In 45 Seconds, Michael Lewis Explains How The Stock Market Is Rigged

Michael Lewis’ new book Flash Boys comes out today. It’s all about the confusing world of high-frequency, algorithmic trading.

He was on 60 Minutes last night talking about the subject and promoting his book.

In this short segment, he argues that the stock market is rigged.

The first 45 seconds are the key part, wherein he explains the mechanism by which high-frequency traders get ahead of retail orders so as to inflate the price you have to pay for a stock.

The basic mechanism that he describes is this: You place an order for a stock, say Microsoft. That order goes to something called the “BATS exchange” at which point high-frequency traders pick up on your order, and then race to the exchange with an order for Microsoft faster than you can get there. They buy the Microsoft and bring it back to you at an inflated price.

So how big of a deal is this? According to Lewis, this is all adding up to billions of lost dollars, easy.

Here’s more from the 60 Minutes piece, wherein he talks about the impact on traditional investors:

Michael Lewis: Brad realises, “Oh my God, that’s how I’m being front-runned. I’m being front-runned because my signal gets to the BATS Exchange first and they can beat me to all the, all the other exchanges.” It only took a tiny fraction of a second for Brad’s trade to reach the next exchanges on the network, but the high-speed traders were able to jump in front of him, buy the same stock and drive the price up before his order arrived, producing a small profit of just one or two pennies. But it was happening to everyone’s trades millions of times a day.

Ronan Ryan: That adds up.

Steve Kroft: You make it sound like a skim.

Ronan Ryan: What else would you call it? Michael Lewis: One hedge fund manager said, “I was running a hedge fund that was $US9 billion and that we figured that the, just our inability to, to make the trades the market said we should be able to make was costing us $US300 million a year.” That was $US300 million a year in someone else’s pocket.

There’s also a big excerpt from Lewis’ new book in the NYT magazine, which includes this fascinating passage, describing a Manhattan-based trader at the bank RBC:

As it happened, at almost exactly the moment Carlin Financial entered Brad Katsuyama’s life, the U.S. stock market began to behave oddly. Before RBC acquired this supposed state-of-the-art electronic-trading firm, Katsuyama’s computers worked as he expected them to. Suddenly they didn’t. It used to be that when his trading screens showed 10,000 shares of Intel offered at $US22 a share, it meant that he could buy 10,000 shares of Intel for $US22 a share. He had only to push a button. By the spring of 2007, however, when he pushed the button to complete a trade, the offers would vanish. In his seven years as a trader, he had always been able to look at the screens on his desk and see the stock market. Now the market as it appeared on his screens was an illusion.

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