Invest Like the Best with Patrick O'Shaughnessy
Brad Katsuyama - What Happens When You Hit “Buy” - [Invest Like the Best, EP.61]
· Summarized
Key takeaways
- Understanding market microstructure is crucial for effective trading and investment.
- The formation of IEX was driven by the need to create a fairer trading environment amid exploitative practices in high-frequency trading.
- IEX employs a unique speed bump to mitigate latency arbitrage and protect investors.
- The revenue models of traditional exchanges can create inequities; IEX strives for a simpler, more equitable revenue structure.
- Entrepreneurial success requires conviction, a deep understanding of the problem being solved, and the ability to adapt as a company grows.
- Personal support from family and mentors is invaluable during challenging entrepreneurial journeys.
Summary
Introduction to Brad Katsuyama and Market Complexity
In this episode, Patrick welcomes Brad Katsuyama, founder of the IEX exchange and protagonist of Michael Lewis's book 'Flash Boys'. The conversation highlights the complexity of financial markets and how few market participants understand all aspects of the trading process. Brad discusses the history of IEX, the evolution of markets and exchanges, and entrepreneurship. He emphasizes the need for investors and professionals to grasp the intricacies of market mechanisms.
Latent Problems in Trading Exchanges
Brad recounts his early discovery of latency issues in trading during his time at RBC. He describes how technological advances in trading created a scenario where traders could not execute orders as expected, leading to frustrations at the buy side. The conversation illuminates how high-frequency trading strategies exploit these latency issues, emphasizing the importance of understanding market microstructure for effective trading.
The Formation and Philosophy of IEX
The discussion moves on to the formation of IEX and its mission to create a fairer trading environment. Brad explains how IEX was born out of the need to address the challenges presented by high-frequency trading and the opacity of traditional exchanges. He introduces the concept of the 'speed bump' that IEX employs to protect traders from being front-run by high-frequency traders, leveling the playing field.
Understanding Exchange Revenue Models
Brad dives into the revenue models of traditional exchanges versus IEX. Traditional exchanges often focus on revenue from market data, technology, and rebates through a 'maker-taker' model, which he argues fosters inequities in trading. In contrast, IEX aims to simplify trading, eradicating excessive fees and ensuring the best outcomes for traders, leveraging a straightforward revenue model based largely on trading activity.
Entrepreneurial Journey and Lessons Learned
Throughout the episode, Brad shares insights into his entrepreneurial journey, describing the challenges of founding IEX without initial funding. He reflects on crucial meetings with potential investors, including David Einhorn and Bill Ackman, which underscored the importance of conviction and focus on solving real market problems. He highlights how personal experiences and understanding market issues fuel the passion of a true entrepreneur.
Future Prospects and Personal Reflections
Towards the end of the conversation, Brad shares his optimism for IEX's future and his commitment to improving trading experiences for the buy side and listed companies. He emphasizes introspection and adaptability as key to navigating leadership challenges in a growing organization. The episode concludes with heartfelt reflections on kindness and support, particularly from his family, which played a significant role during his entrepreneurial struggles.
Sponsors
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Show notes
My guest this week is Brad Katsuyama, the founder of the IEX exchange and protagonist of Michael Lewis’s famous book Flash Boys, which chronicled the role of high frequency trading in markets.
This conversation was yet another reminder of how complicated markets can be, and that very few participants know all aspects of the process well. Brad and I get deep into the history behind his company, and the ways in which markets and exchanges have evolved, better or worse.
One of my favorite parts of this conversation was our exploration of entrepreneurship. Brad’s whole story is one that entrepreneurs will appreciate, and is full of lessons for those aspiring to start their own business.
Please enjoy my conversation with Brad Katsuyama
For more episodes go to InvestorFieldGuide.com/podcast.
To get involved with Project Frontier, head to InvestorFieldGuide.com/frontier.
Sign up for the book club, where you’ll get a full investor curriculum and then 3-4 suggestions every month at InvestorFieldGuide.com/bookclub.
Follow Patrick on Twitter at @patrick_oshag
Books Referenced
Flash Boys: A Wall Street Revolt
Show Notes
2:10 – (First Question) Brad’s original discovery of a latency problem in trading stocks
12:51 – how the business model of the NASDAQ and exchanges and how it may surprise people
14:16 – The edge that exchanges are now monetizing
16:46 – How Brad went from finding a solution to his current firm
20:18 – Types of high frequency traders that there are
24:33 – The formation of IEX
27:56 – Funding IEX
30:48 – What happens to the initial funding
32:30 – Describe what IEX is as it was sold to early buy side investors
34:31 – Explaining the concept of a speedbump
38:18 – Pitching companies so they will be listed on their index
40:37 – Explains maker-taker fees
44:47 – The sources of revenue for IEX vs traditional exchanges
46:53 – Most memorable meeting Brad has had in establishing IEX
49:39 – How did he do this with young kids?
52:38 – Has the pool of potential profits that high-frequency trading firms can earn gone down
53:53 – What has Brad most excited about the future in terms of helping the buyside
55:17 – What was it like to see Brad’s venture get turned into a best-selling book. (Flash Boys: A Wall Street Revolt)
59:00 – Biggest thing that Brad has learned
1:00:56 – What would Brad do if he couldn’t work in the investing world.
1:02:25 - Kindest thing anyone has done for Brad
Learn More
For more episodes go to InvestorFieldGuide.com/podcast.
Sign up for the book club, where you’ll get a full investor curriculum and then 3-4 suggestions every month at InvestorFieldGuide.com/bookclub
Follow Patrick on twitter at @patrick_oshag
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