8 of 8 people found the following review helpful
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This is a very important book dealing with a subject that many people find baffling. Nowadays financial markets have become so complex that it is nearly impossible for an outsider to grasp how they work. Sal Arnuk and Joseph Saluzzi try their best to reduce this complexity to terms comprehensible to the layman; but in the end it's almost a quixotic venture. If you know little of financial markets you might find "Broken Markets" difficult to follow. But the Arnuk's and Saluzzi's thesis is not all that complex. The authors argue that our financial markets are thoroughly broken. They explain how stock exchanges have been taken over by high frequency traders who use sophisticated computer algorithms to scalp pennies off nearly every share traded. This has essentially transformed stock exchanges from facilitators of capital formation to arbitrage driven casinos that are rigged in favor of a class of speculators, the high frequency traders, who account for 50 to 70 percent of the volume traded on stock exchanges and, still more ominously, 80% of the profits.
It's hard to see why anyone, after going through this book, would want to have anything to do with stock market investing. To be sure, the intention of the authors is not to scare investors away, but to motivate investors to demand reform. I'm not sure whether the specific reforms advanced in the book are either politically feasible or will actually cure the ills of hyper frequency trading. There are a number of other problems afflicting asset markets other than those limned by Arnuk and Saluzzi in "Broken Markets"; and their doesn't seem to be much interest in even comprehending, let alone tackling, these issues. Curiously, the authors of Broken Markets trace the rise of high frequency trading, not to deregulation, but to misregulation. But if this is true, how can we be sure that attempts to reregulate won't lead to an even greater disaster? We seem to be suffering from a failure of leadership in such matters. Hopefully, this book will help turns thing around and bring a bit more intelligence and wisdom to the whole issue of regulating and improving free and open markets.
19 of 26 people found the following review helpful
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Have you ever done something like the following: you place an order to buy a stock at $15.00, and your order is filled at $14.99999? The answer, which I learned from this book, is that you have just unknowingly traded with a high frequency trading (HFT) algorithm. My understanding (although the book doesn't explain this so clearly) is that something like the following happens: a (human) seller offers to sell the stock at $15.00. The computer, which is located in the same building as the computers that run the stock exchange and so has access to huge amounts of information that you don't at enormous speed, decides based on order flow that the stock is headed downward in the next few seconds and that you were an idiot to buy it (in the very short term). So the computer jumps in front of the seller, winning the auction by .001 cent per share. The human seller hasn't yet sold the stock and so may need to lower their price. This can then help the stock's price decline (in the very short-term), and the computer can then buy shares to cover the ones that it sold to you and make a profit of a couple of pennies per share. HFT algorithms do this kind of thing hundreds of millions of times a day and make billions of dollars a year. They also rapidly enter and cancel huge numbers of orders in an attempt to manipulate prices in their favor, making short term prices impenetrable and good order execution difficult for human investors.
This book passionately argues that our markets are broken as a result of HFT algorithms and the unfair conditions in which they operate. My summary of the argument as I understood it is as follows: In the "old days", the stock market was kept going by (human) market makers and specialists, who provided liquidity (i.e. being willing to buy or sell something when no one else was) and smoothing out fluctuations (e.g. by matching up large buy and sell orders). They profited from substantial spreads (e.g. bid and offer prices might be required to differ by intervals of 1/8 of a dollar), in addition to the privileged information they had. Then new regulations were introduced which allowed stocks to trade in intervals of a penny and which enabled fast electronic trading. While these nominally helped small investors by reducing spreads and taking out the middleman, they counterintuitively made things worse by causing market makers and specialists to be replaced by HFT algorithms. The HFT algorithms skim roughly as much money from the markets as the market makers and specialists used to, but without providing the same services. In particular, while the large number of high frequency trades nominally provides liquidity, when things get bad the HFT firms can simply shut down the computers and bail, as happened in the "flash crash" of May 6, 2010, when stock prices dropped a huge amount for no fundamental reason and then rebounded, all within minutes. In addition HFT makes it difficult for mutual funds that need to make large trades. Although a large trade can be broken into small chunks, HFT algorithms can sense that this is being done (with the help of information which they really shouldn't have access to) and work to move prices against you.
In addition to all of the above, there are some serious conflicts of interest and lack of transparency. Many trades are executed in one of dozens of "dark pools" whose activity does not appear in ordinary listings. A brokerage can choose among these venues to execute your order in a way which minimizes their cost of execution but which does not necessarily give you the best price. Data about your every move can be sold to HFT firms which will use it against you. HFT firms buy "colocation" (i.e. the right to place their computers in the same building as the stock exchange computers). This means that the stock exchange, instead of working to make a level playing field for all participants, is selling advantageous conditions to those that can afford the fee (as well as the necessary high tech).
I would give the book five stars for being thought provoking and informative (even though I was not convinced by all of the arguments). I am deducting a star for suboptimal organization. The book repeats the things that the authors are upset about a lot, but does not give a very clear and organized explanation of the basic facts, with interruptions for biographical interludes, and more repetition. It reads as if a collection of related blog postings were edited into a book. This is made worse by the inclusion of three guest chapters by other authors; while the guest chapters are well written by themselves (although I found their arguments more extreme and less convincing than those of the main two authors), they further repeated many of the same points. There are also appendices with "white papers" by the authors, but I didn't read them because I didn't want to hear the same stuff again (although maybe it is more clearly explained there).
Some of the arguments didn't quite convince me. For example, the "dark pools" originated as places for large orders (e.g. by mutual funds) to trade quitely without moving prices a lot. Later they became dominated by HFT. The authors seem to feel that the lack of transparency in the dark pools is good when it helps the "good guys" (mutual funds managing your hard earned savings), and bad when it helps the "bad guys" (HFT firms which skim investor pennies and perform no social good). This seems inconsistent to me (although I don't have a better suggestion and I admittely know extremely little about this topic). The first two guest chapters argue that the "flash crash" was a huge catastrophe, but if you are a long term investor, then you probably didn't notice anything (unless you were unlucky enough to sell using a market order during those few minutes). The last guest chapter argues that the introduction of penny increments for stock prices caused the loss or lack of creation of 20 million American jobs. What? The argument is that the penny increments put market makers and specialists out of business, reducing the money available to financial firms to shepherd small IPO's into the marketplace, with a resulting lack of job creation. Well, maybe something is going on there, but I think there are some other significant factors for reduced IPO's and jobs, for example, so many IPO's introduced in the late 90's were such junk that no one wanted to invest in anything like that anymore, and our country is losing its lead in education and technology so that many of our jobs can be done by workers overseas who will do so for much less.
Anyway, at the end of the book there are a few suggestions for improving the situation. Meanwhile, happy reading, and don't use market orders.
9 of 12 people found the following review helpful
James J. Biancamano
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I have been following the (meandering at times) thoughts and opinions of Sal Arnuk and Joe Saluzzi for a number of years. The guys at Themis have become thought leaders on market structure, and while for some it may be easy to disagree with their opinions, it is very hard to ignore them. I will be quite frank and say that there are quite a few issues that I differ with them on, but that's no reason for me or anyone else to have a negative opinion of this book. The book itself is not meant to be read at one sitting, it is a much easier read taken in small doses. The authors are outspoken, passionate, and right or wrong willing to take a stand on issues that too many in our industry either ignore, or afraid to speak about. Market volume is down nearly 50%, something is wrong and the authors are giving their POV. They made me question some of my own opinions, and for that alone it is worth the four star review.
One of the reasons to read this book, especially if you have witnessed the events and turmoil of the last few years, is to understand just how we have gotten to this point. Yes it focuses on HFT, but HFT is now probably more than 90% of the volume on any given day in the Equities markets. While not perfectly organized, since it covers quite a bit of ground, it still gives a good accounting of the history of the Equities Industry in the last 10-15 years. Yes it is an "insider's view" but that exactly what this subject needs. While not written as a narrative like Scott Patterson's "Dark Pools", it still manages to tell an interesting and compelling story with enough facts for the reader to understand what the flaws are and what can be done. Of all the numerous topics it tries to cover it is especially detailed when discussing the rise of HFT and Dark Pools. It's very hard to write something interesting about Exchange demutualization, Co-location, Reg NMS, Reg ATS, et al, but since the authors pull no punches, it makes for some very enjoyable reading.
The real reason to read this book is because the authors actually go out on a limb and offer solutions. Are all those solutions the right ones? Far from it, but I'd rather hear someone offer even the most ridiculous solution than offer nothing at all. It is thought provoking, informative and very entertaining. There are many people in our industry that have jumped on the anti-HFT bandwagon (and let me say for the record I don't think Sal and Joe are altogether anti-HFT) for nothing more than self serving reasons without offering real solutions; you don't get that feeling here. It is actually an enjoyable read with enough anecdotes to keep it from being tedious. It leaves the reader, especially anyone who has a very limited understanding of the equities markets armed with enough information to investigate further, and that is exactly what the authors want you to do.
15 of 21 people found the following review helpful
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When it came time for FDR to appoint the first chairman of the Securities and Exchange Commission, he selected Joseph P. Kennedy, a well-known stock market operator and speculator, presumably on the theory "it takes one to know one." Well, it was a good choice, and the SEC got off to a good start, its reputation and effectiveness not only lasting, but increasing for several decades. Unfortunately, in the last 10 years or so, this has not been the case, as theoretical economists and attorneys have led the regulator far afield from protecting investors, the original intent of the '33 and '34 Acts.
As a result many new rules have been instituted changing the investment climate, and this treatise indicts many of them, especially what has become known as high frequency trading ("HFT"), a method that allows "front running," something that was always illegal. The authors, two well-known institutional traders, have been conducting a long-standing effort to do something about the practice for several years. Their contention, of course, is that HFT is destroying investor confidence and portfolios, in general, by allowing these practioners to scalp trades with advance order knowledge and steal (often literally) pennies which mount up to millions of dollars.
It should be noted that conflicts of interest have always been present on Wall Street: Was the broker who sold you that stock acting in your or his best interest? But generally, the markets worked, companies were able to raise money, the public could amass stocks for savings and retirement. At present, however, the authors contend that this is not the case, especially when the very institutions (the SEC, NYSE, NASDAQ and other regulators) are more interested in profits and speed and volume than in the orderly markets of the past.
Read it and weep.
89 of 130 people found the following review helpful
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Broken Markets tries to be informative of the problems with modern stock markets. At times, the book is informative. Unfortunately, the authors cannot make the picture clear. Their arguments sound correct at first, but after thinking about it, they contradict themselves many times on the same page (i.e., the authors are not coherent) Examples:
- authors claim that HFT provides liquidity to the top 5% liquid stocks, but hurts the remainder 95% because they are unwilling to create a market for the less liquid stocks. On the same page, they also claim that the specialists (human market makers) are driven out because they cannot compete on speed. But if both these statements are true, why don't the human traders make markets for the 95% when HFT is not present? Makes no sense.
- authors complain about the parity priority rules. Also, they say that old specialist systems are better and praise NYSE over NASDAQ, BATS, EDGE, etc. Upon looking into the issue, only NYSE has parity priority rules, and these rules were shenanigans from the past. In other words, the authors are using bad policy from the past, claim it's used on the newest exchanges (BATS, NASDAQ, Direct EDGE) when it's not, while praising the old NYSE. This is straight up mis-representing the facts.
- authors correctly state that there's no SEC rule against flash orders, and claim they are alive and well. This is a lie. After searching on Google, I found out that NASDAQ and BATS policed themselves immediately back in september 2009 and Direct EDGE ended the practice in february 2011 (for stocks). ARCA never had flash orders. (NOTE: flash orders are present in the options market)
- on medium liquidity stocks, the authors claim that the HFT is moving the bids/asks up and down without any trades happening, and this pushes the price the mutual fund is paying in execution. Also the authors claim HFT only hold stocks for seconds. Third they claim that the previous system where the investors would trade only between themselves was offering better prices. These 3 statements create a contradiction. Here's how: say investor A is buying and investor B is selling, while you have HFT (market maker) C. Since C's holding time is so small, it must be that it trades with both A and B within a short period. This means the most C can do is make the spread. Since spreads are smaller, the system is more fair than the old stock market system. This contradicts the main claim of the book. What the authors should have said is that there are different strategies. In particular one that tries to capture the spread and minimize the holding time, and another that plays on momentum. The authors are confusing by taking some properties from some strategies and combining with properties of others. The result is incoherence.
- the authors correctly state many times, that in times of stress HFTs don't want to provide liquidity (too risky). They say the specialist system was better because they were forced to make a market. In reality no rule can force the market maker to make markets. As 1987 proved, the specialists simply didn't pick up the phone. So, it was way way worse... the market became totally illiquid. During the flash crash, the spreads were huge (about 1%) and the price move was tremendous, but there was a market (not all HFTs left). The 1987 crash took days to recover, while the flash crash recovered in 10 minutes. Also, as a magnitude, the 1987 crash was much bigger (44% from watermark, 22% in one day, and 30% in consecutive day loss); the flash crash is generally quoted at 9%. The modern market proved to be the much more robust system by comparison. The authors fail to recognize that. In any case, this should be an example on how modern market makers are better than the old time specialists. The authors draw the opposite conclusion.
- the authors keep calling HFTs as "wall street". In reality these first have little to do with banks. Yes, there are HFT groups at Goldman and Barclays, but there are maybe 100 different HFT firms, and some are not even located in NY. (Getco in Chicago, Knight in Jersey City, Tradebot in Kansas, Tradeworx in Red Bank) More important is that these firms are technology firms and in structure have nothing to do with banks. The authors are trying to piggy-back on the layman hate of banks to create hate for HFTs. Also, the HFTs are very diverse and very disorganized. The author is claiming the HFTs were using lobbying, but in reality the SEC decided to push for new rules because the old system ware extremely unfair and opaque. A couple of big HFT firms (Getco) are lobbying and try to create barriers of entry for the competition. This is nothing compared to the lobbying from banks and old brokers like the authors.
- the authors mention Kweku Adoboli, an UBS rogue trader as a bad example on HFTs. I'm not sure what they are trying to accomplish here, as this trader has nothing to do with the automatic market making of HFTs, and even if he had it'd be an example on how to lose lots of money. The authors are simply trying to link HFTs to a scandal, when no link is present. This is intentional, malicious and manipulative.
- authors claim that the fact that a hidden order matched on NASDAQ is identified with the same number if is filled multiple times (lots of partial fills). The authors claim that this is a big disadvantage because the other players can figure out there's a lot of liquidity there because the same number appears many times. This is just stupid, as the player that puts the hidden orders can just put many small orders of 100 shares, and different ID numbers would be generated. The authors are either stupid or playing stupid here.
- the authors correctly mention that the computation of indexes are based on the prices on the exchange. They claim that because of fragmentation, the regular investor doesn't see the accurate index and HFTs can compute their own based on all the prices. This is simply a stupid argument, because of reg NMS the market only has one price, and any advantage an HFT would have would be in milliseconds. The investors are not doing strategy based on changes in milliseconds. Also, since it's an aggregate, a lot of data goes into the computation of the index. Even sampling would be more than good enough to make decisions based on the index for long term investing. (unless you're doing microsecond level arbitrage, which obviously investors are not doing) In other words, the authors are claiming the investors are at a disadvantage when in reality they are not based on their example.
- colocation: the authors say it's unfair, and claim it's something new. In reality colocation appeared with the first market during the time of John Law in the 1700's when prices were different at different parts of the same square. In the 1800's the Rothschild family send their children to different markets basically using colocation. There was always a need to get close to the market. In the pit, many traders were selected from football linebackers simply because they were bigger, more visible and able to jerk others around. Needless to say we used to have a much more unfair system. Now, everybody who collocates in a datacenter has cables of the same length, (i.e., no advantage to anyone) and it's relatively cheap to colocate compared to the fees of the past.
- algos that read news: it's just stupid to complain. if they make mistakes they lose. they take risks. it's their problem. the authors claim the algos that read news destabilize the market because they can make mistakes. humans can make mistakes too. if algos make mistakes, doesn't that create opportunities for others?
- stop-loss: the authors claim many times that these orders may be triggered by temporary swings (flash crash is an extreme case). These are traditional types of instructions given to brokers. The authors never take issue with the stop-loss orders, which obviously accentuate the swings (i.e., sell when stock drops) and increase volatility. If you want to minimize volatility, stop loss orders are obviously bad to the market. No mention that these orders affected the flash crash in the sense that it made the drop bigger.
- the mention of BATS IPO is laughable at best. BATS chocked on their own technology. Nothing to do with HFTs.
- the mention of the lack of IPOs is hilarious. The authors claim that it was automatic trading the reason why we had few IPO's in the last 10 years, and also claim it costed the US economy 20 million jobs. Yeah, it had nothing to do with the fact that the banks sold a lot of snake oil during the tech bubble... and also nothing with the fact that it got expensive to go to IPO based on other regulation that has nothing to do with HFT. I'm not sure what the authors were smoking, but it must have been very potent.
On top of these the authors completely fail to recognize how much better the market is for some stocks, if not all. Say trading IBM, the spread is at times 1-2 cents and it's hard to move the price, but with the specialists, it was 100 times bigger. The costs of trading IBM went down by a factor of 100. In other words, up to 100 times reduction in costs. On trading bank of america, the spread is always 1 cent, while in the past it was force to be at least 12.5 cents, and it was at least 25 because of the gentlemen agreement they had between them.
The authors are experienced old brokers/traders from the old Instinet that cannot compete and frankly understand the market microstructure only superficially. The bottom line is that they are bitter they cannot compete with the HFT, and don't seem to have the skills to build good algos for execution. They didn't complain in the past when they were sitting in the middle making huge spreads from their clients. (yeah, they want that system back)
I give it 1 star because the book is manipulative. The authors do illuminate some of the actual problems (most which got fixed), but are trying hard to manipulate the reader and paint their image of HFTs by fabricating facts. Initially I thought they are just clueless, but after reading the entire book I'm sure they are malicious. Also note that the authors have economic incentives to stop modern trading. If you want reasons why not to trust an old broker, this book is for you.