Imagine you are negotiating a price with a seller at a local market. You are about to close the deal, when somebody suddenly rushes up to the stall, snatches the item from the seller's hands, sells it to you at a higher price, and pockets the difference. This is a simplified example of what goes on thousands of times a day during trading on the financial markets in the form of high frequency trading, or HFT for short.
In this book, Michael Lewis exposes this algorithmic trading, and homes in on the story of Brad Katsuyama, a former executive of the Royal Bank of Canada, who waged a real battle against high-frequency, semi-automated trading. Before we go on, it is also worth mentioning that some industry insiders found this book quite controversial, and did not agree with the author's point of view, maintaining that HFT is lawful.
In 1987, the US stock market suddenly collapsed, taking everyone by surprise, including Wall Street insiders. No one had seen it coming, nor could they explain it. Following the collapse, a series of regulatory adjustments were put in place, and some of them facilitated the transition human traders made (who were more prone to making mistakes) to computer assisted trading. The trend continued over the next couple of decades, and this new market regulation contained a flaw which brought about new systemic injustices, as many of them do.
A few years earlier, in 1978, Bradley Katsuyama, an extremely intelligent and gifted child, was born in Markham, Canada. He graduated from Laurier University in Waterloo, Ontario, and attended the Lazaridis School of Business and Economics. Throughout his life, Katsuyama cared more about morals than ambition: instead of attending a school for gifted children, he stayed in the local school, where his friends were, instead of applying to Ivy League universities, he enrolled in the Laurier, so he could stay close to his girlfriend. These are just a few examples of the kind of person he was, and still is.
After graduation, he began trading stocks at the Royal Bank of Canada, RBC, and his brilliant results earned him a promotion to head of the trading section of RBC's electronic stock sales, in New York. As time went on, Katsuyama gradually began to notice some irregularities which started to affect his work, until they reached a point, in 2007, when he could no longer buy or sell stocks at the exact same price that flashed up on his computer trading screens, because just as he was about to make a transaction, the price would suddenly change.
Differences between the offer price and the purchase price became more and more frequent, which excluded the likelihood that these fluctuations were influenced by market news. Obviously, these price discrepancies were a problem, and the lack of stability made it almost impossible to carry out any risk assessment of short-term trades.
It was as if someone out there was using the fact that stock market orders arrived at slightly different times, and at different exchanges, to front-run orders from one market to another, and profit on the difference, but this was practically impossible. So, Katsuyama and his team ran some tests to find out if their suspicions were true. Katsuyama pushed a button on his computer, and sent the same order to several different markets. Since they are in different places, there were slight differences in the time each electronic signal took to reach each market. It was only a matter of milliseconds, but mysteriously, some traders managed to collect Katsuyama's orders for specific shares and somehow beat him on a whole series of orders thanks to that tiny time gap. Once again, his order was fulfilled at a higher price than the one which appeared on his screen when he pressed the button. He didn’t understand it yet, but he knew that something was wrong.
