ is painting high-frequency trading (HFT) as an unadulterated evil.
The reality, of course, is a lot more complex and nuanced. But nuance rarely, if ever sells. To get nuance, you need to turn to people who don’t really have a horse in the race. The real question we should be asking is, Does HFT serve a useful purpose for society, and if it does, is it worth whatever external costs there might be?
It’s really not much different than, say, evaluating whether or not to pave the road in front of your house. It costs money. It damages the environment. But darn it if a nice paved road doesn’t get me to the office a lot faster.
In a recent (as in, officially published last week) paper, Bruno Biais, Thierry Foucault and Sophie Moinas look at the social welfare implications of HFT, although the paper’s titular focus is on the actual amount of money being invested in HFT infrastructure.
It’s a blisteringly mathematical paper, but the conclusion, thankfully, is written in good old-fashioned English: “Investment in fast trading technology helps financial institutions cope with market fragmentation. To the extent that this enhances their ability to reap mutual gains from trade, it improves social welfare. On the other hand, fast institutions observe value relevant information before slow ones, which creates adverse selection, lowering welfare. Thus fast trading generates a negative externality.”
Problem 1: Information Flow
I admit, this is arcane language, and a whole lot less catchy than the money-quote from Michael Lewis’ new book, “Flash Boys”: “The United States stock market, the most iconic market in global capitalism, is rigged.” But they’re actually making the nuanced point—there is a societal good here, but there’s also a problem, and that problem isn’t one of a game being rigged—an image that conjures up the gambling façade from “The Sting.” It’s simply a problem of information flow.
Looked at from another angle, HFT is just a single narrow slice of what happens when you have a world moving faster in every way. Not to get too philosophical, but the really interesting work being done on trading isn’t about trading, per se, it’s about changing our understanding of time.