Dark Pools and High Frequency Trading

I have yet to receive my copy of Flash Boys – clock is ticking, Amazon! – but my expectations are high. I believe Michael Lewis is one of the best writers of our day, full stop.

Should the book not measure up, however, I think I know why that will be. In my mind, the bar has already been set pretty high when it comes to books about High Frequency Trading.

In 2012 former Wall Street Journal reporter Scott Patterson wrote the excellent Dark Pools: The Rise of the Machine Traders and the Rigging of the U.S. Stock Market. As I told several friends at the time, I felt like there were at least a dozen things in that book that I should have known as a fiduciary and portfolio manager…yet I had no clue. Truly educational – and more than a bit unsettling.

As it turns out, the apparent star of Michael Lewis’ latest book, Brad Katsuyama, also very much liked Dark Pools. Here is a snippet from his full review of it on Amazon at the time:

To take a quote from the author’s previous book, The Quants: “The market was like a coin with a small flaw that makes it slightly more likely to come up heads than tails (or tails than heads). Out of a hundred flips, it was likely to come up heads fifty-two times, rather than fifty. The key to success was discovering those hidden flaws, as many as possible. The law of large numbers that [Ed] Thorp had used to beat the dealer and then earn a fortune on Wall Street dictated that such flaws, exploited in hundreds if not thousands of securities, could yield vast riches.”

By using math, science, and computers to detect slight imperfections in the market, people made fortunes, but in many ways this type of arbitrage was fair. Those who studied the coin in great detail had a better chance of predicting the outcome of the coin flip.

But has the pendulum swung too far?

This book is a good first step towards transparency, bringing to light many subjects that would never be presented to the average reader. When evaluating the fairness of today’s market, and as you read through Dark Pools, the most important question to consider is: What if some coin producers are *purposely* making imperfect coins?

The most important question, indeed.

Here is a bit more on Dark Pools from my Twitter stream at the time…

Incidentally, the other Patterson book that Katsuyama referred to in his review above is The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It. I read that after Dark Pools, and thought that it, too, was excellent.

One more book out of Patterson like those two and he’s gonna be up there on my list with Lewis.

Cale Smith

About Cale Smith

Portfolio Manager at Islamorada Investment Management.

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