{"id":25193,"date":"2014-03-31T09:21:45","date_gmt":"2014-03-31T13:21:45","guid":{"rendered":"http:\/\/www.technologyinvestor.com\/?p=25193"},"modified":"2014-03-31T09:21:45","modified_gmt":"2014-03-31T13:21:45","slug":"how-high-frequency-traders-hurt-you-and-me","status":"publish","type":"post","link":"https:\/\/www.technologyinvestor.com\/?p=25193","title":{"rendered":"How high frequency traders hurt you and me"},"content":{"rendered":"

Drop everything and watch last night’s 60 Minutes<\/em>:<\/p>\n

\"60MinutesPR\"<\/a><\/p>\n

\"60MintuesMarketRigged\"<\/a><\/p>\n

For the 60 Minutes<\/em> segment, click here.<\/strong><\/a><\/p>\n

Once you’ve watched it, go to Amazon, buy and download a Kindle copy of Michael’s book:<\/p>\n

\"FlashBoys\"<\/a><\/p>\n

For the Kindle $9.18 copy, click here.<\/strong><\/a><\/p>\n

There are many ways of reading an Amazon Kindle book, including a Kindle, an iPad, an iPhone and a laptop. I prefer reading Kindle book on my laptop. I don’t have to hold the gadget. Recently I got this irksome error message:<\/p>\n

\"KindleErrorMessage\"<\/a><\/p>\n

If you get this error message, uninstall your old Kindle software, then download and install the latest (free) Kindle software. Click here.<\/strong><\/a><\/p>\n

Caution: Once you’ve downloaded Michael’s book, you’ll be hooked. You will not put it down. Here’s Michael’s Introduction:<\/p>\n

I suppose this book started when I first heard the story of Sergey Aleynikov, the Russian computer programmer who had worked for Goldman Sachs and then, in the summer of 2009, after he’d quit his job, was arrested by the FBI and charged by the United States government with stealing Goldman Sachs’s computer code. I’d thought it strange, after the financial crisis, in which Goldman had played such an important role, that the only Goldman Sachs employee who had been charged with any sort of crime was the employee who had taken something from Goldman Sachs. I’d thought it even stranger that government prosecutors had argued that the Russian shouldn’t be freed on bail because the Goldman Sachs computer code, in the wrong hands, could be used to “manipulate markets in unfair ways.” (Goldman’s were the right hands? If Goldman Sachs was able to manipulate markets, could other banks do it, too?) But maybe the strangest aspect of the case was how difficult it appeared to be — for the few who attempted — to explain what the Russian had done. I don’t mean only what he had done wrong: I mean what he had done. His job. He was usually described as a “high-frequency trading programmer,” but that wasn’t an explanation. That was a term of art that, in the summer of 2009, most people, even on Wall Street, had never before heard. What was high-frequency trading? Why was the code that enabled Goldman Sachs to do it so important that, when it was discovered to have been copied by some employee, Goldman Sachs needed to call the FBI? If this code was at once so incredibly valuable and so dangerous to financial markets, how did a Russian who had worked for Goldman Sachs for a mere two years get his hands on it?<\/p>\n

At some point I went looking for someone who might answer those questions. My search ended in a room looking out at the World Trade Center site, at One Liberty Plaza. In this room were gathered a small army of shockingly well-informed people from every corner of Wall Street- big banks, the major stock exchanges, and high-frequency trading firms. Many of them had left high-paying jobs to declare war on Wall Street, which meant, among other things, attacking the very problem that the Russian computer programmer had been hired by Goldman Sachs to create. In the bargain they’d become experts on the questions I sought answers to, along with a lot of other questions I hadn’t thought to ask. These, it turned out, were far more interesting than I expected them to be.<\/p>\n

I didn’t start out with much interest in the stock market- though, like most people, I enjoy watching it go boom and crash. When it crashed on October 19, 1987, I happened to be hovering around the fortieth floor of One New York Plaza, the stock market trading and sales department of my then employer , Salomon Brothers. That was interesting. If you ever needed proof that even Wall Street insiders have no idea what’s going to happen next on Wall Street, there it was. One moment all is well; the next, the value of the entire U.S. stock market has fallen 22.61 percent, and no one knows why. During the crash, some Wall Street brokers, to avoid the orders their customers wanted to place to sell stocks, simply declined to pick up their phones. It wasn’t the first time that Wall Street people had discredited themselves, but this time the authorities responded by changing the rules — making it easier for computers to do the jobs done by those imperfect people. The 1987 stock market crash set in motion a process — weak at first, stronger over the years- that has ended with computers entirely replacing the people.<\/p>\n

Over the past decade, the financial markets have changed too rapidly for our mental picture of them to remain true to life. The picture I’ll bet most people have of the markets is still a picture a human being might have taken. In it, a ticker tape runs across the bottom of some cable TV screen, and alpha males in color-coded jackets stand in trading pits, hollering at each other. That picture is dated; the world it depicts is dead. Since about 2007, there have been no thick-necked guys in color-coded jackets standing in trading pits; or, if they are, they’re pointless. There are still some human beings working on the floor of the New York Stock Exchange and the various Chicago exchanges , but they no longer preside over any financial market or have a privileged view inside those markets. The U.S. stock market now trades inside black boxes, in heavily guarded buildings in New Jersey and Chicago. What goes on inside those black boxes is hard to say- the ticker tape that runs across the bottom of cable TV screens captures only the tiniest fraction of what occurs in the stock markets. The public reports of what happens inside the black boxes are fuzzy and unreliable- even an expert cannot say what exactly happens inside them, or when it happens, or why. The average investor has no hope of knowing, of course, even the little he needs to know. He logs onto his TD Ameritrade or E* Trade or Schwab account, enters a ticker symbol of some stock , and clicks an icon that says “Buy”: Then what? He may think he knows what happens after he presses the key on his computer keyboard, but, trust me, he does not. If he did, he’d think twice before he pressed it.<\/p>\n

The world clings to its old mental picture of the stock market because it’s comforting; because it’s so hard to draw a picture of what has replaced it; and because the few people able to draw it for you have no interest in doing so. This book is an attempt to draw that picture. The picture is built up from a bunch of smaller pictures- of post-crisis Wall Street; of new kinds of financial cleverness; of computers, programmed to behave impersonally in ways that the programmer himself would never do personally; of people, coming to Wall Street with one idea of what makes the place tick only to find that it ticks rather differently than they had supposed. One of these people — a Canadian, of all things- stands at the picture’s center, organizing the many smaller pictures into a coherent whole . His willingness to throw open a window on the American financial world, and to show people what it has become, still takes my breath away.<\/p>\n

As does the Goldman high-frequency trading programmer arrested for stealing Goldman’s computer code. When he worked for Goldman Sachs , Sergey Aleynikov had a desk on the forty-second floor of One New York Plaza, the site of the old Salomon Brothers trading floor, two floors above the place I’d once watched the stock market crash. He hadn’t been any more interested in staying in that building than I had been and, in the summer of 2009, had left to seek his fortune elsewhere. On July 3, 2009, he was on a flight from Chicago to Newark, New Jersey, blissfully unaware of his place in the world. He had no way of knowing what was about to happen to him when he landed. Then again, he had no idea how high the stakes had become in the financial game he’d been helping Goldman Sachs to play. Oddly enough, to see the magnitude of those stakes, he had only to look out the window of his airplane, down on the American landscape below.<\/p>\n

As a result of the realization that they were being ripped off by high frequency traders, a bunch of buy-side investors, including mutual funds, hedge funds, and family offices, have formed a new stock exchange called IEX. You can read more about it here.<\/strong><\/a><\/p>\n

You should also watch the IEX video — it’s on the link. It’s a little simplistic, but you’ll get the idea of what they’re trying to accomplish — namely stopping high frequency traders from front-running their orders.<\/p>\n

\"IEXVideo\"<\/a><\/p>\n

Why Putin’s Power Play won’t work long-term. <\/strong>The best analysis of why is from my second favorite author, the New Yorker’s James Surowiecki:<\/span><\/span><\/p>\n

Putin’s Power Play<\/strong><\/p>\n

Vladimir Putin, in his campaign to restore Russian dominance over post-Soviet states, has an unconventional weapon in his arsenal: vast supplies of natural gas. In 2006 and 2009, Gazprom, the Russian gas company, cut off supplies to Ukraine (the second time, this created shortages in Europe, too). In 2010, it reduced supplies to Belarus, and last fall Russia threatened Moldovans with the same if they didn’t abandon plans to sign a free-trade accord with the European Union. “We hope that you will not freeze,” a Russian deputy foreign minister said ominously. During the current crisis in Crimea, Putin’s readiness to use natural resources for strategic ends has made it difficult for Europeans to take a hard line against him, since Europe gets roughly thirty per cent of its gas from Russia, mostly via pipelines running through Ukraine. “One big difference between the U.S. and Europe on this issue is energy,” Jeffrey Mankoff, a Russia expert at the Center for Strategic and International Studies, told me. “The assumption that, because of the energy relationship, Europe was not going to risk a major confrontation over Ukraine was surely part of Russia’s calculations.”<\/p>\n

You might take Putin’s brandishing of the gas weapon as a shrewd geopolitical move. But it’s a classic case of putting short-term interests ahead of long-term gain. Although the region’s need for Gazprom supplies may strengthen his hand in the present, the strategy is forcing Europe to end its reliance on Russia. After the crises of 2006 and 2009, Europe increased imports from Norway and Qatar. It built new facilities for receiving liquefied natural gas, and upgraded storage capacity, so that supplies could be stockpiled in case of a cutoff. It imported more coal. Pipeline connections within the E.U. were improved, making shortages easier to alleviate. The Crimea crisis will give new impetus to these efforts. The U.K.’s foreign secretary has said that the crisis is likely to make Europe “recast” its approach to energy. A draft document prepared for a forthcoming E.U. summit deplored the Continent’s “high energy dependency” and called on E.U. members to diversify their supplies. These moves are reminiscent of what happened after the oil crises of the nineteen-seventies made it clear to the West and Japan that relying on OPEC suppliers was foolish. Europe installed energy-saving technologies and invested heavily in nuclear energy and natural gas. France built fifty-six nuclear reactors in the fifteen years after the oil embargo of 1973.<\/p>\n

This time around, we’re sure to see more infrastructure for liquefied natural gas and more emphasis on renewables. Europe may also finally make its peace with fracking-a hard sell till now, not just because of environmental concerns but also because European landowners typically don’t own the mineral rights to their property, and so have no incentive to allow drilling. But there are Eastern European countries, including Poland and Ukraine, sitting on billions of cubic feet of shale gas, and Ukraine signed exploration contracts with Chevron last year. Russia is clearly anxious. Gazprom executives have been quick to belittle fracking’s potential, and the issue has turned Putin into the world’s most unlikely environmentalist. Fracking, he says, makes “black stuff” come out of your faucet.<\/p>\n

There’s also the question of American natural gas, currently something of a congressional obsession. A couple of weeks ago, Poland, Hungary, Slovakia, and the Czech Republic called on the U.S. to begin exports to Europe, and Republican congressmen have been pushing the same idea as a way to combat Russia. For now, this is just grandstanding: even if the U.S. did issue companies permits to export gas, building the necessary infrastructure would take till at least late 2015. But an increase in U.S. exports will hurt Russia no matter where the gas actually goes; the U.S. is well placed to compete with Russia in Asian markets, which are increasingly important to Gazprom’s business. Indeed, the boom in U.S. gas production has already weakened Russia’s hand. Former suppliers are free to export elsewhere; Qatar quadrupled its supply of gas to Europe between 2008 and 2013, and now provides a tenth of Europe’s imports. More fundamentally, increased supply means increased competition, which puts pressure on how much Russia can charge for its gas. Gazprom historically pegged its price to the price of oil, which has remained stubbornly high. But, as gas prices in the U.S. have fallen, countries have demanded concessions. In 2012, Bulgaria got a twenty-per-cent price cut over ten years, and some of Gazprom’s biggest customers have been pushing it to do away with the oil-price peg. As Mankoff puts it, “global changes in energy markets are not working to Russia’s advantage.”<\/p>\n

Still, Russia’s predicament is essentially of its own making. It remains the world’s second-largest natural-gas producer, and its pipelines into Europe make it a low-cost supplier there. (Sending gas through pipelines is typically cheaper than transporting it in liquid form.) If Gazprom were seen as a reliable supplier, rather than as a tool of the Russian government, it wouldn’t be so vulnerable to competition. Of course, former K.G.B. agents aren’t known for their respect for market forces, and Putin cares far more about using Russian power than about Gazprom’s profits. But he’s about to find out that, when you’re running an authoritarian petrostate, energy profits are power: Russia depends on oil and gas revenue to fund its imperial ambitions and maintain stability at home. Alienating customers and giving competitors an opening isn’t just bad business. It’s bad politics. Putin likes to think of himself as a geopolitical grandmaster. But when it comes to natural gas he isn’t thinking enough moves ahead. \u0004<\/p>\n

Favorite recent New Yorker cartoons.<\/strong><\/span><\/p>\n

\"BucketList\"<\/a><\/p>\n

\"ThreeStraightMen\"<\/a><\/p>\n

\"Dead\"<\/a><\/p>\n

\"HarryNewton\"<\/a>
\nHarry Newton, who’s back in New York and not enjoying the cold, wet weather. Good: My Internet is faster — nearly 50 megs up and down. Speed makes a huge difference. Bad: My pile of mail and boxes full of online purchased junk I absolutely don’t need is overwhelming. It’s time to give up my online buying habits.<\/p>\n

I’m not the only one obsessed with online shopping. Business Insider<\/em> has a new slide deck:<\/p>\n

\"FutureofRetail\"<\/a><\/p>\n

You can watch it here.<\/strong><\/a> The Big Message: Stay away from store-based retailers.<\/p>\n

Please don’t accuse me of being sucked in by Michael Lewis’s awesome\u00a0 publicity machine. This stuff is important. All of us need to understand what’s going on with high frequency trading.<\/p>\n