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BLOG: Are stock markets rigged?
That's the question at the heart of the best-selling new book by Michael Lewis, Flash Boys. It tracks the rise of high frequency trading (HFT), and how computer algorithms use microseconds to make a year on the trades of slower competition.
Why should you care about these firms operating in the shadows of the market? High frequency traders push up the cost of each stock by fractions of a penny, which can add up for large investors. But it also speaks to the integrity of large brokers on Wall Street - they're selling the information of clients they're paid to help. In return, these firms make millions from HFT traders. A high frequency traders uses that information to jump the line and buy your stock, and then sell it to you for a slightly higher price a millisecond, or one millionth of a second, later.
Using fiber optic cables and powerful computer processors, HFT firms scour the market for these trades. It's happening millions of times a day and it may be adding to volatility in equity markets. In the book, Lewis describes how high frequency traders are willing to pay millions a year to use the fastest fiber optic connections and save valuable microseconds on each transaction.
That brings us to the main character of Flash Boys, Brad Katsuyama. When the former RBC trader and Wilfrid Laurier University graduate discovers the way HFT is manipulating his transactions, he sets out to find a new way to protect his trades. In the end, he creates a new exchange - IEX - which slows down each transaction just enough to make the information useless to high frequency traders. And markets seem to like what he's selling - trading volume on IEX is up about 27% in April versus the daily average in March.
No trader gets the best price all the time. But, at the very least, the hope is that the playing field is fair. When Brad Katsuyama joins me on Tuesday, I'll ask him whether he thinks that playing field actually exists.
To watch Part 2, please click here.