And I just thought it was high-frequency thieving.
Michael Lewis's "60 Minutes" interview about high-frequency trading, the subject of his new book "Flash Boys," was illuminating for me as a former hedge-fund trader.
The hero of the story is Brad Katsuyama, formerly of Royal Bank of Canada. He figured out what we were all thinking: Somebody was stealing from us. But who? It almost became accepted that everyone executing orders on Wall Street was inept.
I feel like I owe a thousand apologies. I would let sales traders know they probably didn't belong in this business on a daily basis. I would see a market on the screen, make a phone call or send an order electronically and expect it to be executed. More times than not, I would get a report telling me where I bought or sold my shares - always a notch below where I'd hoped. "Everybody sucks," I thought.
The quick and dirty of what's going on here: When an order is sent electronically, HFT is able to intercept the trade and then run ahead of you and buy or sell the shares in front of you, which is called front-running. So, if you send an order to buy 100,000 shares of XYZ, HFT sees the order and then buys everything it can and then sells it back to you at a higher price.
A common phrase on Wall Street was "limits are for losers." Limits are when you give an order but with a specific price set. It doesn't allow the broker any room to use his or her brain. And the simple thinking was: If you want to buy a stock, then buy the stock. Don't mess around with limits. But by 2006, I didn't care anymore. I was going to use limits. It was the only way to trade. It didn't always work. I would send an order down to buy stock at a half. I'd watch the market tick up ahead of me and then wait for a phone call back telling me it traded ahead. But I should feel comfortable knowing my order is in good hands and we'll buy any stock if it comes back to a half. More times than not, the stock eventually did trade back to my level and I bought my shares, but it was risky knowing the market could get away from me. Then I face telling my portfolio manager that we didn't buy any stock because I used a limit.
So then, I started trading against myself. If I wanted to buy 100,000 shares of something, I would send an order with a limit of 25,000 shares slightly above where I wanted to buy it. I had some success doing it, but it started to get complicated. And it didn't always work - and was even riskier. Imagine telling your portfolio manager, who wanted to buy 100,000 shares, that not only do you not own any, but you're actually short 25,000 shares. Not good...
I expect to hear a lot more about "Flash Boys" and high-frequency trading over the next few years.
In the "60 Minutes" interview, Lewis says the market is "rigged." I think that's a little aggressive use of the word. It would imply that the whole market is set up to make you lose. That being said, I'm very thankful for now understanding how others are playing with an unfair advantage.
The interesting part about this is that the person getting screwed isn't the typical victim - the little guy. That's what most people think when they hear a word like "rigged" when used to describe the stock market. C'mon, I don't think anyone is front -running the 1000-share orders. No, the people who are getting hurt the most are the ones who don't usually garner a lot of sympathy from the public - hedge funds and mutual funds.
- By Turney Duff
Turney Duff is a former trader at the hedge fund Galleon Group. He chronicled the spectacular rise and fall of his career on Wall Street in the book, "The Buy Side." He is currently working on his second book. Sony recently bought the rights to his first book to turn it into a movie or TV show. Follow him on Twitter @turneyduff.