In the book, Lewis claims that high speed traders are able to use non-public information to make trades ahead of traditional investors. By front running trades, flash traders are costing investors tons of money each year, Lewis maintains. He has generated his fair share of media attention and the book has prompted regulators to scrutinize flash traders.
While the total impact and popularity of flash trading remains to be determined, one thing is clear: with Flash Boys generating a large amount of publicity, advisors should be prepared to answer clients’ questions about flash trading.
Some clients may simply want an explanation of the practice while others may want to know what their advisors are doing to protect their accounts from flash traders. With that in mind, advisors may want to brush up on the issue so that they can respond appropriately to client inquiries.
Flash trading is also called high speed trading. By some accounts, it allows traders to jump ahead of existing trade orders, or front run other investors. In the case of buy orders, that can increase the trading price that traditional investors get.
In a similar manner, sellers may get less for their holdings if other traders are able to front-run sell orders. The traders can also generate large trade orders quickly, which can be a shock to markets. Indeed, the substantial and rapid market decline in May of 2010 is believed to have resulted from high speed traders placing large sell orders.
Most market observers, therefore, conclude that flash trading can contribute to two issues. First, it can cause violent market declines in the absence of headline news that could justify major market moves. Secondly, it can allow investors to front run.
Advisors can protect against violent market declines with time-tested strategies such as taking a long-term perspective on investing and maintaining a diversified asset allocation.
The common belief is that most flash trading declines are short lived, which was the case in the flash crash of May 2010. By contrast, the current bull market, which includes that event, is up more than 100%.
While riding out such declines can be scary, doing so eliminates the possibility of selling shares at a temporary market low that was created by high speed traders. At the same time, maintaining a diversified portfolio can help smooth out market declines as a dip in the equity market probably won’t involve declines in asset classes such as bonds and precious metals.
Ensuring that high speed traders don't front run is a trickier issue, but some market observers maintain that even though flash traders costs investors significantly in aggregate, the total cost on individual trades may be only pennies. One way, of course, to minimize trading costs is to reduce the number of trades—or, in other words—avoid trying to time the market and instead, take a long term approach to investing.
Advisors should also explain that they will continue to follow the flash trading issues. It’s likely that increased scrutiny of the practice may call for legislative reform. If so, advisors should say they will advocate new legislation that can help protect their clients from flash traders.