High Tech Front Running

In his new book Flash Boys, Michael Lewis describes how Brad Katsuyama at Royal Bank of Canada deduced what the high frequency traders were doing. Brad had been frustrated that whenever he went to trade stocks on a posted price, he’d routinely get a much smaller amount of shares than advertised. 10,000 shares of stock may be offered on several different exchanges and yet he would wind up with a fraction of that.

It turned out that his order was reaching different exchanges at different points in time. Mere milliseconds separated the time at which his orders arrived at each exchange, and yet this was sufficient to allow the HFT traders to see his order when it arrived at the first exchange (BATS), and then swiftly move to buy in front of him at the other exchanges where his order arrived less than a blink of an eye later.

Brad figured this out by inserting software that slowed down his order from reaching the closest exchange, thus ensuring they all arrived simultaneously. When transmitted in this way he was generally successful in trading the amount of shares advertised.

So nice move by the HFT crowd. Very clever, you’ve made your money. It ought to be illegal but of course technology has outpaced the regulatory framework that forbids front running. It’s obviously wrong. This is why the claim by HFT proponents that they merely provide liquidity is so disingenuous.