A detailed exposé on how the market is rigged from a data-centric approach(nanex.net)
nanex.net
A detailed exposé on how the market is rigged from a data-centric approach
http://www.nanex.net/aqck2/4661.html
16 comments
That's not what's happening here. Traders are arbitraging and reacting to public trades and orders on multiple markets.
If you walk through a physical market where 8 apple carts are lined up, all selling apples for $1, buy every apple at cart #1, then buy every apple at cart #2, and so on, would you be surprised to find the price moving up or sellers stepping away as you approached carts #7 and #8?
The same thing happens when trading. Securities trade on multiple markets and multiple exchanges cannot match cross-market trades atomically. It's absurd to suggest that one side of the trade should be expected to close his eyes to what's happening in the world around him and sit tight while a huge trader runs his quote over. Why is one party more deserving of a good price than the other?
If you route to one exchange only there is no way for anyone to see or react to your marketable order before it executes, ever. If you route your orders intelligently, it can be very difficult or impossible for anyone to pull away before you get your fills. That's the executing broker's job. Instead of getting better at his job, this broker would rather complain to a very vocal conspiracy theorist who has been proven wrong many times in the past by people with actual experience and data: http://zacharydavid.com/bad-research/the-hunsader-follies/
If you walk through a physical market where 8 apple carts are lined up, all selling apples for $1, buy every apple at cart #1, then buy every apple at cart #2, and so on, would you be surprised to find the price moving up or sellers stepping away as you approached carts #7 and #8?
The same thing happens when trading. Securities trade on multiple markets and multiple exchanges cannot match cross-market trades atomically. It's absurd to suggest that one side of the trade should be expected to close his eyes to what's happening in the world around him and sit tight while a huge trader runs his quote over. Why is one party more deserving of a good price than the other?
If you route to one exchange only there is no way for anyone to see or react to your marketable order before it executes, ever. If you route your orders intelligently, it can be very difficult or impossible for anyone to pull away before you get your fills. That's the executing broker's job. Instead of getting better at his job, this broker would rather complain to a very vocal conspiracy theorist who has been proven wrong many times in the past by people with actual experience and data: http://zacharydavid.com/bad-research/the-hunsader-follies/
"If you walk through a physical market where 8 apple carts are lined up, all selling apples for $1, buy every apple at cart #1, then buy every apple at cart #2, and so on, would you be surprised to find the price moving up or sellers stepping away as you approached carts #7 and #8?"
If some guy had a business where his sole service was to sit in the apple cart market waiting to front run me and then immediately sell the apples right back to me, I'd be surprised and super pissed.
If some guy had a business where his sole service was to sit in the apple cart market waiting to front run me and then immediately sell the apples right back to me, I'd be surprised and super pissed.
There's an analogue in the entertainment industry: ticket touting.
If buyers were to time divide their order and time it so the request ended up at each exchange at the exact same millisecond, would this prevent others from reacting to the big trader?
If you read "Flash Boys" by Michael Lewis, he describes the creation of the IEX, which attempts to do exactly this. RBC created a tool to try and synchronize order flow, which worked for a time. Part of the solution that IEX uses is to put large spools of fiber-optic line in between the servers to delay order flow long enough to negate the HFT systems.
Also if you read "Flash Boys" you will realize that the guys that started IEX previously worked for brokers whose central job is making sure orders get executed well and they were terrible at it. They literally did not understand basic market fundamentals that they were getting paid millions of dollars to understand. I'm not convinced I want these same guys routing my orders.
As anyone with a lick of understanding in technology has to ask, why the hell do they need big spools of fiber to negate HFT systems? Can't they implement low latency time stamping much cheaper? I suppose that a box full of computer chips won't impress big named "journalists" nearly as much as a spool of fiber though...
As anyone with a lick of understanding in technology has to ask, why the hell do they need big spools of fiber to negate HFT systems? Can't they implement low latency time stamping much cheaper? I suppose that a box full of computer chips won't impress big named "journalists" nearly as much as a spool of fiber though...
>As anyone with a lick of understanding in technology has to ask, why the hell do they need big spools of fiber to negate HFT systems? Can't they implement low latency time stamping much cheaper?
It's actually a quite elegant solution, and most likely cheapest: it gives you very precise, reliable, repeatable, order-preserving delay for one-time installation cost and you don't have to pay to developers, wait for software to be written and debugged and don't have to buy additional hardware!
It's actually a quite elegant solution, and most likely cheapest: it gives you very precise, reliable, repeatable, order-preserving delay for one-time installation cost and you don't have to pay to developers, wait for software to be written and debugged and don't have to buy additional hardware!
Yes, this is what a good broker does.
Except that what's happening is that the order is against a "cart" with sufficient inventory to completely fulfill the initial order, and other actors are interrupting the transaction to add carts 2-n. Is that not the case?
I'd say its worse than that. As you reach for each apple in the cart you've chosen, someone with an empty cart runs over and grabs it just before your hand can close around it, takes it back to his own cart and marks it up a few cents.
Not for each apple. At the very worst case you get the first apple you tried to reach for. After that all further apple prices may change. Then you can reach and take another one and all further apple prices may change, etc.
You'll notice that there was a quote at exchange A and exchange B. You reached for, and got, an apple at exchange A. Now you're trying to reach for an apple at exchange B and you're surprised that it's a different price.
People are mostly pissed because the time between reaching for the apple at A and B is so fractionally small that they feel there shouldn't be a difference in price. That's really the only issue they have.
You'll notice that there was a quote at exchange A and exchange B. You reached for, and got, an apple at exchange A. Now you're trying to reach for an apple at exchange B and you're surprised that it's a different price.
People are mostly pissed because the time between reaching for the apple at A and B is so fractionally small that they feel there shouldn't be a difference in price. That's really the only issue they have.
It's not the case. The trader wanted 20 000 shares, there was a combined amount of 24 800 shares, i.e. every exchange had less then 20 000.
If you stood in front of all of those carts simultaneously and said "I'll take all of your stock at the advertised price", I'm guessing you'd be a bit peeves if someone else pushed in front of you and started buying some of the stock (the equivalent of the 1,570 shared bought by some random buyer at the exact point this order was put in).
You would be peeved. Doubly so, because in the context of finance, that's actually illegal.
But the key word in your example is "simultaneously", and it's the thing that did not happen in this example. This is more like "I bought all the apples at the first cart, and by the time I got to the second card, half the carts had raised their prices, and most of the apples at the remaining parts had been bought by enterprising traders who decided there must be something special about apples all of a sudden".
It's hard to see the problem. Or the solution.
But the key word in your example is "simultaneously", and it's the thing that did not happen in this example. This is more like "I bought all the apples at the first cart, and by the time I got to the second card, half the carts had raised their prices, and most of the apples at the remaining parts had been bought by enterprising traders who decided there must be something special about apples all of a sudden".
It's hard to see the problem. Or the solution.
There are two possible solutions.
The first solution is to forbid multiple marketplaces for a single virtual asset. Honestly, the service provided by these marketplaces is very simple, and could be provided by a non-profit organization that is bound by law to ensure low barriers to entry. This would be a win for everybody, really.
The second solution is to enforce that markets operate on a synchronized heartbeat with sealed bid changes. It would work somewhat like this:
T=0: Bids from the last heartbeat are published; market starts accepting bids for the next heartbeat, but those bids remain sealed T=1: Market stops accepting bids T=2: Trading engine matches bids, executes orders, and publishes all bids; market starts accepting bids for the next heartbeat, but those bids remain sealed (that is, the market is now in the same state as it was at T=0)
Have one time unit be something like a minute, and force markets trading the same asset to be sufficiently synchronized.
The first solution is to forbid multiple marketplaces for a single virtual asset. Honestly, the service provided by these marketplaces is very simple, and could be provided by a non-profit organization that is bound by law to ensure low barriers to entry. This would be a win for everybody, really.
The second solution is to enforce that markets operate on a synchronized heartbeat with sealed bid changes. It would work somewhat like this:
T=0: Bids from the last heartbeat are published; market starts accepting bids for the next heartbeat, but those bids remain sealed T=1: Market stops accepting bids T=2: Trading engine matches bids, executes orders, and publishes all bids; market starts accepting bids for the next heartbeat, but those bids remain sealed (that is, the market is now in the same state as it was at T=0)
Have one time unit be something like a minute, and force markets trading the same asset to be sufficiently synchronized.
Well, yes, those are potential solutions. But are they solutions to the problem we actually have? Indeed, what problem do we have?
Do we, in point of fact, even have a problem that needs solving? The core complaint is some unnamed institutional trader really wanted to buy a very large number of shares in one go at a very low price, while other institutional traders wanted to sell the shares at a higher price. Why are we meant to care who wins that fight?
Do we, in point of fact, even have a problem that needs solving? The core complaint is some unnamed institutional trader really wanted to buy a very large number of shares in one go at a very low price, while other institutional traders wanted to sell the shares at a higher price. Why are we meant to care who wins that fight?
Yes. We have the problem that the 'financial industry' is running some kind of insane MMORPG which excludes and abuses most of the population to make a fast buck.
What markets should do to be efficient is invest in clever, talented people doing clever, talented things.
Every step back from that is economically inefficient, because it makes it harder to create a population with deep reserves of wealth and opportunity.
Games like this one are the equivalent of having someone cut in front of you on the freeway in a semi.
It's not efficient, it's just banal abuse of a system that is supposed to reward good ideas and filter out bad ones.
What markets should do to be efficient is invest in clever, talented people doing clever, talented things.
Every step back from that is economically inefficient, because it makes it harder to create a population with deep reserves of wealth and opportunity.
Games like this one are the equivalent of having someone cut in front of you on the freeway in a semi.
It's not efficient, it's just banal abuse of a system that is supposed to reward good ideas and filter out bad ones.
Your second solution already exists and is called an auction. Most exchange have an auction before market open and one after market close. Some even have auctions during the day.
I think part of the problem is a disconnect between what the customer conceptually thinks is going on (a single buy request, as far as I can tell) and what is going on behind the scenes - a bunch of individual purchases being made by the broker.
If it wasn't possible for people not directly involved in those individual purchases to listen in and react to them quicker than the broker can fulfil the remaining purchases, it wouldn't be a problem. What is going on may well not actually be illegal, but as an individual trader it's not something you'd expect to be able to happen so it's definitely worth knowing about.
If it wasn't possible for people not directly involved in those individual purchases to listen in and react to them quicker than the broker can fulfil the remaining purchases, it wouldn't be a problem. What is going on may well not actually be illegal, but as an individual trader it's not something you'd expect to be able to happen so it's definitely worth knowing about.
That is very true, but nobody is pushing through here. The trader clearly didn't send his orders to all exchanges at the same time since other traders had time to update their prices. The article talks about milliseconds when arbitraging happens in microseconds.
What you are describing isn't what happened. What happened was you stand in front of the carts and yell "I'll take all of your stock at the advertised price" but all the sellers hear you say that too so they say, "man, if you want to buy out everything we're going to raise the price on you a bit."
This isn't a perfect analogy, but it's close.
You're making the mistake of thinking that HFTers are inserting themselves between the buyers and the people offering to sell. That's not right. The HFTers ARE the ones offering to sell.
This isn't a perfect analogy, but it's close.
You're making the mistake of thinking that HFTers are inserting themselves between the buyers and the people offering to sell. That's not right. The HFTers ARE the ones offering to sell.
The trader wanted to buy 20 000 shares at 17.38, that's a bit less than 350 000 dollars, certainly not pocket change. In fact, that was more than any individual exchange could provide, and barely enough with all exchanges combined. You would expect the price to go up with such high demand and limited supply. And indeed you see that, when he starts trading on BOST, other market participants update their price in other markets by cancelling their orders and inserting them at a higher price.
From the article:
>Also note how the cancellations rotate through many different exchanges. That's one sure way to throw off, confuse, stall a smart order router.
Or you know, because it's multiple market participants that are updating their prices.
>Someone else shouldn't have the facility to buy it based on my own trade signal and try sell it back to me.
What? If you're the owner of a bakery and you see a guy buying every single bread that your competitor is selling, wouldn't you increase the price of your own bread in case this guy comes to you?
From the article:
>Also note how the cancellations rotate through many different exchanges. That's one sure way to throw off, confuse, stall a smart order router.
Or you know, because it's multiple market participants that are updating their prices.
>Someone else shouldn't have the facility to buy it based on my own trade signal and try sell it back to me.
What? If you're the owner of a bakery and you see a guy buying every single bread that your competitor is selling, wouldn't you increase the price of your own bread in case this guy comes to you?
It doesn't sound like anything different from "normal" markets is happening.
You are selling stuff, someone or some people buys a big bunch of it, you think it sells good an rise the price later, now the someone has to buy the stuff for a higher price.
The only difference is the time between the first buy and the second buy for a higher price.
Even if you send your buy-orders at the same time to two different sellers, they don't have to arrive at the same time and if the second seller has "heard" about the first sell, he has enough time to rise the price.
You are selling stuff, someone or some people buys a big bunch of it, you think it sells good an rise the price later, now the someone has to buy the stuff for a higher price.
The only difference is the time between the first buy and the second buy for a higher price.
Even if you send your buy-orders at the same time to two different sellers, they don't have to arrive at the same time and if the second seller has "heard" about the first sell, he has enough time to rise the price.
Say there are three exchanges, A, B, C, each with 1k shares of Ford on offer at $20. They are all random numbers of ms away from me, and for simplicity say A is closest and C is farthest. I send out my order for 3k shares at $20, and it hits A then B then C. People who are watching A see my request, and try to make adversarial changes on B and C. They have a low chance of success on B because it's almost as close to me as A is, but they have a higher chance on C because it's pretty far from me.
One way to fix this is to delay your orders carefully so that A, B, and C will all get your order at almost the same time. Now there's not time for someone who sees your order on A to react and send a message to C that will beat your message to C.
I believe this is what IEX does: http://en.wikipedia.org/wiki/IEX
One way to fix this is to delay your orders carefully so that A, B, and C will all get your order at almost the same time. Now there's not time for someone who sees your order on A to react and send a message to C that will beat your message to C.
I believe this is what IEX does: http://en.wikipedia.org/wiki/IEX
That's not what IEX does. IEX is, to fit within your example merely exchange A. It can't control whether you delay your order to B or C or not.
What A does do is delay the output. When it receives an order it doesn't immediately broadcast that information back out, it waits some small (but relevant) period of time.
What A does do is delay the output. When it receives an order it doesn't immediately broadcast that information back out, it waits some small (but relevant) period of time.
A solution: Discrete double auctions. Instead of continuous trading, the exchange can divide up the day into a series of small windows (say 100ms). When you come to trade in the market, you have to wait for the next window to open. You submit your order and you find out what happened at the end of the window. This way nobody has any timing advantage and the delay is barely noticeable to 'normal' traders (waiting 1/5 of a second is hardly an inconvenience). It also stops all the order-book shenanigans that HFT players get up to (where they stuff the book with orders and cancel/resubmit them at high frequency).
So why don't exchanges do this? They make a ton of money in fees, it simply isn't in their interest to prevent HFT at the moment. Change their incentives (ie. regulate differently) and they might actually do something about it.
So why don't exchanges do this? They make a ton of money in fees, it simply isn't in their interest to prevent HFT at the moment. Change their incentives (ie. regulate differently) and they might actually do something about it.
Actually there are lots of discrete auctions in the electronic trading world. For instance the S&P futures contracts trade this way before the open and depending on your perspective they have more "shenanigans" being played by HFT players. Not less.
There are 2 major issues that no one brings up when they say "simply add discrete auctions". A) what happens when there are more participants on 1 side of a price than on the other, what is the tie breaker after price? B) How does this solve the distributed systems problem of multiple exchanges trading at the same time?
There are 2 major issues that no one brings up when they say "simply add discrete auctions". A) what happens when there are more participants on 1 side of a price than on the other, what is the tie breaker after price? B) How does this solve the distributed systems problem of multiple exchanges trading at the same time?
If you offer something for sale at a certain price and someone says "I'll buy it!" you have a contract at that moment.
I don't fully understand the conditions under which you can cancel an order but it seems all the cancellations happened on exchanges where no orders had yet been fulfilled so I assume this means that the order had not yet arrived. This seems ethically just about OK to me but a sign that there is not one single stockmarket and that the system could be far better designed.
There is the single front-running trade which is suspicious but it seems plausible (unless it happens every time) that it was just a small random trade that happened to coincide with the timing of the big trade. It should be monitored though.
My conclusions:
1. There is not one single market with a number of available shares but a number of linked markets. Send your trade to a single exchange (first at least) with enough offered shares that it should execute before offers can be cancelled. Wait, repeat.
2. Much of the liquidity supposedly offered by HFT is illusory and disappears if you try to use it.
I think that the market could probably be improved if cancellation weren't free or at least weren't instant. If cancellations took a second (maybe 100ms or 10ms would be enough) to process and the offers could still be accepted in that period the offers made would be more serious and although the spread might be slightly larger it would more honestly reflect reality.
I don't fully understand the conditions under which you can cancel an order but it seems all the cancellations happened on exchanges where no orders had yet been fulfilled so I assume this means that the order had not yet arrived. This seems ethically just about OK to me but a sign that there is not one single stockmarket and that the system could be far better designed.
There is the single front-running trade which is suspicious but it seems plausible (unless it happens every time) that it was just a small random trade that happened to coincide with the timing of the big trade. It should be monitored though.
My conclusions:
1. There is not one single market with a number of available shares but a number of linked markets. Send your trade to a single exchange (first at least) with enough offered shares that it should execute before offers can be cancelled. Wait, repeat.
2. Much of the liquidity supposedly offered by HFT is illusory and disappears if you try to use it.
I think that the market could probably be improved if cancellation weren't free or at least weren't instant. If cancellations took a second (maybe 100ms or 10ms would be enough) to process and the offers could still be accepted in that period the offers made would be more serious and although the spread might be slightly larger it would more honestly reflect reality.
Cancellations aren't free and they aren't instant. Every (reputable) exchange out there requires you maintain a fill ratio or you will be fined. That is, you have to maintain a minimum number of quotes that get filled before they are cancelled.
I don't know how "fill ratio" is defined. I don't see a problem in unfilled orders at prices that are never reached but if you pull out from the market as soon as someone offers the other side to your trade that doesn't sit well with me. I wouldn't mind companies offering small quantities at the current price and other quantities at progressively higher prices and cancellations/adjustments being made after a particular trade had been processed which would be a transparent way to handle it
What do you mean that the cancellations aren't instant? If they can outrun a bid to accept them that is instant as far as I'm concerned.
What do you mean that the cancellations aren't instant? If they can outrun a bid to accept them that is instant as far as I'm concerned.
Well "fill ratios" are defined differently by each different exchange, but the simplest definition is the number of orders entered divided by the number of orders traded must be above a certain threshold or you will have negative consequences (fees, trade bans, etc).
Your description of how companies are pricing orders is exactly what's happening. On a given exchange no cancel can outrun a bid to accept a resting order. In fact, you don't have any idea that the bid has arrived until after a trade has happened.
What is being described in the article is that a trader is viewing an aggregate of all exchanges as if they were one exchange (either due to ignorance, naivety, bad tools, or due to misrepresentation). The trader then takes out an entire price level at one exchange (none of those orders are cancelled) before trying to do the same thing at the other exchanges. The participants who just got filled at exchange A, then cancel their orders at exchange B. To the trader who was viewing multiple exchanges as a single entity this seemed like it happened all at once, but to the traders who were viewing the exchanges, correctly, as different entities there is a timeline that is observable and public (in fact nanex describes it).
Your description of how companies are pricing orders is exactly what's happening. On a given exchange no cancel can outrun a bid to accept a resting order. In fact, you don't have any idea that the bid has arrived until after a trade has happened.
What is being described in the article is that a trader is viewing an aggregate of all exchanges as if they were one exchange (either due to ignorance, naivety, bad tools, or due to misrepresentation). The trader then takes out an entire price level at one exchange (none of those orders are cancelled) before trying to do the same thing at the other exchanges. The participants who just got filled at exchange A, then cancel their orders at exchange B. To the trader who was viewing multiple exchanges as a single entity this seemed like it happened all at once, but to the traders who were viewing the exchanges, correctly, as different entities there is a timeline that is observable and public (in fact nanex describes it).
Plucking from throwaway's example. You have 20,000 copies of a book you just wrote. You put half of them on Amazon, and the other half on eBay, so Amazon has 10,000 and ebay has 10,000 of them.
You see an order come in for 5,000 of them on Amazon. You think "Hot dog, these books are popular. I must be selling them too cheaply!" You immediately raise the price of all the books by 25 cents to capitalize on this.
The books you sold on Amazon are sold, so they're gone. The remaining books on Amazon are slightly more expensive.
The guy who bought the books on Amazon also bought the same number of books on eBay, but the order hadn't arrived there yet, so between when he hit the buy button and the time the order arrived, the price had changed, so those orders aren't filled.
You see an order come in for 5,000 of them on Amazon. You think "Hot dog, these books are popular. I must be selling them too cheaply!" You immediately raise the price of all the books by 25 cents to capitalize on this.
The books you sold on Amazon are sold, so they're gone. The remaining books on Amazon are slightly more expensive.
The guy who bought the books on Amazon also bought the same number of books on eBay, but the order hadn't arrived there yet, so between when he hit the buy button and the time the order arrived, the price had changed, so those orders aren't filled.
Using the analogy of the books you are raising the price in the milliseconds between the customer clicking buy and packets of that request reaching ebay's servers and all after the user has seen your price and stock availability a second ago. I don't think this acceptable business practice, if you have seen a price and a stock you should be able to place the order and (unless another order that isn't front running has arrived first to deplete the stock) the order should be fulfilled even if you show a different price to the next visitor to the product page.
I can sort of see that but I don't quite understand why there are different exchanges. I can't see the benefit except to those for whom it is an arbitrage opportunity.
I would also expect there to be low cost systems by which you could place simultaneous orders on all exchanges (at the cost of a slight delay in the order starting to allow them all to be posted at the same time as the furthest one.
The HFT still seems to add little real liquidity. The spreads that are shown may be narrower but the real spread seems much higher.
I can sort of see that but I don't quite understand why there are different exchanges. I can't see the benefit except to those for whom it is an arbitrage opportunity.
I would also expect there to be low cost systems by which you could place simultaneous orders on all exchanges (at the cost of a slight delay in the order starting to allow them all to be posted at the same time as the furthest one.
The HFT still seems to add little real liquidity. The spreads that are shown may be narrower but the real spread seems much higher.
> Using the analogy of the books you are raising the price in the milliseconds between the customer clicking buy and packets of that request reaching ebay's servers and all after the user has seen your price and stock availability a second ago. I don't think this acceptable business practice
Speed shouldn't be the factor for why this isn't acceptable. The seller doesn't know that there are orders in the queue for the eBay order, they're just raising the price. That they're doing it quickly is just a matter of efficiency.
> I can sort of see that but I don't quite understand why there are different exchanges.
Yeah. No idea there.
> I would also expect there to be low cost systems by which you could place simultaneous orders on all exchanges
There are.
Speed shouldn't be the factor for why this isn't acceptable. The seller doesn't know that there are orders in the queue for the eBay order, they're just raising the price. That they're doing it quickly is just a matter of efficiency.
> I can sort of see that but I don't quite understand why there are different exchanges.
Yeah. No idea there.
> I would also expect there to be low cost systems by which you could place simultaneous orders on all exchanges
There are.
Fair enough speed isn't really the criteria. In the Ebay example Ebay know what price they showed the customer on the product page when they went to the checkout and should fulfil it if they can (provided the transaction is completed in reasonable time - a couple of minutes in the book buying world). This is maybe an illustration of the problem with the analogy rather than being a useful insight into the trading system.
I think that the analogy works pretty well, surprisingly. I see no functional difference between changing the price in near real time as a reaction to another order on another exchange as I do "Hey, let's wait til midnight", which might equally screw the guy trying to put his order in at 11:59:59.
That said, I'm not an expert in the field, and I've just pieced this information from other posts. I have no strong opinion on the matter, but after throwaway's explanation (and all the subsequent discussion), my uninformed position agrees with his; that this article is exaggerative, and not indicative of anything being 'rigged'.
Moving fast, at least in my opinion, isn't cheating.
If they were raising the price on Ebay in response to the same customer's buy offer on Ebay, I would consider that unseemly, but not even necessarily unfair, as it only assumes that the buyer is willing to pay the newly raised price, and has approximately as much risk of losing the sale as making it.
That said, I'm not an expert in the field, and I've just pieced this information from other posts. I have no strong opinion on the matter, but after throwaway's explanation (and all the subsequent discussion), my uninformed position agrees with his; that this article is exaggerative, and not indicative of anything being 'rigged'.
Moving fast, at least in my opinion, isn't cheating.
If they were raising the price on Ebay in response to the same customer's buy offer on Ebay, I would consider that unseemly, but not even necessarily unfair, as it only assumes that the buyer is willing to pay the newly raised price, and has approximately as much risk of losing the sale as making it.
As far as I understand it a contract is made when there is an offer and an acceptance of that offer. If you are Ebay/Amazon I don't think that you can show one price and then just happen to change it as the user accepts it. The price charged should be the one offered. If the product page shows a price and user puts it in their basket and orders in within a reasonable time (5-10 minutes) the offered price should be honoured even if the price changed in the 5-10 minutes and all customers going to the product page at that point see the new price.
Note: This is not the behaviour I expect to see of share trading platforms but it is the way consumer goods sales should behave.
Note: This is not the behaviour I expect to see of share trading platforms but it is the way consumer goods sales should behave.
With the advent of electronic price labeling in retail stores we will soon live in a world where the price can change after you've picked up an item of the shelf and before you check out at the front of the store.
http://www.marketingmagazine.co.uk/article/1181195/real-time...
http://www.marketingmagazine.co.uk/article/1181195/real-time...
I don't think that this would be legal in the UK unless on upwards changes the labels changed a reasonable[0] time before the prices. Unfair Commercial Practices Directive and probably some other laws would probably cover it.
[0] A small shop could probably do it much quicker than a large supermarket which might have to allow for people being in there for an hour.
[0] A small shop could probably do it much quicker than a large supermarket which might have to allow for people being in there for an hour.
Ya, I'm sure there will be tricky regulatory issues here both in the UK and elsewhere. I'm just pointing it out as I find it interesting.
Yeah, and if this happened at, let's say, 10 hour intervals, I'm sure the average layman would have no problem with the "fairness" of this. People are getting their panties in knot because it's somehow "unfair" that this can happen at the millisecond level.
I personally don't have a problem with this type of trading activity. A few guys are making easy money. So what?
I personally don't have a problem with this type of trading activity. A few guys are making easy money. So what?
Actually it's not easy money at all. It is very risky money done on razor thin margins.
I don't think that makes the case for allowing it any stronger.
What I do wonder is if these market reactions are so automatic and predictable whether there is a way to game them (I'm sure people already do this). It is probably a deterrent to front running on a large scale.
What I do wonder is if these market reactions are so automatic and predictable whether there is a way to game them (I'm sure people already do this). It is probably a deterrent to front running on a large scale.
A) Repeat after me. There is no front running in these scenarios. Front running happens between a client and his intermediary that has a fiduciary duty to him. Other market participants do not have that duty.
B) Yes, market making HFT are routinely fighting against other HFT that are designed to predict their behavior and make money from them.
The case for allowing it is simple. How do you disallow it without having even worse outcomes. There is quite a bit of evidence that suggests that for the average market participant HFT market makers are a positive not a negative.
B) Yes, market making HFT are routinely fighting against other HFT that are designed to predict their behavior and make money from them.
The case for allowing it is simple. How do you disallow it without having even worse outcomes. There is quite a bit of evidence that suggests that for the average market participant HFT market makers are a positive not a negative.
A) I wasn't saying that there was front running in the scenario, just that the exploitability of front running by deliberately trying to trigger it was probably a deterrent.
Not convinced about that statement about average market participants, also define average market participant and explain where the HFT's profits come from if not other participants.
How do you disallow it?
My initial suggestion was to slow down cancellations so that they take substantially longer than a new trade does to pass through the system. My perception is that it might reduce the visible liquidity/availability but not the real liquidity as much of the visible liquidity disappears when someone tries to trade against it.
Another suggestion would be to move to a single exchange
Not convinced about that statement about average market participants, also define average market participant and explain where the HFT's profits come from if not other participants.
How do you disallow it?
My initial suggestion was to slow down cancellations so that they take substantially longer than a new trade does to pass through the system. My perception is that it might reduce the visible liquidity/availability but not the real liquidity as much of the visible liquidity disappears when someone tries to trade against it.
Another suggestion would be to move to a single exchange
Yes, HFTs profit from other participants because they are selling a service: liquidity.
There have ALWAYS been sellers of liquidity. Due to automation human sellers have been replaced by computers that cost far far less. So the cost of liquidity has gone down DRAMATICALLY. Spreads used to be a quarter (or higher). Now they are a penny. That's a 25x reduction!
Here's the chief executive of Vanguard (the world's largest mutual fund company) talking about how HFTs have lowered trading costs for their clients:
http://www.cnbc.com/id/101615521
If you slow down cancellations or otherwise try to slow information flow to HFTs you will simply raise their risk which will force them to raise the price they charge for selling liquidity by increasing spreads.
Stop thinking of HFTers as parasites and think of them as service providers and you'll have a clearer picture of reality.
There have ALWAYS been sellers of liquidity. Due to automation human sellers have been replaced by computers that cost far far less. So the cost of liquidity has gone down DRAMATICALLY. Spreads used to be a quarter (or higher). Now they are a penny. That's a 25x reduction!
Here's the chief executive of Vanguard (the world's largest mutual fund company) talking about how HFTs have lowered trading costs for their clients:
http://www.cnbc.com/id/101615521
If you slow down cancellations or otherwise try to slow information flow to HFTs you will simply raise their risk which will force them to raise the price they charge for selling liquidity by increasing spreads.
Stop thinking of HFTers as parasites and think of them as service providers and you'll have a clearer picture of reality.
The difference would be that you cancel all the orders currently in progress, so a bunch of people who've clicked "buy" are now in the lurch.
What is happening here is really quite simple, and doesn't deserve an entire blog post.
There are two exchanges, A and B, and a market maker Jill is quoting (say) 10,000 shares on each of those two exchanges for $17.
Big institutional trader Jack sees the 20,000 shares and decides that he wants to buy 15,000 of them, so he sends two orders for 7,500 shares each to A and B. Because of various effects (network latencies, routing switching delays, whatever) his order arrives at exchange A first, and is immediately filled at $17.
Jill, who has her computer co-located at exchange A, sees that she has sold 7,500 shares for $17, and realizes that there is demand for shares. Because of this demand, she decides to raise her prices. She immediately cancels her remaining 2500 shares on exchange A and replaces them with 10,000 shares at $17.05 and sends an instruction to do the same thing at exchange B.
Because Jill has fast computers and low-latency connections, her cancellation arrives at exchange B before Jack's buy order, so Jack is told that there are no longer shares available on exchange B at $17.
RESULT: Jack is filled for 7500 shares at $17 (half of what he requested) and the new market best offer is $17.05. Jack is welcome to submit another order for $17.05 if he wants to buy at that price. Jill is now short 7500 shares at $17, and will try to buy them back at a lower price (she may or may not succeed - until she does, she is exposed to the risk of further price rises).
Jill was able to use her speed advantage to detect that there was additional demand to buy this stock, and raise the price at which she was willing to sell it before Jack had finished buying all that he wanted to. This is exactly the way that an efficient market is supposed to work - it reacts to fluctuating demand (and other information) to set appropriate prices.
I think there are several things that get glossed over while people are working themselves up about this -
1. Jack is upset because he couldn't buy 15,000 shares at the price he wanted to buy them. But Jack has no god-given right to be able to buy shares at the price he likes best. He is subject to the laws of the market, just like everyone else.
2. The only reason that Jill has a speed advantage over Jack is because she has paid for it! She has paid to co-locate her server at the exchange, and she has paid to use high-speed connections between exchanges. Are we going to declare that paying for a competitive advantage is suddenly immoral?
3. If Jack doesn't like this state of affairs, he has several options. He can invest in high-speed infrastructure as well. He can use smarter order-routing logic (e.g. adding delays to his orders so that they arrive at the exchanges approximately simultaneously, or splitting his large order up into multiple smaller orders). Or he can use a broker who will do these things for him. If Jack doesn't want to pay for any of these things, then he has to put up with lower quality execution. As much as he might wish it, the ability to buy as many shares as he wants at the price he wants them is not a universal human right.
There are two exchanges, A and B, and a market maker Jill is quoting (say) 10,000 shares on each of those two exchanges for $17.
Big institutional trader Jack sees the 20,000 shares and decides that he wants to buy 15,000 of them, so he sends two orders for 7,500 shares each to A and B. Because of various effects (network latencies, routing switching delays, whatever) his order arrives at exchange A first, and is immediately filled at $17.
Jill, who has her computer co-located at exchange A, sees that she has sold 7,500 shares for $17, and realizes that there is demand for shares. Because of this demand, she decides to raise her prices. She immediately cancels her remaining 2500 shares on exchange A and replaces them with 10,000 shares at $17.05 and sends an instruction to do the same thing at exchange B.
Because Jill has fast computers and low-latency connections, her cancellation arrives at exchange B before Jack's buy order, so Jack is told that there are no longer shares available on exchange B at $17.
RESULT: Jack is filled for 7500 shares at $17 (half of what he requested) and the new market best offer is $17.05. Jack is welcome to submit another order for $17.05 if he wants to buy at that price. Jill is now short 7500 shares at $17, and will try to buy them back at a lower price (she may or may not succeed - until she does, she is exposed to the risk of further price rises).
Jill was able to use her speed advantage to detect that there was additional demand to buy this stock, and raise the price at which she was willing to sell it before Jack had finished buying all that he wanted to. This is exactly the way that an efficient market is supposed to work - it reacts to fluctuating demand (and other information) to set appropriate prices.
I think there are several things that get glossed over while people are working themselves up about this -
1. Jack is upset because he couldn't buy 15,000 shares at the price he wanted to buy them. But Jack has no god-given right to be able to buy shares at the price he likes best. He is subject to the laws of the market, just like everyone else.
2. The only reason that Jill has a speed advantage over Jack is because she has paid for it! She has paid to co-locate her server at the exchange, and she has paid to use high-speed connections between exchanges. Are we going to declare that paying for a competitive advantage is suddenly immoral?
3. If Jack doesn't like this state of affairs, he has several options. He can invest in high-speed infrastructure as well. He can use smarter order-routing logic (e.g. adding delays to his orders so that they arrive at the exchanges approximately simultaneously, or splitting his large order up into multiple smaller orders). Or he can use a broker who will do these things for him. If Jack doesn't want to pay for any of these things, then he has to put up with lower quality execution. As much as he might wish it, the ability to buy as many shares as he wants at the price he wants them is not a universal human right.
"Fresh Apples here! Only the best apples for 2 dollars!" -
"I would like one, please." -
"Thatll be 2.50, sir." -
"What? I thought you just said 2?" -
"Demand has just gone up."
I'm glad you brought this up, because this kind of thing happens precisely never on a financial exchange.
If you go to a store, the store owner sees you take your apples up to the counter, and so he can theoretically change his price before you get there (although in practice, if he ever did that he would soon be out of business).
On a financial exchange, the market maker doesn't even find out that you wanted to buy until the trade has already happened. It is literally impossible for the market maker to change his price, because he doesn't find out about your order until it's already occurred.
What is possible is that the market maker is also quoting on another, totally separate exchange, and he decides to change his prices there, in reaction to seeing a big order on the first exchange.
It's like an apple seller who owns two carts in different parts of town. When you come to his first cart and buy all his apples for $2, he guesses that maybe you are going to go over to his second cart and buy all the apples there as well, so he calls his business partner who's running that cart, and tells him to raise his prices to $2.50 - which makes perfect sense as a business strategy, because demand has gone up.
Note that he only raised his prices because you bought all the apples at his first cart. If you just bought one apple out of the hundreds he has (because you're a small investor, not a giant investment bank) then he wouldn't bother to raise his prices.
If you go to a store, the store owner sees you take your apples up to the counter, and so he can theoretically change his price before you get there (although in practice, if he ever did that he would soon be out of business).
On a financial exchange, the market maker doesn't even find out that you wanted to buy until the trade has already happened. It is literally impossible for the market maker to change his price, because he doesn't find out about your order until it's already occurred.
What is possible is that the market maker is also quoting on another, totally separate exchange, and he decides to change his prices there, in reaction to seeing a big order on the first exchange.
It's like an apple seller who owns two carts in different parts of town. When you come to his first cart and buy all his apples for $2, he guesses that maybe you are going to go over to his second cart and buy all the apples there as well, so he calls his business partner who's running that cart, and tells him to raise his prices to $2.50 - which makes perfect sense as a business strategy, because demand has gone up.
Note that he only raised his prices because you bought all the apples at his first cart. If you just bought one apple out of the hundreds he has (because you're a small investor, not a giant investment bank) then he wouldn't bother to raise his prices.
I accept that your explanation makes sense, but the fact that this can happen automagically in an intransparent way when someone just wants to buy a number of shares at a quoted price just feels wrong. And reading a few other articles on Nanex also give me weird image of what happens in stocks in general.
Then again, I have no idea about these things and should probably shut up.
Then again, I have no idea about these things and should probably shut up.
Just remember that when you say
"someone wants to buy a number of shares at a quoted price"
"a giant investment bank or hedge fund with some privileged
information about a stock wants to buy so many shares that
they actually need to go to multiple exchanges to satisfy
their demand"
This is the flawed analogy that keeps being propagated that is completely untrue.
A much better one is to think of a string of gas stations running down the highway. They all have an advertised price. A tanker truck arrives at the first gas station and buys all the gas at the advertised price. It then goes down the road and buys all the next stations gas at the same advertised price. Then the manager of the 2nd gas station calls the 3rd and says hey, we've just gotten wiped out of gas there is a lot of demand. The 3rd manager raises his price accordingly. The tanker truck can then decide if it wants to buy more gas at the new price or just take what they currently have.
A much better one is to think of a string of gas stations running down the highway. They all have an advertised price. A tanker truck arrives at the first gas station and buys all the gas at the advertised price. It then goes down the road and buys all the next stations gas at the same advertised price. Then the manager of the 2nd gas station calls the 3rd and says hey, we've just gotten wiped out of gas there is a lot of demand. The 3rd manager raises his price accordingly. The tanker truck can then decide if it wants to buy more gas at the new price or just take what they currently have.
Fair enough.
That's wrong. It's more like:
"Fresh Apples here! Only the best apples for 2 dollars!" - "I would like every single apple you have, please. Also I'm buying all the apples from the guy across the street too." - "Thatll be 2.05 each, sir." - "What? I thought you just said 2?" - "Demand has just gone up."
"Fresh Apples here! Only the best apples for 2 dollars!" - "I would like every single apple you have, please. Also I'm buying all the apples from the guy across the street too." - "Thatll be 2.05 each, sir." - "What? I thought you just said 2?" - "Demand has just gone up."
"Fresh Apples here! Only the best apples for 2 dollars!"
"I would like 1000 apples, please."
"Sir, I only have 600 apples in the shop. I can give you those now, and I'll ask the guy across the street if he has any."
"How much will that cost?"
"I think he's also selling them at 2 dollars each. Let me just look - oh, nope, he's seen us talking and changed his sign. Well. Have these 600 at the quoted price, and if you want more you'll have to pay the new price."
Indeed this is even better.
There is still something that nags me.
I've heard a bunch of explanation about liquidity and how HFT allows for large orders to be fulfilled, but it seems like this is quite the opposite.
What purpose does this serve? Is society as a whole better off when Jill is able to make this .05 per share more? I wouldn't frame the debate as 'god given rights' and 'competitive advantage'. What I really want to know is why a society where trades and quotes happen on a millisecond scale is better off than one where they happen on a second scale.
It's an honest question. Someone please convince me.
I've heard a bunch of explanation about liquidity and how HFT allows for large orders to be fulfilled, but it seems like this is quite the opposite.
What purpose does this serve? Is society as a whole better off when Jill is able to make this .05 per share more? I wouldn't frame the debate as 'god given rights' and 'competitive advantage'. What I really want to know is why a society where trades and quotes happen on a millisecond scale is better off than one where they happen on a second scale.
It's an honest question. Someone please convince me.
What's great is that we don't have to engage in thought experiments about what would happen if we didn't have trading activity with fast computers on a millisecond scale - we can just look back to any time before the 1990s, when most market making was done by humans, on human time scales.
Before 2001 the minimum tick size on any exchange was 1/16th of a dollar ($0.0625) and before 1997 it was 1/8th ($0.125), so the absolute minimum you would pay for a round trip (buying a stock and later selling it) was that much. Frequently, the bid-offer spread would be many ticks wide, so you could easily be paying $0.25 or $0.50 for each round trip.
The current minimum tick size is $0.01, and there are many stocks which trade at that level. Even if you suffer $0.05 of slippage on a round trip, you're still better off than you would have been under the old regime.
In the old regime, instead of high frequency traders, you had floor brokers who would work orders. Fortunately, floor brokers were paragons of virtue and morality, who would certainly never front run their clients orders, and would take any trade even if it worked to their disadvantage (NB in case you don't get it - this is sarcasm. In the 1987 crash, most brokers wouldn't even pick up their fucking phone because too many people were trying to sell stock, and the brokers didn't want to buy).
I honestly find it hard to believe that some people think that was better than what we have today.
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Edit: The other thing I don't get is why ordinary investors (by which I mean anyone with less than $100m to invest) care about this. For a small investor, you are actually getting an even better deal because your order for 1000 shares or whatever can get filled instantaneously, in one chunk, for a great price! It's only when you're trying to buy hundreds of thousands of shares in a few minutes that you end up suffering price slippage.
The standard response is that ordinary investors have their money invested in mutual funds and pensions, who are large investors. But in that case you are already paying 0.5-2% per year to your fund manager, and why do you give a shit if they lose 10 basis points (0.1%) in price slippage because the market is more efficient than it used to be?
In fact, why is my pension fund manager trading so fucking much anyway? I don't have a pension because I think the fund manager is some genius stock picker, I have it because it's tax efficient and my employer contributes to it. Just buy the S&P500 and sit on it.
Before 2001 the minimum tick size on any exchange was 1/16th of a dollar ($0.0625) and before 1997 it was 1/8th ($0.125), so the absolute minimum you would pay for a round trip (buying a stock and later selling it) was that much. Frequently, the bid-offer spread would be many ticks wide, so you could easily be paying $0.25 or $0.50 for each round trip.
The current minimum tick size is $0.01, and there are many stocks which trade at that level. Even if you suffer $0.05 of slippage on a round trip, you're still better off than you would have been under the old regime.
In the old regime, instead of high frequency traders, you had floor brokers who would work orders. Fortunately, floor brokers were paragons of virtue and morality, who would certainly never front run their clients orders, and would take any trade even if it worked to their disadvantage (NB in case you don't get it - this is sarcasm. In the 1987 crash, most brokers wouldn't even pick up their fucking phone because too many people were trying to sell stock, and the brokers didn't want to buy).
I honestly find it hard to believe that some people think that was better than what we have today.
---
Edit: The other thing I don't get is why ordinary investors (by which I mean anyone with less than $100m to invest) care about this. For a small investor, you are actually getting an even better deal because your order for 1000 shares or whatever can get filled instantaneously, in one chunk, for a great price! It's only when you're trying to buy hundreds of thousands of shares in a few minutes that you end up suffering price slippage.
The standard response is that ordinary investors have their money invested in mutual funds and pensions, who are large investors. But in that case you are already paying 0.5-2% per year to your fund manager, and why do you give a shit if they lose 10 basis points (0.1%) in price slippage because the market is more efficient than it used to be?
In fact, why is my pension fund manager trading so fucking much anyway? I don't have a pension because I think the fund manager is some genius stock picker, I have it because it's tax efficient and my employer contributes to it. Just buy the S&P500 and sit on it.
I see a false dichotomy here. The fact that floor brokers were dishonest doesn't imply we need to have continuous computerized trades. We could still have discrete steps and computers filling orders, right?
Right, and maybe one day the market will work that way. But
(a) what we have at the moment is still a lot better than what we had before - incremental progress!
(b) it's not at all obvious (to me) that discrete time steps would be better than what we have now. Market makers would be taking more risk, so that would quote in smaller size and at wider spreads, which could make trading more expensive for everybody.
(a) what we have at the moment is still a lot better than what we had before - incremental progress!
(b) it's not at all obvious (to me) that discrete time steps would be better than what we have now. Market makers would be taking more risk, so that would quote in smaller size and at wider spreads, which could make trading more expensive for everybody.
Thanks for the perspective - very helpful.
>2. The only reason that Jill has a speed advantage over Jack is because she has paid for it! She has paid to co-locate her server at the exchange, and she has paid to use high-speed connections between exchanges. Are we going to declare that paying for a competitive advantage is suddenly immoral?
If we want an efficient market,we need perfect information. Information asymmetry creates inefficient markets.
The moral argument behind free markets is that it leads to "efficient" outcomes. If people are going to do bullshit like this, there's no reason _not_ to set regulations to stop this.
If we want an efficient market,we need perfect information. Information asymmetry creates inefficient markets.
The moral argument behind free markets is that it leads to "efficient" outcomes. If people are going to do bullshit like this, there's no reason _not_ to set regulations to stop this.
If you want a reasonably efficient market, you need some participants to have close to perfect information.
There is no market anywhere in the world that is 100% efficient, because the costs of getting to efficiency are prohibitively high. It's like trying to reach the speed of light - you can expend more and more effort getting closer and closer, but you can never actually reach it.
I'm not saying that what we have now is perfect, but it's a damn sight better than what we used to have.
There is no market anywhere in the world that is 100% efficient, because the costs of getting to efficiency are prohibitively high. It's like trying to reach the speed of light - you can expend more and more effort getting closer and closer, but you can never actually reach it.
I'm not saying that what we have now is perfect, but it's a damn sight better than what we used to have.
> If you want a reasonably efficient market, you need some participants to have close to perfect information.
Is this proven somewhere or you just assume the optimal strategy for markets is continuous?
I mean, it's not clear that the optimal strategy for "slightly imperfect markets" is at all close to the optimal strategy for markets with perfect information. And I actually doubt it can be proven, in the general case.
Is this proven somewhere or you just assume the optimal strategy for markets is continuous?
I mean, it's not clear that the optimal strategy for "slightly imperfect markets" is at all close to the optimal strategy for markets with perfect information. And I actually doubt it can be proven, in the general case.
Not only is it not clear, intuition from other areas of optimization would suggest it's unlikely to be true.
I've asked a couple of economists about this, but didn't get a satisfying answer. To be fair, it wasn't their area at all - and I may just have misunderstood what they were saying.
I've asked a couple of economists about this, but didn't get a satisfying answer. To be fair, it wasn't their area at all - and I may just have misunderstood what they were saying.
I'm curious: can you name an optimization problem you would get that intuition from?
I am not a game theorist, but take Centipede game for instance. If you know the exact number of rounds in advance, the optimal strategy is markedly different than if you don't know it. And I think there are many weird behaviors like that in iterated games, where optimal solution for infinite time horizon is not the same (or doesn't even exist) as the limit of optimal solutions for finite horizons approaching infinity.
> If you want a reasonably efficient market, you need some participants to have close to perfect information.
I don't think this follows at all. It isn't clear that if the assumptions are almost true the outcome reasonably close to that if the assumptions were true.
Even if it does hold true remember that economists view monopolies as perfectly efficient solutions but that in that scenario it is efficient because the monopoly captures all the available value not the consumers. I also believe that the maths behind the efficient market hypothesis break down if its assumptions don't hold.
I don't think this follows at all. It isn't clear that if the assumptions are almost true the outcome reasonably close to that if the assumptions were true.
Even if it does hold true remember that economists view monopolies as perfectly efficient solutions but that in that scenario it is efficient because the monopoly captures all the available value not the consumers. I also believe that the maths behind the efficient market hypothesis break down if its assumptions don't hold.
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What if it is a third party who is the HFT? Mary sees Jacks buy on A and uses the speed advantage to buy Jill's shares on B preventing Jack from finishing the transaction and Jill from reacting to increased demand. What if Mary was created solely for this purpose? When does it turn from arbitrage to rent seeking?
Same thing: now it is Mary who trades her short exposure risk for a bet that Jack's buy offer of $17.00 is not his maximum willingness to pay, while Jill just gets to fill her original sell order instantly (as opposed to "waiting" a few ms for the offer to arrive at her exchange). In both cases, Jack's is being forced to reveal more about his true valuation of the stock by paying up closer to his best possible offer.
Note in a perfect auction it should be Jill who receive the $17.05; but exchanges are more like (millisecond fast) mail-order catalogues, where the prices you quote are fixed the moment you send off your order. It would piss many people off that you only got half the items you wanted every time because the listed prices "went up" in between the time you mailed your order; but it would also make the whole thing closer to an auction.. so that's that.
Note in a perfect auction it should be Jill who receive the $17.05; but exchanges are more like (millisecond fast) mail-order catalogues, where the prices you quote are fixed the moment you send off your order. It would piss many people off that you only got half the items you wanted every time because the listed prices "went up" in between the time you mailed your order; but it would also make the whole thing closer to an auction.. so that's that.
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> But Jack has no god-given right to be able to buy shares at the price he likes best
It seems like the disagreement really lies here. I'm not a finance expert so I'll probably get a few things wrong but is it fair to summarize the two perspectives as follows?
1. Jill is merely quoting a price for independent blocks of shares on independent exchanges. If a buy order is placed against that quoted price, she has the right to reissue quotes elsewhere. This is no different from Jill selling apples at the market on 1st street, as well as at the market on 2nd street, then receiving a large order on 1st street that prompts her to call her sales manager on 2nd street and have him increase the price of apples there. Or for Janice, sitting next to Jill's stall on 1st street, overhearing the sale at $17 and repricing her apples upwards for when the demand inevitably spills over to her stall.
2. Jill is making an offer to sell a combined block of shares at a particular price. Even though her offer is broken up over multiple exchanges, since a single buy order can execute on multiple exchanges her offer should hold across all of these exchanges. Yet she is taking advantage of the physical makeup of the market to bait large orders (thereby revealing market demand) and then switch to higher prices (thereby capturing a larger profit).
I emphasized "quote" and "offer" above because they capture two different concepts in contract law. I'm not sure if the concepts are the same in financial markets but the principle seems to be at the root of the disagreement. If Jill was merely "quoting", unless the rules of the exchange specify otherwise, she is free to reissue her quote and therefore perspective #1 makes sense. If Jill was making an "offer" however, presumably she should be bound to the terms of her offer regardless of the physical details around how she publishes that offer, reinforcing perspective #2.
So: do the market rules have such a distinction? I found the link [1] below which suggests both perspectives are valid - depending on the type of market one is participating in, if I understand it correctly. Is this a matter of people confusing the two types of markets? (I have to say that perspective #2 seems pretty impractical to me in markets with multiple exchanges participating, and #1 doesn't negatively impact the market -- either it makes economic sense for Jack to pay the new price or not, why do we care if he saves a few bucks if we fiddle with the rules?)
[1] http://www.investopedia.com/ask/answers/06/quoteorderdrivenm...
It seems like the disagreement really lies here. I'm not a finance expert so I'll probably get a few things wrong but is it fair to summarize the two perspectives as follows?
1. Jill is merely quoting a price for independent blocks of shares on independent exchanges. If a buy order is placed against that quoted price, she has the right to reissue quotes elsewhere. This is no different from Jill selling apples at the market on 1st street, as well as at the market on 2nd street, then receiving a large order on 1st street that prompts her to call her sales manager on 2nd street and have him increase the price of apples there. Or for Janice, sitting next to Jill's stall on 1st street, overhearing the sale at $17 and repricing her apples upwards for when the demand inevitably spills over to her stall.
2. Jill is making an offer to sell a combined block of shares at a particular price. Even though her offer is broken up over multiple exchanges, since a single buy order can execute on multiple exchanges her offer should hold across all of these exchanges. Yet she is taking advantage of the physical makeup of the market to bait large orders (thereby revealing market demand) and then switch to higher prices (thereby capturing a larger profit).
I emphasized "quote" and "offer" above because they capture two different concepts in contract law. I'm not sure if the concepts are the same in financial markets but the principle seems to be at the root of the disagreement. If Jill was merely "quoting", unless the rules of the exchange specify otherwise, she is free to reissue her quote and therefore perspective #1 makes sense. If Jill was making an "offer" however, presumably she should be bound to the terms of her offer regardless of the physical details around how she publishes that offer, reinforcing perspective #2.
So: do the market rules have such a distinction? I found the link [1] below which suggests both perspectives are valid - depending on the type of market one is participating in, if I understand it correctly. Is this a matter of people confusing the two types of markets? (I have to say that perspective #2 seems pretty impractical to me in markets with multiple exchanges participating, and #1 doesn't negatively impact the market -- either it makes economic sense for Jack to pay the new price or not, why do we care if he saves a few bucks if we fiddle with the rules?)
[1] http://www.investopedia.com/ask/answers/06/quoteorderdrivenm...
Yes, I think that's a fair summary.
I don't know much about contract law, but it may be interesting to know that a resting order on exchange, with a set price and size, is called a quote.
The terminology offer is used in financial markets for a resting order to sell, distinguishing it from a bid which is a resting order to buy, although many market participants will actually use the terms bid and ask rather than bid and offer. Whether this is to avoid confusion with the contract law term, I have no idea.
It won't surprise you to learn that I also think that your perspective #2 is unworkable in a situation where you have multiple exchanges (how would it work - would you require that quotes on exchange B must remain for a specified period after a quote on exchange A is hit? That doesn't seem sensible).
I don't know much about contract law, but it may be interesting to know that a resting order on exchange, with a set price and size, is called a quote.
The terminology offer is used in financial markets for a resting order to sell, distinguishing it from a bid which is a resting order to buy, although many market participants will actually use the terms bid and ask rather than bid and offer. Whether this is to avoid confusion with the contract law term, I have no idea.
It won't surprise you to learn that I also think that your perspective #2 is unworkable in a situation where you have multiple exchanges (how would it work - would you require that quotes on exchange B must remain for a specified period after a quote on exchange A is hit? That doesn't seem sensible).
It is supposed to be the case that you do not place orders on an exchange that you have no intention of executing. i.e. if you place an offer which you intend to withdraw then replace with a higher one the moment you detect interest in the offer then you are breaking the rules.
In general it's also pretty scummy to do it. Imagine a shop seeing you taking items from shelves at an advertised price and saying "Well that shows there's demand in these goods so we're raising the prices on everything in the customers basket before they get to the checkout."
In general it's also pretty scummy to do it. Imagine a shop seeing you taking items from shelves at an advertised price and saying "Well that shows there's demand in these goods so we're raising the prices on everything in the customers basket before they get to the checkout."
That is not at all true. It is perfectly legal and valid to place quotes at a price that you expect is valid and change them once interest is detected. This is a standard market dynamic and one that makes the markets work.
Your analogy is not all how HFT works. A better analogy would be a string of gas stations going down the highway. A tanker truck comes to the first one and buys all it's gas. Then the second one, and then the third. The manager at the third station calls the fourth and tells them to raise their prices. How is it scummy to do that, but not to buy up all the gas at what is clearly a too low price?
Your analogy is not all how HFT works. A better analogy would be a string of gas stations going down the highway. A tanker truck comes to the first one and buys all it's gas. Then the second one, and then the third. The manager at the third station calls the fourth and tells them to raise their prices. How is it scummy to do that, but not to buy up all the gas at what is clearly a too low price?
> This is a standard market dynamic and one that makes the markets work.
I don't believe this is necessary to make markets work.
I don't believe this is necessary to make markets work.
Forgot your mumbo jumbo evidence & logical reasoning! I believe what I believe and you can't stop me!
stomps foot
stomps foot
Please don't be so rude, it doesn't add anything to the conversation.
There are many markets where you list a product for a price, and are legally bound to sell them at that price.
Those markets function, proving that withdrawing quotes is not necessary to make markets work.
There are many markets where you list a product for a price, and are legally bound to sell them at that price.
Those markets function, proving that withdrawing quotes is not necessary to make markets work.
What markets are those? I can think of no markets in which you're not allowed to change the price of whatever goods you're selling.
Best Buy runs a flier with a price. You walk in, and Best Buy tells you they're not selling that product at that price... but they do have it in inventory at a higher price.
You drive up to a gas station, listing one price on its sign. By the time you pay, they've changed the price.
You see a house for sale. You make an offer, at that exact amount. There are no higher competing offers, but they want to back out.
You have legal recourse in each of those situations.
You drive up to a gas station, listing one price on its sign. By the time you pay, they've changed the price.
You see a house for sale. You make an offer, at that exact amount. There are no higher competing offers, but they want to back out.
You have legal recourse in each of those situations.
1) That's not because Best Buy isn't allowed to change prices. There's even fine print on their marketing that says the prices on the flyer are marketing only and may or may not match pricing when you get to the store. They just choose not to most of the time for marketing reasons.
2) Actually, at least in New York there are no regulations that discuss the large roadsign pricing signs at gas stations. The law just says the price on the pump must match what you get charged. If they change the price at the pump but get behind on updating their big sign you are SOL.
3) People back out of selling houses all the time.
And for all of these it's worth pointing out that what we're really arguing about is time scale. No one would argue that the gas station (for example) wasn't allowed to sell gas for a different price today than it charged yesterday right?
Bid and ask prices for securities just change prices faster than what we're used to for retail products.
To really expand the scope of this discussion it's worth noting that time scales for retail product price changes are actually shrinking. Walmart has experimented with electronic labels in stores that allow them to change prices in real time. Uber changes prices in real time based on demand. It's interesting to watch consumer reaction to these new trends.
2) Actually, at least in New York there are no regulations that discuss the large roadsign pricing signs at gas stations. The law just says the price on the pump must match what you get charged. If they change the price at the pump but get behind on updating their big sign you are SOL.
3) People back out of selling houses all the time.
And for all of these it's worth pointing out that what we're really arguing about is time scale. No one would argue that the gas station (for example) wasn't allowed to sell gas for a different price today than it charged yesterday right?
Bid and ask prices for securities just change prices faster than what we're used to for retail products.
To really expand the scope of this discussion it's worth noting that time scales for retail product price changes are actually shrinking. Walmart has experimented with electronic labels in stores that allow them to change prices in real time. Uber changes prices in real time based on demand. It's interesting to watch consumer reaction to these new trends.
There's still bait-and-switch lawsuits... so advertising has some legal binding. I guess all advertisers know how to write in enough small print to get around it now, huh?
And I guess securities don't have any "this offer good for [x seconds]" on them. That's totally counter-intuitive to laymen, and speaking as a professional layman, I'm pretty sure I'm getting screwed because of it.
Electronic labels - you should be able to reserve a price for a time. Like, you want that shaving cream for $1.45, then you should be able to scan your Walmart member card at the electronic label to reserve that price. Should be valid for an hour, or a day, for up to X number of them.
...because the nightmare of picking it off the shelf, and the price is different when you check-out is just awful for consumers.
...and just to ramble a bit more... Sometimes it's cheaper for me to DRIVE to City A, fly back to my town, and then fly to my real destination than it is to book a flight from my town to my real destination. That's crazy, and I'm totally getting screwed, and I hope laws are enacted to stop that.
And I guess securities don't have any "this offer good for [x seconds]" on them. That's totally counter-intuitive to laymen, and speaking as a professional layman, I'm pretty sure I'm getting screwed because of it.
Electronic labels - you should be able to reserve a price for a time. Like, you want that shaving cream for $1.45, then you should be able to scan your Walmart member card at the electronic label to reserve that price. Should be valid for an hour, or a day, for up to X number of them.
...because the nightmare of picking it off the shelf, and the price is different when you check-out is just awful for consumers.
...and just to ramble a bit more... Sometimes it's cheaper for me to DRIVE to City A, fly back to my town, and then fly to my real destination than it is to book a flight from my town to my real destination. That's crazy, and I'm totally getting screwed, and I hope laws are enacted to stop that.
Huh? The rule is you can't place orders that you have no intention of executing at the time you place them. You're perfectly entitled to change your mind afterwards, or adjust your price as new information becomes available. You just can't place orders when it is your goal to not have them execute, and that was your goal before you even sent them.
Whether she has to honour the quote is irrelevant, as she yanks the quote at the second exchange before it is hit.
2. The only reason that Jill has a speed advantage over Jack is because she has paid for it! She has paid to co-locate her server at the exchange, and she has paid to use high-speed connections between exchanges. Are we going to declare that paying for a competitive advantage is suddenly immoral?
Here's the problem with that: the number of available ultra-close connections to the market is finite. If you carry this out to its only possible conclusion, whomever has the closest connection always wins, and everyone else always loses. The other market participants eventually realize that it is simply not possible for them to win, and that a closer connection is not for sale at any price, so they simply stop participating. This solves one problem - people stop losing money - but also destroys the market.
Here's the problem with that: the number of available ultra-close connections to the market is finite. If you carry this out to its only possible conclusion, whomever has the closest connection always wins, and everyone else always loses. The other market participants eventually realize that it is simply not possible for them to win, and that a closer connection is not for sale at any price, so they simply stop participating. This solves one problem - people stop losing money - but also destroys the market.
It's empirically not true that "whomever has the closest connection always wins and everyone else always loses" as is evidenced by the fact that there are multiple competing market makers who are all profitable.
Arguments of the kind "let's carry this to its logical conclusion" are almost always fallacious, because they ignore limiting factors, or alternative explanations.
If your only advantage is speed then you need to have the fastest connection to the exchange, else your business model doesn't exist. If you have other advantages, then speed is less important. Nowadays there are very few market makers whose only advantage is speed, because most of them realized that continually paying through the nose to compete on speed is a mug's game.
Arguments of the kind "let's carry this to its logical conclusion" are almost always fallacious, because they ignore limiting factors, or alternative explanations.
If your only advantage is speed then you need to have the fastest connection to the exchange, else your business model doesn't exist. If you have other advantages, then speed is less important. Nowadays there are very few market makers whose only advantage is speed, because most of them realized that continually paying through the nose to compete on speed is a mug's game.
>there are multiple competing market makers who are all profitable.
That doesn't disprove my statement. The "multiple competing market makers who are all profitable" all have extremely fast connections to the market. They compete on relatively equal footing speed-wise, and so other factors come into play. But everyone outside of the small group of players with that speed advantage will always be paying a tax to those who do. And good luck compensating for your lack of speed by out-predicting large teams of MIT-educated quants with unlimited technology budgets. As an individual investor, your only hope for profit is that market values of the stocks you invest in rise by more than the tax you have to pay to HFT's. You better buy and hold, because with every transaction, you're paying them an additional tax.
When market values are rising, these effects go unnoticed because everyone is generally making money. That doesn't make the tax we are paying to these HFT's any more fair or less damaging to the market.
That doesn't disprove my statement. The "multiple competing market makers who are all profitable" all have extremely fast connections to the market. They compete on relatively equal footing speed-wise, and so other factors come into play. But everyone outside of the small group of players with that speed advantage will always be paying a tax to those who do. And good luck compensating for your lack of speed by out-predicting large teams of MIT-educated quants with unlimited technology budgets. As an individual investor, your only hope for profit is that market values of the stocks you invest in rise by more than the tax you have to pay to HFT's. You better buy and hold, because with every transaction, you're paying them an additional tax.
When market values are rising, these effects go unnoticed because everyone is generally making money. That doesn't make the tax we are paying to these HFT's any more fair or less damaging to the market.
You aren't paying a tax to HFTs. You are receiving a substantial discount to trade due to them being there. Fees are lower than they've ever been, spreads are tighter and technology is cheaper. You are in fact reaping the "peace" dividend of the HFT wars.
This is obvious for any market that has a single physical location. People who stand next to the apple seller get local apple price information faster than those standing in the next town.
You've also got a very peculiar definition of winning. A person who wishes to buy 10,000 Ford shares who places an order at $17 only to find that in the meantime the market has shifted to $17.01 and therefore purchases at that price hasn't "lost". They set out to buy Ford stock at market rate, and that's what they ended up doing.
You've also got a very peculiar definition of winning. A person who wishes to buy 10,000 Ford shares who places an order at $17 only to find that in the meantime the market has shifted to $17.01 and therefore purchases at that price hasn't "lost". They set out to buy Ford stock at market rate, and that's what they ended up doing.
>You've also got a very peculiar definition of winning
Not really. The stock market is a giant pool of money. These parasite traders are nothing more than leaks in that pool. With enough of these leaks, the pool runs out of water. Additions of water to the pool (through a combination of rising market values and more investment) at various times will overshadow the effect of the leaks, but they are there nonetheless.
A person who wishes to buy 10,000 Ford shares who places an order at $17 only to find that in the meantime the market has shifted to $17.01 and therefore purchases at that price hasn't "lost"
Actually, they have lost. They lost 10,000 pennies, or $100, and received absolutely no value in return. That money is gone, never to return, into the pocket of an HFT. It has simply evaporated from the market.
Not really. The stock market is a giant pool of money. These parasite traders are nothing more than leaks in that pool. With enough of these leaks, the pool runs out of water. Additions of water to the pool (through a combination of rising market values and more investment) at various times will overshadow the effect of the leaks, but they are there nonetheless.
A person who wishes to buy 10,000 Ford shares who places an order at $17 only to find that in the meantime the market has shifted to $17.01 and therefore purchases at that price hasn't "lost"
Actually, they have lost. They lost 10,000 pennies, or $100, and received absolutely no value in return. That money is gone, never to return, into the pocket of an HFT. It has simply evaporated from the market.
What does this even mean? "Eventually the pool runs out of water". What?
Last I checked, the stock market was a market. Anyone is allowed to play, and like most things in life, you can pay to upgrade (either your connection, your analyst talent, etc. etc.). Look at the recent Barclays dark pool fiasco to find out what the liquidity in a market without HFT and transparent books looks like.
Last I checked, the stock market was a market. Anyone is allowed to play, and like most things in life, you can pay to upgrade (either your connection, your analyst talent, etc. etc.). Look at the recent Barclays dark pool fiasco to find out what the liquidity in a market without HFT and transparent books looks like.
>What does this even mean? "Eventually the pool runs out of water". What?
Well, when you have a pool, and water is constantly being sucked out of it, even a tiny bit at a time, eventually you will have no water left in the pool. Not a hard concept.
Well, when you have a pool, and water is constantly being sucked out of it, even a tiny bit at a time, eventually you will have no water left in the pool. Not a hard concept.
But your analogy is backwards. HFT (of the market making variety) are putting water into the pool, not taking it out.
It's not backwards. Market making HFT's are like a casino's bankroll. The only purpose that their bankroll serves is to suck money out of the pool.
Well, let me say it's not backwards, it is just nonsensical. Market making HFTs don't have any built in mathematical edge like a roulette wheel. Further, they lower the cost of trading, they add money into the pool in the form of the risks they take and the infrastructure they create.
As I look around the markets, I don't see a lot of participants that are there to lose money. The ability to make a profit from market activities is central to a correctly working market.
As I look around the markets, I don't see a lot of participants that are there to lose money. The ability to make a profit from market activities is central to a correctly working market.
I'm pretty sure he was asking how that concept applies to financial markets.
Exactly. The poor hardworking people who get to invest in the stock market should have all the benefits of liquidity without paying for it.
Right, because without HFT's there would be no one investing in the markets at all.
Most dark pools that exclude HFTs fail to get off the ground because they are unable to offer the liquidity that investors require.
Jack is not upset because he couldn't buy the shares at the price he wanted. He is upset because someone was offering shares at a specific price, and Jack was willing to pay that price, but the order was not executed. The reason the order was not executed is not because someone else accepted the offer before him, or because Jill cancelled before he tried to accept. It was because Jill was able to see his acceptance in transit and cancel part of her offer as a result of this new information. This isn't how markets are supposed to work. If Jill had posted a single offer for half the number of shares that Jack wanted, it would be different.
Someone shouldn't need to use Thor or some other delaying mechanism to accept open offers. The latency between different exchanges (which was exploited in this example) does nothing to increase market efficiency.
You're right that I shouldn't care about this as a practical matter, as the impact on me is very small, but that doesn't mean it's right.
I really appreciate the clarity in your comments on this thread.
Someone shouldn't need to use Thor or some other delaying mechanism to accept open offers. The latency between different exchanges (which was exploited in this example) does nothing to increase market efficiency.
You're right that I shouldn't care about this as a practical matter, as the impact on me is very small, but that doesn't mean it's right.
I really appreciate the clarity in your comments on this thread.
Here is our point of disagreement, then - I think that this is exactly how markets are supposed to work (in the presence of multiple exchanges).
The job of a market maker is to supply liquidity at a price/risk tradeoff that is reasonable to them, subject to the information available to them. If there are multiple exchanges, and someone trades with them on one exchange, then the set of information available to them has changed (specifically, their knowledge of the supply/demand balance for a particular stock has changed). It's only natural that they will want to change their prices in response.
Now, we could change legislation to either (a) go back to having a single exchange or (b) restricting the ability of market makers to move their quotes on one exchange if they trade on another. But that won't necessarily result in a better deal for non-market makers, because instead of quoting 20,000 shares split across 4 exchanges, the market maker now quotes 5,000 shares on 1 exchange.
The benefit is that all market participants have a more accurate idea of the true liquidity available in the market. The disadvantage is that you have removed the element of competition between exchanges, so the exchange is no longer incentivized to offer low fees and keep improving its service.
The job of a market maker is to supply liquidity at a price/risk tradeoff that is reasonable to them, subject to the information available to them. If there are multiple exchanges, and someone trades with them on one exchange, then the set of information available to them has changed (specifically, their knowledge of the supply/demand balance for a particular stock has changed). It's only natural that they will want to change their prices in response.
Now, we could change legislation to either (a) go back to having a single exchange or (b) restricting the ability of market makers to move their quotes on one exchange if they trade on another. But that won't necessarily result in a better deal for non-market makers, because instead of quoting 20,000 shares split across 4 exchanges, the market maker now quotes 5,000 shares on 1 exchange.
The benefit is that all market participants have a more accurate idea of the true liquidity available in the market. The disadvantage is that you have removed the element of competition between exchanges, so the exchange is no longer incentivized to offer low fees and keep improving its service.
OK. So it's because there are multiple markets. We want multiple markets because competition, but multiple markets mean latency which means HFT using info from one exchange as a signal in another exchange.
If I could wave a magic wand then we would have one exchange which was run as a public service, by some beneficent person with no profit motive. I don't have a magic wand :(
I agree that the current situation is the result of the market structure (multiple competing markets) but I don't agree that this is how markets are supposed to work. The reason I say this is that people with no knowledge of market microstructure (e.g. ordinary people or people with undergraduate degrees in economics) would not expect this kind of 'arbitrage' to be possible. I hesitate to call it front-running because this is a term better reserved for instances where a client relationship and non-public information exists.
I take your point that the situation we have now (multiple exchanges without specialists) may be better than we had before (a single exchange with specialists) but I still don't think it's _fair_.
I wonder what would happen if I could wave my magic wand and have multiple exchanges with no specialists and zero latency...
If I could wave a magic wand then we would have one exchange which was run as a public service, by some beneficent person with no profit motive. I don't have a magic wand :(
I agree that the current situation is the result of the market structure (multiple competing markets) but I don't agree that this is how markets are supposed to work. The reason I say this is that people with no knowledge of market microstructure (e.g. ordinary people or people with undergraduate degrees in economics) would not expect this kind of 'arbitrage' to be possible. I hesitate to call it front-running because this is a term better reserved for instances where a client relationship and non-public information exists.
I take your point that the situation we have now (multiple exchanges without specialists) may be better than we had before (a single exchange with specialists) but I still don't think it's _fair_.
I wonder what would happen if I could wave my magic wand and have multiple exchanges with no specialists and zero latency...
If you could wave that magic wand big players with proprietary information (like hedge funds) would win a bit and everyone else (which includes you by the way) would lose because of slower price discovery.
Do you have opinions about a third proposal that's occasionally floated, (c) discretize the market's timeline to something smallish but not miniscule? For example, the market maker can move their quotes however often they want, but changes take effect on the next tick, which happens every (say) 1 second. So therefore you can't trade on advance knowledge in the sub-second range, and market makers can't gain a trading advantage vis-a-vis investors solely by having a slightly lower latency connection to the exchange.
It's possible there's some massive downside to that, but afaict the advantages of liquidity that market-makers provide mostly accrue at larger timescales. So it's not clear the millisecond-shaving game is really improving markets (though it provides interesting challenges for technologists).
It's possible there's some massive downside to that, but afaict the advantages of liquidity that market-makers provide mostly accrue at larger timescales. So it's not clear the millisecond-shaving game is really improving markets (though it provides interesting challenges for technologists).
How do you pick the timeframe? Seconds are still too fast for humans. Minutes would be too fast for people who are not professional traders, hours would be too fast for people who can't be near a computer all day.
There is always a locality advantage in the market, this has been true as long as there have been markets, and it will be true forever. Why do we as market participants care?
The other problem with your scenario is that you make market making more risky. The riskier it is, the higher the profits must be. This means that the market makers must keep the bid/ask spread higher (their means of making a profit). This cascades to all of us in the form of higher execution costs.
There is always a locality advantage in the market, this has been true as long as there have been markets, and it will be true forever. Why do we as market participants care?
The other problem with your scenario is that you make market making more risky. The riskier it is, the higher the profits must be. This means that the market makers must keep the bid/ask spread higher (their means of making a profit). This cascades to all of us in the form of higher execution costs.
> The other problem with your scenario is that you make market making more risky.
The problem with the current scenario is that it makes market making more expensive, as it requires a lot of technological investment into the microsecond arms race. This means the market makers must pull in more revenue from their trading to cover these expenses, before they even get to thinking about making a profit. This cascades to all of us in the form of higher execution costs. The huge amount of money being spent on HFT infrastructure, software development, etc. is ultimately being paid by market participants. It's worth considering if this is an arms race worth funding to the max, or if 99% of the benefits could be had much more cheaply just by putting a floor on execution latency, thereby rendering this whole millisecond-shaving industry unnecessary.
At the very least, I'd be interested in seeing rigorous models that show a benefit to, say, markets that can trade at 1-microsecond granularity vs. 1-millisecond vs. 1-second.
The problem with the current scenario is that it makes market making more expensive, as it requires a lot of technological investment into the microsecond arms race. This means the market makers must pull in more revenue from their trading to cover these expenses, before they even get to thinking about making a profit. This cascades to all of us in the form of higher execution costs. The huge amount of money being spent on HFT infrastructure, software development, etc. is ultimately being paid by market participants. It's worth considering if this is an arms race worth funding to the max, or if 99% of the benefits could be had much more cheaply just by putting a floor on execution latency, thereby rendering this whole millisecond-shaving industry unnecessary.
At the very least, I'd be interested in seeing rigorous models that show a benefit to, say, markets that can trade at 1-microsecond granularity vs. 1-millisecond vs. 1-second.
The claim that market makers pass costs on to end users is only true if they have pricing power. In reality, on-exchange liquidity provision is basically the kind of perfect competition that only exists in economics textbooks. Market makers are selling a commodity product (you don't care or control who you trade stocks with) in a market where buyers are purely sensitive to price (tightest market always wins and is enforced by exchange matching rules).
So what actually ends up happening in a market with multiple competitive market makers? To make money, a market maker needs to trade a lot of volume. The only way to trade a lot of volume is to put up the most aggressive (worse for the market maker, better for end users) prices at any time. Market makers can only do this by charging a smaller spread than their competitors. They can only charge a smaller spread by either reducing their margins or getting smarter at deciding when to be in or out of the market, usually a combination of both. The end result is extremely tight markets that react to information very quickly (i.e. cheap to trade and very efficient).
Competition keeps markets honest. If you had one very fast guy, he would clean up, but when you have a dozen guys who are roughly equally fast, they all compete one another down to barely making profit above their cost of doing business. Only the most efficient can survive. If anything, we want more HFT by removing barriers to entry rather than creating a lot of regulations that would ironically help incumbents by killing off weaker competitors.
So what actually ends up happening in a market with multiple competitive market makers? To make money, a market maker needs to trade a lot of volume. The only way to trade a lot of volume is to put up the most aggressive (worse for the market maker, better for end users) prices at any time. Market makers can only do this by charging a smaller spread than their competitors. They can only charge a smaller spread by either reducing their margins or getting smarter at deciding when to be in or out of the market, usually a combination of both. The end result is extremely tight markets that react to information very quickly (i.e. cheap to trade and very efficient).
Competition keeps markets honest. If you had one very fast guy, he would clean up, but when you have a dozen guys who are roughly equally fast, they all compete one another down to barely making profit above their cost of doing business. Only the most efficient can survive. If anything, we want more HFT by removing barriers to entry rather than creating a lot of regulations that would ironically help incumbents by killing off weaker competitors.
Except thats demonstrably not what has happened. Market making has gotten cheaper, not more expensive. Spreads have tightened, not gotten wider. Fees have gone down not up. Literally every cost to trading has been reduced.
The single biggest cost to any market maker is their market risk. Latency is exceedingly cheap in comparison. Any increase in latency raises market risk thereby raising their biggest cost.
The single biggest cost to any market maker is their market risk. Latency is exceedingly cheap in comparison. Any increase in latency raises market risk thereby raising their biggest cost.
I basically agree with what you're saying, but I think there's another point to make - market making is simply not as profitable as it once was.
I've seen estimates that the entire high frequency trading industry made $1 billion profit in 2013, down from $5 billion in 2009. [0]
In contrast, JPMorgan made $6 billion profit in the last quarter, and that was reported as "not particularly impressive"! [1]
[0] http://www.reuters.com/article/2014/04/06/us-dark-markets-an...
[1] http://dealbook.nytimes.com/2014/07/15/jpmorgan-earnings-dec...
I've seen estimates that the entire high frequency trading industry made $1 billion profit in 2013, down from $5 billion in 2009. [0]
In contrast, JPMorgan made $6 billion profit in the last quarter, and that was reported as "not particularly impressive"! [1]
[0] http://www.reuters.com/article/2014/04/06/us-dark-markets-an...
[1] http://dealbook.nytimes.com/2014/07/15/jpmorgan-earnings-dec...
Moving to a 1 second tic wouldn't save money on infrastructure because HFTers would still have an incentive to wait for the last possible moment before the tic to update their orders to make sure that they had access to all possible information when making their decisions.
Excellent analysis. I am sick of seeing these Nanex posts(rants); the lack a basic familiarity of market microstructure mechanisms.
The market maker is not sitting there to let you run him over and thank you for it.
As a price taker, the trader has to incur slippage due to the market impact of his large order.
The market maker is not sitting there to let you run him over and thank you for it.
As a price taker, the trader has to incur slippage due to the market impact of his large order.
This article establishes that two things often happen shortly after you place an order to buy shares: 1) Another trader places a similar order on another exchange. 2) A large number of outstanding sell orders are cancelled.
It's not clear to me that either of these are Bad Things, deontologically speaking. [I don't recall Jesus mentioning them.]
The key question is consequentialist: Are there regulatory changes which would improve the lot of the average investor, investing through, say, an index tracker or pension fund? For each potential change, one ought see how it fares w.r.t. this standard, considering, to the extent that it is possible, the induced second-order effects.
Talk of theft, rigging, fairness (you don't owe people like me anything), stolen goods and frontrunning is only useful to the extent that it helps us converge on an answer to this question. These words are tools that we have developed for analysing more familiar situations, where they correspond to actions which are clearly harmful.
Most changes proposed here either lose market efficiency directly (trade buffering / increased tick sizes) or just give us new games to play (if the market clears once a second, we will get our orders in last), potentially resulting in a less direct loss. The question remains.
It's not clear to me that either of these are Bad Things, deontologically speaking. [I don't recall Jesus mentioning them.]
The key question is consequentialist: Are there regulatory changes which would improve the lot of the average investor, investing through, say, an index tracker or pension fund? For each potential change, one ought see how it fares w.r.t. this standard, considering, to the extent that it is possible, the induced second-order effects.
Talk of theft, rigging, fairness (you don't owe people like me anything), stolen goods and frontrunning is only useful to the extent that it helps us converge on an answer to this question. These words are tools that we have developed for analysing more familiar situations, where they correspond to actions which are clearly harmful.
Most changes proposed here either lose market efficiency directly (trade buffering / increased tick sizes) or just give us new games to play (if the market clears once a second, we will get our orders in last), potentially resulting in a less direct loss. The question remains.
I don't see how this proves the market is rigged. What I do see is:
1) One market participant is being less than clever by trying to buy, in one order, 80% of the offered quantity, and
2) Another market participant realizes this, and reacts accordingly.
The post is written as if the world should freeze once the client sends an order. He was 'stolen' shares. Really?
The post is written as if the world should freeze once the client sends an order. He was 'stolen' shares. Really?
[deleted]
As a non-trader, my question is:
Were the 24k shares being offered by one seller/broker, as in "I have 24k shares to sell at 17" or was the 24k just an aggregation of the availability all the smaller offers?
If the former, it seem to me that the seller is cheating, if it is the latter then I can see how the HFT systems would raise the price in response to a sale, but I also see how frustrating that is to the buyer.
I wonder why these trades are not being performed in parallel across the various exchanges, partially preventing this kind of arbitrage?
Were the 24k shares being offered by one seller/broker, as in "I have 24k shares to sell at 17" or was the 24k just an aggregation of the availability all the smaller offers?
If the former, it seem to me that the seller is cheating, if it is the latter then I can see how the HFT systems would raise the price in response to a sale, but I also see how frustrating that is to the buyer.
I wonder why these trades are not being performed in parallel across the various exchanges, partially preventing this kind of arbitrage?
> Were the 24k shares being offered by one seller/broker, as in "I have 24k shares to sell at 17" or was the 24k just an aggregation of the availability all the smaller offers?
The shares were being quoted on different exchanges, at the same ask price. 24k was the cumulative volume that the buyer wanted, but that couldn't be fulfilled by a single exchange (the quote was for a smaller volume at that price). Therefore, to buy 24k shares, the buyer needs to trade twice, once at each exchange.
> I wonder why these trades are not being performed in parallel across the various exchanges, partially preventing this kind of arbitrage?
As has been pointed out, this is what a good broker will do - they will compensate for latency to make sure that bids arrive at differing venues at the same time to prevent the market shifting underneath them. A naïve broker will simply send out the bids at the same, and latency means that they arrive at different exchanges at different times. This lets the sellers at the more distant exchange move the market in response to the information of the trade being executed at the closer exchange.
The shares were being quoted on different exchanges, at the same ask price. 24k was the cumulative volume that the buyer wanted, but that couldn't be fulfilled by a single exchange (the quote was for a smaller volume at that price). Therefore, to buy 24k shares, the buyer needs to trade twice, once at each exchange.
> I wonder why these trades are not being performed in parallel across the various exchanges, partially preventing this kind of arbitrage?
As has been pointed out, this is what a good broker will do - they will compensate for latency to make sure that bids arrive at differing venues at the same time to prevent the market shifting underneath them. A naïve broker will simply send out the bids at the same, and latency means that they arrive at different exchanges at different times. This lets the sellers at the more distant exchange move the market in response to the information of the trade being executed at the closer exchange.
All exchanges should have synced clocks and all messages should have a timestamp up to 2 seconds in the future when they will be published by each exchange. The buffering would be internal to each exchange and not shared with anybody. You can only cancel after what you are cancelling is published. This would allow everyone to make all exchanges publish at once so people with fast cable between exchanges can't beat out those that don't.
>This would allow everyone to make all exchanges publish at once so people with fast cable between exchanges can't beat out those that don't.
Why is one actor paying for an advantage that is available to anyone who should desire it, and have the means to pay for it, an issue?
Why is one actor paying for an advantage that is available to anyone who should desire it, and have the means to pay for it, an issue?
What do you think would happen to bid-ask spreads if this was imposed?
Can someone explain what's happening with the order cancellations? What causes it? Who is the party that is canceling orders?
"Holy shit, someone is working there way through every broker, buying ever share of Ford stock they have! ...huh, I've got some Ford stock for sale. Maybe if I quickly pull it out of the shop window, and change the price, I can make some extra cash!"
That's what it is: People are seeing the orders pour through the various exchanges, and are reacting to it. If they were seeing the orders before they hit the exchanges, that would be front running, and it would be illegal. But Nanex appears to be showing people responding to orders after they hit the exchanges, and that would seem to be legal and moral.
The moral is that if you want to buy so much of a single stock that you can't even buy it all from a single exchange, you MAY end up paying a bit of a premium, unless you're quite good at hiding what you're doing. And in this example, the purchaser was not. It's a story as old as markets.
That's what it is: People are seeing the orders pour through the various exchanges, and are reacting to it. If they were seeing the orders before they hit the exchanges, that would be front running, and it would be illegal. But Nanex appears to be showing people responding to orders after they hit the exchanges, and that would seem to be legal and moral.
The moral is that if you want to buy so much of a single stock that you can't even buy it all from a single exchange, you MAY end up paying a bit of a premium, unless you're quite good at hiding what you're doing. And in this example, the purchaser was not. It's a story as old as markets.
The question, from a society-design point of view, is whether it is useful to have a whole class of people who engage in what is ultimately a zero-sum game and therefore an arms race, and whether it wouldn't be better to design markets in such a way that a large buy order can be placed without having to be an expert at HFT.
After all, the market is supposed to be useful for organizing long-term investments. The short-term stuff is pretty far removed from the progress of society.
After all, the market is supposed to be useful for organizing long-term investments. The short-term stuff is pretty far removed from the progress of society.
"After all, the market is supposed to be useful for organizing long-term investments"
This is a very HN specific way of thinking (and probably obvious given the startup culture here) but it is not a truism. Many, many, many (perhaps most) market participants are not involved in the markets to organize long term investments. They are there to hedge risk (whole classes of exchanges exist nearly solely for this, think commodities markets).
But that is the glory of the markets. You can be a participant who is looking for long term investment, Southwest Airlines can be there to hedge risk, and I can be there to make a dime fast and we can all participate in what seems to be a zero sum game and win.
This is a very HN specific way of thinking (and probably obvious given the startup culture here) but it is not a truism. Many, many, many (perhaps most) market participants are not involved in the markets to organize long term investments. They are there to hedge risk (whole classes of exchanges exist nearly solely for this, think commodities markets).
But that is the glory of the markets. You can be a participant who is looking for long term investment, Southwest Airlines can be there to hedge risk, and I can be there to make a dime fast and we can all participate in what seems to be a zero sum game and win.
That's what I've always thought as well. We have large numbers of very intelligent people dedicating all their efforts to playing games with the values of real companies. It seems like a massive waste of talent IMHO.
Is this comment real? You made this comment on a site that most people use to waste time, and where one of the top posts is an Assembly implementation of Flappy Bird.
Fun fact: HFT has an annual revenue ~1/50th[1][2] of Google's. What's worse: a few hundred people wasting their time moving prices of select stocks a few pennies, or several thousand wasting their time collecting scary amounts of data about you to try and get you to click an ad?
[1]http://en.wikipedia.org/wiki/High-frequency_trading#Market_s...
[2]http://en.wikipedia.org/wiki/Google
Fun fact: HFT has an annual revenue ~1/50th[1][2] of Google's. What's worse: a few hundred people wasting their time moving prices of select stocks a few pennies, or several thousand wasting their time collecting scary amounts of data about you to try and get you to click an ad?
[1]http://en.wikipedia.org/wiki/High-frequency_trading#Market_s...
[2]http://en.wikipedia.org/wiki/Google
But Nanex appears to be showing people responding to orders after they hit the exchanges, and that would seem to be legal and moral.
It's legal, yes, but you can't make a jump to moral so easily.
I don't think it's necessarily immoral either, but morality depends on much more - what the end results are, who is affected, what kind of effect, etc. Morality doesn't exist in the vacuum of an isolated decision.
It's legal, yes, but you can't make a jump to moral so easily.
I don't think it's necessarily immoral either, but morality depends on much more - what the end results are, who is affected, what kind of effect, etc. Morality doesn't exist in the vacuum of an isolated decision.
Very true! But the reverse is also true: Critics need to show that something immoral is going on. Nanex's analysis does not, to my eye, even try and make this case.
An interesting contradiction appears here. On one hand, this increases market efficiency, or so we're told. On the other, we are also told that if a big pension fund wants to avoid being played like this, they should spend money on their own HFT equipment.
It seems there is only one clear winner here - the IT people making money off developing HFT systems.
It seems there is only one clear winner here - the IT people making money off developing HFT systems.
Here's the chief executive of Vanguard (one of the largest investment management companies in the world) discussing how HFT has dramatically lowered their trading costs:
http://www.ft.com/intl/cms/s/0/ff8c6486-cb37-11e3-ba95-00144...
Spreads used to be a quarter, and now they're a penny! That's a huge deal!
http://www.ft.com/intl/cms/s/0/ff8c6486-cb37-11e3-ba95-00144...
Spreads used to be a quarter, and now they're a penny! That's a huge deal!
Doesn't surprise me the least bit. Where there is something available to exploit (in this case, access to direct, fast feeds), it will be exploited.
Would it be possible, legally and technically, to put a special additional fee/tax onto high-frequency trading while leaving normal high-volume traders alone?
Would it be possible, legally and technically, to put a special additional fee/tax onto high-frequency trading while leaving normal high-volume traders alone?
Its certainly possible technically (and legally in some cases). Italy has a 0.02% tax on transactions lasting less than half a second: http://www.dw.de/italy-first-to-slap-tax-on-high-speed-stock...
Go to the router just entering the exchange, type:
tc qdisc change dev eth0 root netem delay 100ms 10ms
what does this do? (non-finance guy here)
The command introduces a delay of between 100 and 10ms to every packet. Screwing up trades that rely on being the fastest.
http://www.linuxfoundation.org/collaborate/workgroups/networ...
http://www.linuxfoundation.org/collaborate/workgroups/networ...
Its a bit of a joke. Its a network thing, not a finance thing. What it does is adds a delay and more importantly, a bit more random delay to the time it takes the order to reach the exchanges server. Once you add in the non-determinism, HFT basically falls apart because you can't take your truckload of cash and buy yourself a place in a datacenter that's 2ms closer to the exchange and front-run everyone.
It would be a wonderful thing to see all of those millions these guys have "invested" shaving a millisecond or two off their transaction times laid waste by a single command.
It would be a wonderful thing to see all of those millions these guys have "invested" shaving a millisecond or two off their transaction times laid waste by a single command.
This "solution" will only make it harder for regular folks to execute orders, since HFTs will beat the randomness by shooting multiple orders through multiple order gateways.
Guess we'll need a hierarchical token bucket with stochastic fairness queueing as well.
We don't just need it to be random. We need there to be no way of ever quite knowing if any given order will beat another order to the exchange (within a given time period, of course). They won't know if they can beat joe ordinary, and they definitely won't know if they can beat the other HFT's. That might be enough to put a lid on it.
Edit: For those playing along, here's the metaphor. Joe goes to market to buy sheep. Bill knows Joe is going so he sends a fast runner ahead of him to buy the cheapest sheep in town first so he can mark them up and sell them to Joe when he arrives. We try making everyone wait at the town gate for a random amount of time to give Joe a chance to arrive and get through. So Bill (being very rich) just sends 10 guys so one is very likely to be let in before Joe anyway. Next we introduce the stochastic filter. We make everyone line up and then shuffle the order every once in a while, but Bill still has more guys so he might still get one in first more often than not. Finally, we add the token bucket. For every one guy that we know employed by Bill admitted, we make the next one wait twice as long to get in, so if Joe and 10 Bills show up, Joe and the first Bill are essentially on even footing again because the 2nd through 10th Bill would have to wait too long to matter.
We don't just need it to be random. We need there to be no way of ever quite knowing if any given order will beat another order to the exchange (within a given time period, of course). They won't know if they can beat joe ordinary, and they definitely won't know if they can beat the other HFT's. That might be enough to put a lid on it.
Edit: For those playing along, here's the metaphor. Joe goes to market to buy sheep. Bill knows Joe is going so he sends a fast runner ahead of him to buy the cheapest sheep in town first so he can mark them up and sell them to Joe when he arrives. We try making everyone wait at the town gate for a random amount of time to give Joe a chance to arrive and get through. So Bill (being very rich) just sends 10 guys so one is very likely to be let in before Joe anyway. Next we introduce the stochastic filter. We make everyone line up and then shuffle the order every once in a while, but Bill still has more guys so he might still get one in first more often than not. Finally, we add the token bucket. For every one guy that we know employed by Bill admitted, we make the next one wait twice as long to get in, so if Joe and 10 Bills show up, Joe and the first Bill are essentially on even footing again because the 2nd through 10th Bill would have to wait too long to matter.
"For those playing along, here's the metaphor. Joe goes to market to buy sheep. Bill knows Joe is going so he sends a fast runner ahead of him to buy the...
"
Seriously, how many times have we discussed this issue on this site and we still get this bullshit. Bill doesn't know Joe is going. He doesn't. Get it through your thick heads.
Seriously, how many times have we discussed this issue on this site and we still get this bullshit. Bill doesn't know Joe is going. He doesn't. Get it through your thick heads.
Somewhat farcically perpetuating the metaphor, is it not the case that Bill gets to know that Joe is interested in buying sheep once Joe has bought a few of them? And at that point Bill can outrun Joe and make money from his (very near) future purchases?
That was my reading of the article - it seems that either there is a flow of information from the trading events to the fast traders, or the scenario portrayed in the article was very unlikely (though I guess that couldn't be ruled out given how much trading there is). noonespecial's metaphor seems to apply, what have I misunderstood?
That was my reading of the article - it seems that either there is a flow of information from the trading events to the fast traders, or the scenario portrayed in the article was very unlikely (though I guess that couldn't be ruled out given how much trading there is). noonespecial's metaphor seems to apply, what have I misunderstood?
Somewhat farcically perpetuating the metaphor, is it not the case that Bill gets to know that Joe is interested in buying sheep once Joe has bought a few of them?
He doesn't know with certainty. He can guess that's what Joe is doing, but he could be wrong and be stuck with sheep that he can't sell for the price he intends to ask. Every second he owns sheep is a second he's taking a risk that they'll go down in price, not up.
He doesn't know with certainty. He can guess that's what Joe is doing, but he could be wrong and be stuck with sheep that he can't sell for the price he intends to ask. Every second he owns sheep is a second he's taking a risk that they'll go down in price, not up.
Yes, that makes sense. From what I understood of the article, and it really isn't my area so maybe I got something wrong, a buy order was not filled completely even though there were sell orders available to fill it. Doesn't that mean that people cancelled their orders whilst the buy was being filled, meaning that they must have been able to execute market actions out of order? That would put people who can act quickly at a big advantage on getting the price they wanted, because they can cancel and re-bid at a higher price. Sure it's a gamble, but it seems like one with little to lose.
I've probably misunderstood something, but it certainly seems to be an issue that gets people very exercised. I presume there must be some competitive advantage in being fast, otherwise people wouldn't do it, so surely the only real issue is whether or not the consequence of exercising that advantage is socially advantageous?
I've probably misunderstood something, but it certainly seems to be an issue that gets people very exercised. I presume there must be some competitive advantage in being fast, otherwise people wouldn't do it, so surely the only real issue is whether or not the consequence of exercising that advantage is socially advantageous?
Its a somewhat leaky metaphor I grant you. So how does Bill have information about what Joe is doing? Joe certainly tries not to telegraph such things for obvious reasons.
From what I've gathered, through methods like "pinging" the market with many tiny transactions in likely spots, Bill can sound out what Joe is doing in the sheep market. Supposedly the market exchange will also "flash" the information about buy and sell orders to the HFT's in favorable network locations a few ms faster than the general public as well. Figuring out that Joe is buying sheep are what all of the "brilliant minds" that are heading into HFT everyone is talking about are doing. They're watching the road for Joe. Also Joe is not a small investor, he's a rancher that buys lots of sheep. Small investors don't place the kind of orders that HFT can attack.
Do note that this metaphor really only applies to the Front Running section of HFT, and really evolved from a fanciful attempt to coagulate network layer and application layer solutions into one magical unicorn fix. (Its kind of more about how tc works in linux than how markets work. :) )
From what I've gathered, through methods like "pinging" the market with many tiny transactions in likely spots, Bill can sound out what Joe is doing in the sheep market. Supposedly the market exchange will also "flash" the information about buy and sell orders to the HFT's in favorable network locations a few ms faster than the general public as well. Figuring out that Joe is buying sheep are what all of the "brilliant minds" that are heading into HFT everyone is talking about are doing. They're watching the road for Joe. Also Joe is not a small investor, he's a rancher that buys lots of sheep. Small investors don't place the kind of orders that HFT can attack.
Do note that this metaphor really only applies to the Front Running section of HFT, and really evolved from a fanciful attempt to coagulate network layer and application layer solutions into one magical unicorn fix. (Its kind of more about how tc works in linux than how markets work. :) )
Pretty sure he's suggesting adding a non-determistic lower bound to trade frequencies at network boundary
Not really no.
High Frequency Traders are selling a service (liquidity). A tax on them is mostly just a tax on their customers.
High Frequency Traders are selling a service (liquidity). A tax on them is mostly just a tax on their customers.
Just in case anyone has time to help me out:
What's the difference between trades and quotes here in this chart? And how are the trader's order and purchases indicated?
What's the difference between trades and quotes here in this chart? And how are the trader's order and purchases indicated?
A quote is a statement that someone is offering to buy or sell a specific quantity of shares/commodities at a specific price: "I want to sell 10g of gold at 40$ each". Typically the identity of the trader is known only to the exchange (and the trader )
A trade is an announcement that an offer was accepted and a contract was agreed on. "10g of gold have been sold at 40$ each". The identity of the traders is typically known only by the exchange, and each of the trader knows they are part of it, but don't know the counterparty.
A trade is an announcement that an offer was accepted and a contract was agreed on. "10g of gold have been sold at 40$ each". The identity of the traders is typically known only by the exchange, and each of the trader knows they are part of it, but don't know the counterparty.
what is market-pricing without arbitrage?
This is the bad part of HFT, the one that is theft and destroy value. It is paid by the big players, and "solved" by imperfect solution like dark pools. A better solution could be to add a hour component to the order, so all commands from an actor in all markets are executed at the exact same time.
This rotted apple should not hide the good part of HFT, which is to reduce spread and inconsistencies between markets and to generate profits from this (positive) action. HFT took the place of traders, who were paid a lot for doing that stupid task.
This rotted apple should not hide the good part of HFT, which is to reduce spread and inconsistencies between markets and to generate profits from this (positive) action. HFT took the place of traders, who were paid a lot for doing that stupid task.
If I ask for X at Y. Someone else shouldn't have the facility to buy it based on my own trade signal and try sell it back to me.
It is mindblowingly simple theft. The arguments for liquidity do not hold. There is some fascinating cognitive dissonance when it comes to the HFT industry.