Thoughts on Michael Lewis’s Flash Boys

The financial press has been asking the question, “Are U.S. stock markets rigged?” since Michael Lewis appeared on CBS’s 60 Minutes on March 30th.  Here is the link:

Our answer: of course they are.  It just happens to be our view that the Federal Reserve is the party most responsible for the rigging.  High frequency traders are a micro distortion on price while the Federal Reserve is a macro distortion on price.  We are also of the view that in the long run neither effect value nor the destination of the market some years hence, but they do change the price path that an investor must journey.

High Frequency Traders

High frequency traders distort prices of individual securities for fractions of a millisecond, or even a trading day, for a fraction of a percent, and there are well worn trading strategies to offset their effect, patience in trading (i.e. stretching trades across days), fundamental information (buying on down days and selling on up days), and a focus on the average price over multiple trading periods and longer time horizons.  The Federal Reserve with its $4.0+ trillion quantitative easing program has distorted prices for years and by orders of magnitude through its suppression of discount rates and interest rates.

High frequency traders focus on price, time, and volume and price prediction horizons measured in milliseconds and minutes, while an investor should focus on the value of a security over a longer period of time or the average price of a security over a period of time.

Real life example

For example, say you are an investor and think that a stock currently priced at $30 might be worth $45 some years hence, but along the way, there is a good possibility that the stock might trade to $28, $35, back to $31, down again to $29, etc. Thus, a high frequency trader might accurately predict that you are willing to buy stock at $30, $30.01, $30.02, $30.03, thus forcing you to pay $30.04 at that moment, but are any of these prices unreasonable if the security is really worth $45? Sure the $.01 difference on a large number of shares is material, but more material is the performance of the business and its true future potential worth of $45.

The issue is not the speed of trading or co-location, but one of permissible order types and false orders.  In Las Vegas, a chip laid is a chip played, but not so in U.S. financial markets where over 90% of orders are cancelled. Financial markets have always had traders who operate on different time frequencies or delays and with different levels of market access.  For example, when I first moved to New York in 1997, I employed a two-dollar floor broker on the floor of the New York Stock Exchange because the market he could see was different than what one would see on the computer screen.  Guys used to go live in Chicago and pile into large, sweaty pits to be closer to the market.  Good for them.  The difference then versus now is that the floor guys still had to use the same order types, and their capital was at risk, whereas the exchanges now allow order types that only a sophisticated computer programmer can read which have enabled the HFT traders nearly risk-free returns like a payment processor.

High frequency traders are just a symptom of a system that has confused price with value, volume with liquidity, high prices with good outcomes, and regulation with safety.   Risk is a necessary element for financial markets.  Yes, risk tends to lower prices, but “everyday low prices” has been a successful recipe for Wal-Mart for decades. It would probably work for U.S. financial markets as well if the Federal Reserve would just let it.

For Our Curious South Carolina Clients

I encourage you to read Dark Pools by Scott Patterson and drive by Automated Trading Desk ( at 11 eWall Street, Mt. Pleasant, SC, just off the frontage road and Hwy 17 when one crosses the bridge to see that the world is flat.

Allen R. Gillespie, CFA is a partner with FinTrust Investment Advisors, in its Greenville, SC office.  For more information, call 864-288-2849 or e-mail