Tagged: High Frequency Trading

High Speed Risk

Is the era of high-frequency trading over? 

While you ponder whether “High Speed Risk” might be a good name for your garage rock band, let’s reflect on stocks. We said last week: “Our Sentiment is negative for the first time since the election. It’s a weather forecast.  No need for panic, only preparation.”

We measure the short-term movement of money with a 10-point scale. It was about 5.0 or higher from the election until Mar 9, 80 trading days. Last week it dipped below 4.5.

And weather arrived yesterday before today’s VIX expirations. It’s not news about the Trump administration.  It’s the end of a long, leveraged run. Monthly options and futures expired Friday the 17th.  New options traded Monday, Mar 20.

Yesterday was what we call Counterparty Tuesday. If counterparties have estimated demand Monday for new options incorrectly, they true up on Tuesday. Since markets fell, counterparties overshot demand.  

Derivatives have featured prominently in gains since the election. Investors have been buying both stocks and rights to more of them in the future. That additional implied future demand breeds higher current stock prices.

For the first time since the election, investors didn’t buy more future rights.  Does this mark an end to that pattern?  Certainly for the moment.  And it dovetails with the state of high-frequency trading.

For you new readers, let’s canvass high-frequency trading.  In 2007 after Regulation National Market System, a firm calling itself Octeg splashed through the data. In Intel alone, Octeg was driving 35% of monthly volume, crushing Goldman Sachs.

Who is Octeg, we wondered? The firm defied what we knew about brokers, which always wanted to hang a sign out, advertise that they had products for sale. We couldn’t find even a phone number for Octeg.  It was like stumbling on an unmarked warehouse in the suburbs packed to the ceiling with all the stuff you tried to buy at the mall.

While rooting through regulatory filings we found an address in Chicago and then another firm in the same suite called Global Electronic Trading Co (GETCO). 

And then we got it.  Octeg was GETCO spelled backward. The two were the same firm.

Getco dominated trading through the financial crisis, profiting on two ideas. First, exchanges began paying traders to sell shares on their markets. Think of it like a store coupon: Do business with us and we’ll give you a discount. Getco cashed coupons. In gargantuan manner. Exchanges paid them in coupons for relentless volume.

Second, Getco realized that it could be first to set price. So why not set as many prices as possible, forcing big institutions to chop their trades into smaller pieces?

Volume exploded. 

But it wasn’t investment.  Getco had no customers. It was using computers and mathematical calculations to continuously set prices in the stock market, getting paid to buy and sell stocks while simultaneously changing the price ever faster to force big investors into chopping up stock orders into smaller pieces so Getco and its burgeoning ilk could sit in the middle buying low and selling high in fractions of seconds.

At the pinnacle in 2009, we pegged this behavior, high frequency trading, at 70% of volume. Now high-frequency trading by our measures is less than 40% of volume.

The entire market the past decade is built on it. On the floor of the NYSE, four big high-speed firms price all NYSE stocks at the open. At the Nasdaq, a larger number does the same, trading prices for coupons.

The problem is high-frequency traders don’t have customers. They aren’t “working orders” for investors. They are buying low and selling high in fleeting fashion, for profit. Mistake these prices for ones from investors, and you mentally misprice stocks.   

You read that high-frequency traders are “market makers.” They’re “furnishing liquidity.” Traders with no customers can’t make markets. They can only exploit what others in the market don’t know. In 2007, it was easy. Now it’s not.

That’s because big stock brokers are doing the same thing with Exchange Traded Funds, rapidly repricing them, and index funds, and the stocks comprising them, and the options and futures derived from them. The big brokers are better at it than high-frequency traders because they have customers and can make longer directional plays by reading what customers are doing.

In a market without high-frequency trading, all stocks would trade like Berkshire Hathaway Class A shares.  About 400 shares daily.  It would be better for investors. But all the exchanges would go broke. Ironic, isn’t it?

High-frequency trading isn’t done. But with the market we’ve got, the harder it is for high-speed machines to price stocks, the greater the risk of big moves.

Bang the Close

I find myself in an uncomfortable position.  I’m siding with a high-frequency trader.

There’s a key lesson here for investor-relations professionals about how prices are set, and it dovetails with why the bulk of volume concentrates around the open and close.

The title of this piece would be a great name for a rock band but it refers to submitting securities trades during the last 15 minutes of trading to affect how average prices are calculated. That’s “banging the close,” it’s said.

Venerable Chicago high-speed firm DRW, a proprietary trader focused on derivatives markets, has been accused by commodities regulators of manipulating prices on a key interest-rate swap. The alleged malfeasance occurred in 2011.

Normally firms settle with regulators when charged with rule-breaking. Founder Donald R. Wilson, a prominent figure in Chicago, insists DRW did nothing wrong and is battling the US Commodities Futures Trading Commission in court.

The CFTC says DRW submitted a thousand orders over seven months that didn’t conform with other prices during the vital last 15 minutes when “settlement prices,” or average prices for contracts and broker margin-requirements, are calculated. A broker serving as counterparty might have to furnish more capital if the price moves.

The CFTC is miffed because it believes DRW made money even though none of its bids produced a matched trade.  DRW says it was simply profiting on differences between the futures contract and the same product traded over-the-counter (that is, by brokers). The swaps contracts pay buyers (DRW was always the buyer) a fixed fee and sellers a floating one. Floaters lost, among them the now-defunct MF Global.

Let’s summarize for those who like me need an adult beverage after sorting this matter. The CFTC claims DRW manipulated prices for gains by putting in bids that weren’t like other bids. DRW says it bids what it thinks things are worth, not whether the price conforms to others’ views, and sometimes someone loses. That’s my interpretation.

What’s this got to do with IR and stock-trading? The IR job is predicated on helping investors understand why your shares are worth more than somebody else’s.  Are you manipulating prices then?  Of course not. And sometimes stocks decline.

Secondly, one reason Blackrock and Vanguard routinely beat your active holders for investment returns is because of stupid rules forcing prices to averages at the expense of those looking for outliers. Without outliers in markets, there’s no room for stock-pickers – the lifeblood of the IR profession. The market should reflect all prices, not averages.

It’s partly why volume is big in the morning and at the close.  Those prices are used to calculate averages. Your shares often move up or down early, toward the mean between, and then up or down into the close (see yesterday’s trading).  It could be argued that many algorithms are banging the close, which means banging is no aberration – or that the whole market is a series of continuous manipulations (don’t answer that!).

If DRW is a manipulator, then so was George Soros in the British pound. So are trading algorithms pursuing volume-weighted average prices because they undermine your effort to help your stock diverge from averages.

So is the Federal Reserve. The Fed sets artificial interest rates to manipulate broader ones, which it will likely do again Dec 14 (with $460 billion of reverse-repurchases on its balance sheet, another manipulation scheme, the Fed signals hike intentions). How is that different from DRW bidding at prices it believes reflect appropriate value?

If DRW is a price-manipulator, so was my dad.  On the cattle ranch of my youth, we’d take our animals to market and bid on them to push the price up to a level we thought proper. If the buyers didn’t like it, we bought the cattle back and took them home.

This would apparently have earned CFTC accusations of manipulating cattle prices.

Pardon me for bluntness but let’s knock off the crap, shall we? Rules that force all prices to the mean – which proliferate in equities and everywhere else now – defy supply and demand, foster mediocrity and promote sudden and irrational reversions to a mean.

I don’t prefer proprietary traders committing no long-term capital to budding businesses.  But.  If we want to reduce risk in the capital market, here’s an idea:  Let any buyer or seller price as he or she wishes. Suppose brokers could do it too. Maybe that would bring aftermarket support back to IPOs, creating new IR jobs again.

That’s my suggestion for the incoming SEC chair.

Light Speed

Alert reader Raj Mehan at Steelcase forwarded a piece from the Wall Street Journal about traders now aiming with machines to execute stock-market transactions near light-speed.

Why the rush?  Companies take flak for “short-termism” that’s a quarter long and yet regulators and traders and academics extol the virtues of fast trading, claiming it makes markets liquid and efficient.

Just this week I was speaking with a CFO for a public company who yawned at the idea he should care about what priced his stock. “It’s interesting but what difference does it make?”  I’m paraphrasing a longer exchange. It’s a vital point of contention, right?

We’ll come to that in a moment. Watching the Olympics this week – exhilarating as ever – the race for speed in the water is stupefying.  Seeing Katie Ledecky crush the field by five seconds for a gold metal gives you goose bumps no matter your country. And the objective of swimming-speed is winning.

It is for traders too. In the WSJ article by Vera Sprothen, folks from high-speed trader DRW Holdings LLC (stands for Donald R Wilson) said competition in financial markets is accelerating the race. A nanosecond is a billionth of a second. Routers can send and receive stock-exchange data in 85 nanoseconds, which is how much time elapses when a bullet fired from a gun travels a half-inch.

Imagine. You fire at a shooting-range target and before the bullet gets there somebody trades your stock several hundred times.

If I’m making a big-ticket purchase the last thing I want is – snap! – to do it faster. Many of you are investor-relations professionals. Do some investors study your business for a year or two before deciding to buy your shares? When I was an IRO, that was common.

Weighty decisions are not made for light speed.  Therefore, traders are not making weighty decisions. Committing capital over time is a risky gambit. Capital deployed the amount of time needed for a bullet to travel a few feet isn’t so fraught.

It’s also not investment. Understand: The stock market in the USA and ever more around the world too is one in which the first trade to arrive prices the stock for everyone. Many stock-trades are paired with other things such as options or currencies or commodities.  Price one superfast, and race over faster than a speeding bullet to something else, and you can make money by taking advantage of price-differences. That is by definition arbitrage.

The efficiency of markets is best assessed by determining how much arbitrage occurs. There’s a lot of arbitrage in booking a hotel room on line. There’s no arbitrage in buying a cup of coffee at Starbucks (unless somebody at the Univ of Chicago wants to study that question and prove me wrong).

In the stock market, almost half of all volume is arbitrage. It may be the most colossally inefficient capital market ever created by human beings. Back up 20 years and it wasn’t. Just 15% of trading could be attributed to arbitrage, and 85% to investment.  Speed and price-differences now consume it.

Which brings us back to our apathetic CFO. If you don’t care about the market for the backbone of your balance sheet enough to understand it, you should be a private company where there’s less arbitrage.

For IR pros in the 21st century, it’s a huge opportunity. Not only is there confidence in knowing how the market works, but somewhere today there’s an IRO who will, having learned, help change the market tomorrow.

Problems are solved after we first understand them.  Most prices for stocks should not be set at the speed of light. Yet that’s happening.

Boards Should Know

We thought we were going to need a boat.

Driving into Kansas City, a torrent fell in such proportion that the sky, the landscape, the topography of the roadway, disappeared into a pelting gloom that had our wipers humming on high amid the beating din on the roof for 40 minutes.  Rarely has the first sliver of cutting light seemed so blessedly hopeful.

It had me thinking how darkness about markets prevails in the Boardrooms of America and investor-relations holds the light and the capacity to chase it out.  Boards don’t understand the market.  Perception about equity-trading is disconnected from data reality.

Across our client base reflecting $1.3 trillion of market capitalization there isn’t a single member not held by both Blackrock and Vanguard.  In most cases, the two rank in the top ten if not the five largest holders.  Below these are a sea of fellow asset-allocators ranging from the Powershares Exchange Traded Funds (ETFs) offered by Invesco to the explosion in so-called robo-advisors like Betterment and Charles Schwab’s ETF-powered Intelligent Portfolios.

This community claims to be “perpetual owners” – they hold things.  But if an investment vehicle has inflows, it buys.  Redemptions, it sells. If it tracks a market benchmark like the S&P 500, it relentlessly buys and sells to track movements.  Combine those two and the result is uniformity around supine volatility.

With a lot of volume. Bloomberg in a July article on ETF trading described how these derivatives of indexes drive dollar-volume of $18 trillion annualized now. The market’s most active stock is the ETF SPY generating billions daily and $6 trillion annually. Three of the four most active stocks by dollar-volume are ETFs. Derivatives are pricing the underlying assets.

Thanks to Michael Lewis’s riveting nonfiction thriller Flash Boys (and more), many understand traders in the middle are distorting outcomes. It’s worse.  Intermediaries are half the volume. Nearly three billion of six billion daily shares are chaff.  No ownership-moves, just cash in a register drawer for making change.

What’s a reasonable commission for service?  Real estate agents split 4-6% on home-sales.  Hedge funds want 2% plus 20% of profits. Your waiter will like 20% on a restaurant dinner. The government takes about 30%.

Virtu (Nasdaq:VIRT), a high-frequency trader deploying its own capital, had revenues of $148 million last quarter and net income of $77 million, a 52% net margin. Having no customers they charge no commissions. But sitting between they keep half.

When trading firms, or exchanges, or members of Congress, or regulators tout the benefits of low-cost trading, the proper response is to ask how a market can be efficient in which the middle men are responsible for half of all sales.  Groceries stores as middlemen for producers and consumers have single-digit margins, often about 2%.

What Boards should conclude is that somebody is getting jobbed.  But they don’t know.

Finra oversees 4,400 brokers. Yet in trade-execution data, 30 control over 90% of volume.  The reason is that rules require brokers with customers to meet defined execution standards comprised of averages in the marketplace.

The biggest brokers are handling order flow for the most active sources of trades:  Indexes and ETFs. So the biggest brokers define the standards. Since Finra fines brokers for failing to meet standards, smaller brokers route their trades to big brokers, who roll them up in algorithms powered by the central tendencies defining the bulk of their trade-executions.  That’s again the Massive Passives – indexes and ETFs.

Here’s a key to why 80% of stock-pickers underperform indexes.  Their trades are not setting prices.

And there’s little true “long only money” in markets now, because everybody hedges macro uncertainty related to globalism, central-bank intervention and floating currencies.  Data from Sifma and the Bank for International Settlements show currency, interest-rate, commodity, credit, equity and other swaps total $630 trillion of notional value, ten times global GDP. Any currency ripple can become a splash in the S&P 500.

Risk Management, Asset Allocation and Intermediation converge around borrowing – the amount of shares short every trading day. That’s 43%. Nearly half of all market-volume comes from borrowed shares, lent by big owners through margin accounts at big brokers, often rented by intermediaries to reduce cost and risk.

Only investor-relations professionals can report these facts to Boards. This is how you get a seat at the table. The only actions worth taking are ones planted in fact (and we can help you on both counts –measures and actions).  It begins with casting a bright IR light that lifts the shroud and defines reality.

Big Opportunity

Amazed. Dazed. Perhaps needing a drink.

Thus shown the faces of investor-relations practitioners at yesterday’s NIRI Southwest Regional Conference as Rajeev Ranjan from the Chicago Federal Reserve Bank put up his final slide and pronounced it a graphical representation of market microstructure. It appeared to be some sort of complex engineering schematic.

And it reflects how stocks trade today. Many say, “Ignore high-frequency trading because it’s noise from those who don’t care about fundamentals.” If traders oblivious to fundamentals and uninterested in owning your shares routinely price them and all other equities, how can you rely on prices the market displays that underpin the corporate balance sheet?

Proving that even the SEC is antsy now about this structure, a tick-size study to consider wider trading spreads is nearing finalization. Did you get the memo? No?  Exactly. Public companies have been omitted – but the comment period is coming! If ever public companies needed to speak up, this is the opportunity. With that preamble, we’ve reserved today’s Market Structure Map for yesterday’s blog post from our good friends at Themis Trading. Take it away, Joe and Sal:

 

While we in the trading community continue to debate the merits of HFT and the structural defects in our market structure, there continues to be a group of market constituents that remains silent in the debate – the public companies.  The stock market has undergone dramatic structural changes over the past decade but many of these changes were done without the input of the public company.

Public companies are the reason that the stock market exists, they are what research analysts cover and who bankers seek to do deals with. Without listed public companies, there would be no S&P 500 ETF or E-mini futures contract.  There would be no rebate or latency arbitrage that hinges on microwave networks and football-field-sized data centers.

We’re not quite sure why the public company largely remains silent in the market structure debate.  Possibly, it is because market structure has continued to get more complicated and they fear they are not up to date on the changes.  Or possibly, they feel that in return for annual listing fees, the stock exchanges should be representing their views.  Considering that exchanges now get most of their revenues from data-related services, looking out for public companies seems to be on the back of their to-do list.

While our friend Tim Quast from ModernIR continues to speak out on structural issues on behalf of his public-company clients, it is rare that we see any others in that segment speak out.   However, we recently came across an article written in Canada’s Financial Post by David Beatty, which tackles the issue of market structure and public listings. Mr. Beatty is Chairman of the Board of Canada-based Rubicon Minerals and is also on the Board of Directors for First Service Corporation and Canada Steamship Lines. (more…)

The Risk

On a hot Sunday 138 years ago today, Lieutenant Colonel George Armstrong Custer rode into the valley Native Americans called the Greasy Grass. The rest is history.

Speaking of unexpected defeat, wonder what ambush caused yesterday’s sharp market reversal? Here’s a ModernIR Rule: The day after a new marketwide series of options and futures begins trading is a leading indicator of institutional asset-allocation plans.

Options and futures expired June 18-20. The new series took effect June 23. Yesterday was Rule Day.  Counterparties including major broker-dealers hold inventory through expirations and these resets. If stocks then decline, they had too much inventory for demand-levels.

Now, one can blame bearish Dubai stocks or sudden weakness in the UK Sterling or something else. But this rule is consistently true: If there’s more money in equities, stocks rise because counterparties undershot estimates. The reverse? Counterparties dump inventory and stocks drop.

Is this dip the tip of the long-anticipated bear turn?  Right now, total sentiment by our measures doesn’t show that risk. But. Sentiment has consistently faded before offering investors a market-top for profit-taking, in itself a bearish signal.

Speaking of risk, Cliff Asness’s high-speed trading piece at Bloomberg is humorous and compelling. I admire the AQR founder for his smarts, success and libertarian leanings.

But I disagree on HFT.  Mr. Asness defends it, saying: “The current competitive market-based solution is delivering the product, meaning liquidity for investors, better and cheaper than ever. Moving away from this competitive landscape would be an invitation for incompetent central planning or rapacious monopolistic practices.” (more…)

Who Is Selling

“Who’s selling?”

It was 2001. I’d look up and there’d be the CEO leaning in the door of my office. This was back when my buns rode the gilded surface of the IR chair. I’d look at my computer screen and our shares would be down a percent or so.

“Somebody, apparently,” I’d say. “Let me make a few calls.”

Today we have Facebook, Twitter, Pandora, iPhones, and Tesla. None of these existed in 2001. The Intercontinental Exchange, formed a year earlier to trade derivatives, now owns the NYSE. What’s remarkable to me is that against this technological wave many issuers, not counting the growing horde with Market Structure Analytics, are still making calls to get answers.

Why wouldn’t everybody be modeling market behavior and measuring periodic change? But that’s another story.

So. What if nobody’s selling and your price is down?

Impossible, you say. For price to decline, somebody has to sell.

Let me tell you about two clients releasing earnings last week.

But first, say I’m a high-frequency trader and you’re reporting. I rent (borrow) 500 shares of stock trading at $25 apiece. Say the pre-open futures are negative. At the open, I explode ahead of all others by three microseconds to place a market order to sell 500 shares. My order plunges the market 8%. I immediately cover. And for the next six hours I and my HFT compatriots trade those 500 shares amongst ourselves 23,000 times. That’s volume of 11.5 million shares.

The huge move in price prompts swaps counterparties holding insurance policies for Blackrock and Vanguard into the market, spawning big block volumes of another 6 million shares. Now you’ve traded 17.5 million shares and your price, after dropping 8%, recovers back 3% to close down 5% on the day.

So who’s selling? Technically I, an HFT firm, sold 500 shares short at the open. I probably paid a $200 finance fee for them in my margin account.

You’re the IRO. You call your exchange for answers. They see the block data, the big volumes, and conclude, yup, you had some big-time selling. Conventional wisdom says price moves, massive volume, block trades – that’s institutional.

You’re getting calls from your holders saying, “What’s going on? I didn’t think the numbers looked bad.”

Your CEO is drumming fingers on your door and grousing, “Who the HELL is selling?!”

Your Surveillance firm says UBS and Wedbush were moving big volumes. They’re trying to see if there are any clearing-relationship ties to potential institutional sellers.

The truth is neither active nor passive investors had much to do with pressure or volume, save that counterparties for passive holders had to cover exposure, helping price off lows.

Those clients I mentioned? One saw shares drop 9% day-over-day. In the data, HFT was up 170% day-over-day as price-setter, and indexes/ETFs rose 5.3%. Nothing else was up. Active investment was down. Thus, mild passive growth-selling and huge HFT hammered price. Those shares are already back in line with fair value because the selling was no more real than my 500-share example above (but the damage is done and the data are now in the historical set, affecting future algorithmic trades).

In the other case, investors were strong buyers days before results. On earnings, active investment dropped 15%, passive investment, 8%, and HFT soared 191%. These shares also coincidentally dropped 9% (programmers of algorithms know limit up/down triggers could kill their trading strategies if the move is 10% at once).

They’re still down. Active money hasn’t come back. But it’s not selling. And now we’re seeing headlines in the news string from law firms “investigating” the company for potentially misleading investors. Investors didn’t react except to stop buying.

This is the difference between calling somebody and using data models. Don’t fall in love with models (this is not a critique of Tom Brady, mind you). But the prudent IRO today uses Market Structure Analytics.

Fires, Crashes and Kill Switches

Suppose the engine of your vehicle was on fire.

The logical response would be to shut it off. But what if you were traveling at highway speed and killing the fuel supply meant you had no power breaks or steering? What if your vehicle was a jet fighter?

There are ramifications.

Last Thursday and Friday stocks plunged. Monday and Tuesday this week, shares soared. I doubt most of us think that people were selling in a stampede last week and then woke up Monday and went, “Shazzam! What have we done? We should be buying!”

Context matters.

This week offers an event in similar rarified air as blood moons in the northern hemisphere. Good Friday closes markets to end the week. Between are the usual three sets of expirations: volatility derivatives, index futures, and the remaining host of options and futures set for monthly expiry (with earnings now too – another reminder for you learned IROs to avoid that mash-up if at all possible). (more…)

The Recovery

It’s all in the recovery.

That’s the philosophy put forth by a friend of mine for dealing with unpleasant facts.

I think the chief reason for the recent swoon in stocks was not anemia in the job market but a sort of investor outrage. You can’t troll a trading periodical or blog or forum without wading through rants on why Michael Lewis, author of the bombshell book Flash Boys on high-speed trading, is either guilty of torpid whimsy (a clever phrase I admit to swiping from a Wall Street Journal opinion by the Hudson Institute’s Christopher DeMuth) or the market’s messiah.

What happens next? Shares of online brokerages including TD Ameritrade, E*Trade and Schwab have suffered on apparent fear that the widespread practice at these firms of selling their orders to fast intermediaries may come under regulatory scrutiny.

What about Vanguard, Blackrock and other massive passive investors? Asset managers favor a structure built around high-speed intermediation because it transforms relentless ebbs and flows of money in retirement accounts from an investing liability to a liquidity asset. Asset management is about generating yield. Liquidity is fungible today, and it’s not just Schwab selling orders to UBS, Scottrade marketing flow to KCG and Citi or E*Trade routing 70% of its brokerage to Susquehanna.

It would require more than a literary suspension of disbelief to suppose that while retail brokers are trading orders for dollars, big asset managers are folding proverbial hands in ecclesiastical innocence. The 40% of equity volume today that’s short, or borrowed, owes much to the alacrity of Vanguard and Blackrock. The US equity market is as dependent on borrowing and intermediation as the global financial system is on the Fed’s $4 trillion balance sheet.

Hoary heads of market structure may recall that we wrote years ago about a firm that exploded onto our data radar in 2007 called “Octeg.” It was trading ten times more than the biggest banks. Tracing addresses in filings, we found Octeg based in the same office as the Global Electronic Trading Co., or GETCO. Octeg. Get it? (more…)

Flash Boys

I don’t skateboard. But the title of Michael Lewis’s new book on high-speed trading, Flash Boys, made me think Lewis could’ve called it DC-town & Flash Boys.

Legendary skateboarder Stacy Peralta directed the 2001 documentary Dogtown & Z-boys chronicling the meteoric rise of a craze involving slapping wheels on little boards and engaging in aerobatic feats using public infrastructure such as steps and handrails. From Dogtown, slang for south Santa Monica near Venice Beach, Peralta’s Sean-Penn-narrated film tracked the groundbreaking (and wrist-breaking) 1978 exploits of the Zephyr skateboarding team, thus the “Z-boys.”

Skateboarding has got nothing to do with trading, save that both are frantic activities with dubious social benefit. We’ve been declaiming on these pages for more than a half-decade how fast intermediaries are stock-market cholesterol. So, more attention is great if the examiner’s light shines in the right place.

If you missed it, literary gadfly Lewis, whose works as the Oscar Wilde of nonfictional exposé include Moneyball (loved the movie), Blindside, Liar’s Poker and the Big Short, last week told 60 Minutes the US stock market is rigged.

The high-frequency trading crowd was caught flat-footed. But yesterday Brad Katsuyama from IEX, a dark pool for long investors that rose out of RBC, dusted it up on CNBC with Bill O’Brien from BATS/Direct Edge, an exchange catering to fast orders.

Which brings us to why Lewis might’ve called his book DC-town & Flash Boys. The exploitation of speedy small orders goes back to 1988. In the wake of the 1987 crash, volumes dropped because people feared markets. The NASD (FINRA today) created the Small Order Execution System (SOES – pronounced “soze”) both to give small investors a chance to trade 100 shares electronically, and to stimulate volume. Banditry blossomed. Professionals with computers began trading in wee increments. Volume returned. The little guy? Hm.

Regulators have always wanted to give the little guy opportunity to execute orders like the big guys. It’s admirable. It’s also impossible. Purchasing power is king. Attempt to make $1 and $1,000 equal in how trades execute, and what will happen is the big guys will shift to doing things $1 at a time. The little guy will still lose out but now your market is mayhem confusing busy with productive.

These benighted gaffes seem eerily to originate in Washington DC. Michael Lewis says big banks, high-speed traders and exchanges have rigged markets. We agree these three set prices for everybody. But they’re following the rules. (more…)