It took a while but my library finally got me a copy of Flash Boys – Michael Lewis. And I finished reading it yesterday.
While reading, I did not pause long enough to understand when Lewis explained why they didn’t name their exchange what they wanted to name it.
Now as I type it into a browser window I see their concern…
Trader Sex Change.com
While reading I came to realize why the markets are so screwed up. Not just screwed up but built, not to promote investors in their pursuit to financially join public corporations in their drive for product and service excellence, but built to game the whole shebang. Built to service traders.
The first obvious problem is the orderbook. The fact that it is exposed at all.
The second is the reporting of anything but price on transactions.
Imagine a grocery store.
Outside this grocery customers stand around and every now and then walk up to a chalkboard and write down their intention to buy a number of avocados. Sometimes they walk up and erase their prior intent. Other customers attempt to walk into the store to buy avocados. But before they get through the door they are accosted by this first group and asked “how many avocados are you going to buy and do you know what price you want to buy them?”
“What?” says this last customer.
“Just tell us,” says the group.
“OK, OK, um, 10 and I’d like to pay nothing more than a dollar apiece.”
“Good” say’s the group, “wait right here,” while one one of them runs in, buys 10 avocados for $0.99 apiece and runs out and sells the last customer 10 avocados for $1.00 each.
“Hey, thanks!” says this customer.
“No. Thank YOU!” say’s the group.
The orderbook is still necessary. It’s part of the matching engine inside each exchange. But exposing it only benefits one class of people – traders.
Fortunately dark pools eliminate this ability. Or at least I think it was their intent to do this. All of the exchanges should be dark pools with no alternate “pay-per-view” windows into their activity.
Imagine this same grocery store again.
This time this same group is sitting outside the grocery story and stopping each customer when they exit the store.
“How many avocados did you buy?”
“What?” says the customer, “what business is it of yours how many avocados I bought?”
“Just tell us the answer!”
“OK, OK, 10, jeeze — now leave me alone alright!”
“Guys, he just bought 10 avocados! Hardly anybody buys 10 avocados in a bunch like that. Something must be up!”
They all run in and try and buy up all the avocados. The price goes through the roof. The original customer comes back in an hour and tries to buy some more because he miscalculated the size of his party and a dozen more people showed up. But now the price of avocados is 3 times what it was an hour ago. But he really needs the avocados and he sees a bunch of people sitting outside the store with sacks of avocados.
“Did you buy all the avocados?”
“Maybe. You need some?”
“Yes, but I’m not paying $3.00 each for them.”
“Well, OK, we’ll sell them for $2.00 then.”
“Jeeze, what a ripoff. FINE! Sell me 5 more.”
This is bizarre – but this is how the markets work.
If the group of people outside the store only knew the PRICE that someone paid for their avocados, that is one thing. That says ‘avocados are worth this $ much.’ Maybe the price goes up a little maybe it drops, depending on what the supply was inside the store. But exposing the quantity of purchases to everyone outside the story only goes to promote gamesmanship. By knowing the quantity traders game the system, becoming extraneous middlemen where not extra middlemen need exist. Traders obviously are NOT investors. They’re not going to make guacamole. They just want to grift investors a few pennies. They just want to add friction costs to the system.
I fucking hate traders.