What Do You Mean, Rigged?

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Anthony Malakian, US Editor, WatersTechnology

The book "Flash Boys" has proven to be something of a tipping point against high-frequency traders. But are the markets really rigged against the retail investor?

Say this for Michael Lewis' new book "Flash Boys", which examines high-frequency trading in the capital markets, it sure does provide for some fun conversational fodder. For my money, the best moment thus far came earlier this week on CNBC, when William O'Brien, president of Bats Global Markets, whose firm is cast as something of a villain by Lewis, had it out with Brad Katsuyama, founder of IEX exchange and who, along with Lewis' own experiences, stars as the protagonist.

The argument kicks off with O'Brien forcefully asking Katsuyama to clarify something he said in the book: Do you believe that the markets are rigged? Katsuyama eventually says, yes, the markets are rigged in favor of high-frequency ─ or flash ─ traders.

The televised debate spawned one between my friend and me. He believes that the markets are inherently rigged against the retail investor ─ but that that premise is understood. What can ya do? Shrug your shoulders and do the best you can.

The analogy he used was this: In basketball, star players get preferential calls from the referees (and this is true in soccer and football and most any other sport that has a referee). In the first game of the NBA season, Oklahoma City superstar Kevin Durant scored 42 points. By that number alone you might think he shot the ball well. But, in fact, he was a poor 9-23 from the floor, but he was an astounding 22-24 from the free-throw line. Oklahoma City beat the Utah Jazz that night. The entirety of the Jazz team went to the line 30 times, only six more times than Durant all by himself.

Now, with Durant getting all those calls, did the Jazz really ever have a chance to win the game? Were the refs were making the correct call each time? Or was he getting preferential treatment, in the way of Michael Jordan, Kobe Bryant, Larry Bird, Wilt Chamberlain and so many superstars who came before? 

The way my friend looks at it, the games are slightly rigged because of preferential calls, but it's an understood fact and any team is welcome to go out and sign or trade for a superstar. This type of rigged system is tolerable ─ very different from the type of rigging where referees (or athletes or coaches) are getting paid to create a non-organic outcome in the final score.

I disagree with this thinking. The way I look at it, those athletes ─ through hard work and superior play ─ have EARNED the benefit of a doubt on a close call. It's not like some random bench player is getting these calls; only the very best get this benefit. So the game isn't rigged, these calls are created by organic results based on top-tier play on the court, and not in some back room where the refs are deciding who will get which calls.

When it comes to high-frequency trading, I do not believe that the markets are rigged; rather, I believe that firms are making huge investments to develop cutting-edge platforms, spending on colo, and dumping money into algorithms in order to gain an advantage. Are retail investors at a disadvantage? Sure, but when the Utah Jazz's Richard Jefferson is at a severe disadvantage when he defends Kevin Durant. And Jefferson is a pro. Imagine Durant against some guy that plays in a rec league?

This opinion might ultimately prove naïve, and I reserve the right to change my mind (on HFT, anyway...I'm set in my beliefs on basketball). There's a case to be made that high-frequency trading adds liquidity to the market and lowers spreads. And as Lewis lays out, there are certainly counters to those benefits.

Are retail investors up against it when it comes to HFT? Sure. But I haven't seen conclusive evidence that proves that retail investors are getting killed because of HFT, either. Again, maybe I'm wrong here, and maybe I talk to too many people with something to gain from HFT's survival, but I'm not ready to advocate killing off the practice.

Think I'm off base here? Am I missing something? Shoot me an email ([email protected]) or give me a call (646-490-3973) and tell me just how wrong I am.

Finally, for what it's worth, CNBC ran a poll asking its readers who won the fight between O'Brien and Katsuyama. As of last night, with over 36,000 votes counted, Katsuyama received a favorable rating of 65 percent, while only 6 percent sided with O'Brien, Eighteen percent said that no one won, but the investors definitely lost, and 11 percent said that they weren't sure.

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