Thursday, 18 December 2014

Review: Flash Boys by Michael Lewis

I love reading Michael Lewis' books - they are almost never dry (which financial books can often be) and he has a particular skill of weaving technical information in with the human experience to create a story out of something that most people would have trouble relating to.

This is exactly the kind of book he has written with Flash Boys - a book dedicated to exposing the rise of high frequency traders and exposing an industry which most do not understand and fewer have an interest in exposing.

What is Flash Boys about?

Flash Boys is the book to read if you are a lay person looking to understand how High Frequency Trading works.  It goes through the industry participants, how the board has been tilted against investors in favour of high frequency traders and how you (as an individual investor) and large institutional investors are being screwed by the stock market which is meant to be clear and transparent.

So what is High Frequency Trading?

I don't want to ruin the book and get into the specifics because it can be extremely complex but broadly speaking high frequency traders have better and faster information than anyone else in the market and can use this information to trade faster than anyone else and make a profit in the market based on this information.

Most people don't understand High Frequency Trading because they don't understand how the stock exchanges are actually set up.  They don't realise that most stocks are actually traded on multiple exchanges in a market.  Why does this make a difference?  Say you are looking to place a large buy order of shares in a market.  Your broker sends it to exchange 1 and exchange 2 both at the same time.  The high frequency trader sees it at exchange one (because your electronic signal gets there first) and then gets to exchange 2 ahead of you (because your electronic signal takes slightly longer to get there) and pushes the price up so you are forced to pay more.  They are effectively front running you...and the system is designed to let them do this.

You as the investor get screwed because you are forced to pay a higher price than you would if you could have gotten all the shares at the market price.  Although this affects large shareholders more than small investors the reality is that even as a small investor you end up paying more for your shares than you have to.  The difference can be tiny but these tiny amounts add up to huge profits for high frequency traders.

I won't go into more detail - but will let you read the book.  It is a fascinating expose on a little talked about industry.

This book is great for any one interested in the share market...but it will not make you a better investor

I generally love books which
teach me something.  I love it when I take take the lessons from a book and apply it to my own investing philosophy.  It is often simple to do this with instructional type investing books like 'You Can Be a Stock Market Genius'.  It is harder to do with books which are about the industry but it is still possible - for example 'The Big Short' (also by Michael Lewis) really taught me the value of seeing through cycles and trusting my judgement when something didn't look right.

Flash Boys, as good as it is, will not teach you something that you as an individual investor can apply.  It teaches you how you are getting screwed by the system...but not how to avoid it.  And it's not because Lewis has been lazy or that the book isn't comprehensive enough.  It is the fact that the board has been tilted against you.  You are being screwed by your broker, the exchange you trade on and high frequency traders.  They are all making more money at your expense...and most people don't even realise it.

Why did I read this book?

I read this book because I am a finance geek.  I love knowing everything about the markets - how they work, who the players are and most importantly in what ways the market is tilted against me.  I can't do anything about this tilt but I find it fascinating to know anyway.

Don't buy this book if you want to know how to become a better trader or if you want a book on investing.  There are far better books for that purpose.  If you're like me, however, and finance generally interests you then this is a great book.  

The greatness of this book comes from it's ability to lift the lid on an industry and market that has done it's best to stay in the shadows.  I had heard about high frequency traders but had no idea what they did or how they did it before reading the book.  More importantly I didn't realise how it actually affected me

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