In March 2014, Michael Lewis published “Flash Boys”, a book that warned about the dangers of High-Frequency Trading (“HFT”). Lewis posited that the stock market is rigged in favor of the High-Frequency traders, to the detriment of the individual investor. HFTers knew how to skim fractions of pennies off of trades and put millions on the line in doing so. Although the trading margins were extremely thin, the HFTers could count on those margins, so they were extremely profitable.
By virtue of his star power (he previously authored “The Blind Side”, “Moneyball”, and several other best-sellers), Lewis got a lot of attention for his warning in “Flash Boys”, including a spot on 60 Minutes. According to Lewis, the individual investor was being ripped off because these HFTers’ actions would not allow the individual investors to buy stocks for the price they wanted to. Lewis thought this would lead to disengagement by individual investors and could spell doom for the markets as a whole.
“Flash Boys” helped spark calls for government and/or SEC action to put the clams on HFTers, if not to shut them down altogether. The book highlighted an alternative exchange, the IEX, that was designed to negate the effects of HFTers and make the markets fairer to individual investors.
Since Then
On March 31, 2014, as “Flash Boys” was published, the SPY (the S&P 500 ETF) closed at 187. The SPY closed last Friday (September 22, 2017) at 249.44, an increase of almost exactly 1/3, or 33%. A number of HFT firms have either gone out of business or consolidated with other firms. One of the larger HFT firms, Virtu Financial, went public in April 2015. It closed at 22.18 its first day of trading. It is currently trading at 16.45, a decline of 26%. There are no more books, articles, or editorials warning of the dangers of HFT. Likewise, there has been no new action by the SEC to restrain HFT. In short, the stock market has risen while the HFT business has declined, and HFT is no longer on the list of problems to deal with.
Was Lewis Wrong?
Does the decline of HFT and the rise of the stock markets mean that Lewis was wrong, and that “Flash Boys” was wrong in its diagnosis of the markets? No, Lewis wasn’t wrong, but he wasn’t correct, either. Perhaps the stock markets have risen despite them being inherently rigged. Perhaps HFTers’ margins were so small that individual investors didn’t much care if they lost out on fractions of pennies and went ahead and bought stocks anyway. HFTers need volatility to make money, and volatility in the markets is at a short-term low, certainly much lower than in 2014. So, market conditions now are not good for HFTers. If volatility increases, HFTers will be back in force to ply their trade.
Self-Correcting
The other point that I want to make is that the HFT issue has been dealt with without further SEC intervention. Market forces caused the phenomenon to ebb. Trading technology improved and got faster, and new companies entered the market in an attempt to get in on the big profits the Virtus of the world were making. This, in turn, cuts into the early entrants’ profits, which caused consolidation. Market volatility has waned. The SEC didn’t need to intervene. Market solutions work best – in this case, market solutions worked far more quickly than the SEC could even get started. My thought is that self-correcting market-based solution will work best in most any issue that arises in the economy wherein there are calls for government action or control. Yes, I am thinking most about health insurance.