High-frequency trading (HFT) is a practice carried out by
many banks and proprietary trading firms using sophisticated
computer programs to send gobs of orders into the market,
executing a small portion of them when opportunities arise to
capitalize on price imbalances, or to make markets. HFT makes up
more than half of all U.S. trading volume.
The trading methods and technology that make HFT possible are
all legal, and the stock exchanges HFT firms trade on are highly
regulated. But Lewis said these firms are using their speed
advantage to profit at the expense of other market participants
to the tune of tens of billions of dollars.
"They are able to identify your desire to buy shares in
Microsoft and buy them in front of you and sell them back to you
at a higher price," Lewis, whose book is available on Monday,
said on the television program "60 Minutes" on Sunday.
"This speed advantage that the faster traders have is
milliseconds, some of it is fractions of milliseconds," said
Lewis, whose books include "The Big Short" and "Moneyball."
Those milliseconds can be valuable, making it possible to send
around 10,000 orders in the blink of an eye.
Darting in and out of trades, HFT firms make just fractions of a
penny per trade, but the sheer speed and volume of their trading
activity allows those that are successful to make significant
Proponents of HFT argue that the presence of such firms makes it
easier for all market participants to find buyers and sellers
for their trades, and that the speed at which HFT firms can
detect and take advantage of pricing imbalances between
different markets and assets leads to smaller bid-ask spreads.
But Brad Katsuyama, former head trader in New York for the Royal
Bank of Canada and a major figure in Lewis's book, said he was
finding that when he would send a large stock order to the
market, it would only be partially filled, and then he would
have to pay a higher price for the rest of the order.
With the help of new hire Ronan Ryan, Katsuyama realized that
his orders traveled along fiber optic lines and hit the closest
exchange first, where high frequency traders would get a
glimpse, and then use their speed advantage to beat him to the
other 12 U.S. public exchanges and 45 private trading venues.
HFT algorithms could then buy the shares Katsuyama wanted, and
then sell them to him at a slightly higher price.
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Katsuyama and Ryan created a system in which RBC would send
its orders first to the exchange that was the furthest away, and
last to the exchange that was closest, with the goal of arriving
at all places nearly simultaneously, cutting out HFT.
"Essentially, our fill rates went to 100 percent. We couldn't
believe it when we actually figured it out," Katsuyama told "60
Katsuyama said he decided to start a new trading platform, called
IEX, for the Investors' Exchange, employing similar tactics to those
he used at RBC.
"It almost felt like a sense of obligation to say we found a problem
that is affecting millions and millions of people — people are
blindly losing money they didn't even know they were entitled to.
It's a hole in the bottom of the bucket," he said.
IEX has attracted the investment of David Einhorn, the billionaire
owner of hedge fund Greenlight Capital, and an endorsement from
Goldman Sachs. The investors in IEX are fund companies and
individuals, not banks.
"We are selling trust, we are selling transparency, and to think
that trust is actually a differentiator in a service business, is
actually a crazy thought, right?" said Katsuyama.
Earlier this month, New York state's Attorney General Eric
Schneiderman said he believes U.S. stock exchanges and other
platforms provide HFT firms with unfair advantages.
Exchanges allow trading firms to place computer servers inside the
exchange's data centers so that the firms can see the data as soon
as possible. The practice, called co-location, is regulated and
available to anyone who wants to pay for it.
Schneiderman has begun meeting with the U.S. exchanges, which
include IntercontinentalExchange Group's New York Stock Exchange,
Nasdaq OMX Group's main bourse, and four platforms run by BATS
Global Markets, on possible reforms, a source close to the situation
A ban on HFT is unlikely, as U.S. regulators would be loath to put
policies in place that could lead to a less liquid market, Robert
Greifeld, chief executive officer of Nasdaq, said on Thursday.
(Reporting by John McCrank; editing by Diane Craft)
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