The gargantuan stupidity of the financial transactions tax(pando.com)
pando.com
The gargantuan stupidity of the financial transactions tax
http://pando.com/2014/03/13/the-gargantuan-stupidity-of-the-financial-transactions-tax/
12 comments
The opposition to HFT here is hilarious to me. HFT and computerized trading is nothing more than the automation of the very lucrative trading industry. Do HFT firms make a lot of money? Sure. But it's coming out of the pockets of traders who in the aggregate would make even more. Its automation concentrating wealth but reducing overall costs, as usual.
People on HN tend not to understand that the beneficiaries of the pre-HFT trading regime were, basically, rent-seekers that profited (often collusively) by increasing the costs of trading.
Indeed, most arguments against HFT say it's a parasite business. However, I haven't seen anyone give precise numbers on how much money they're "stealing" compared to how much money non-HFT hedge funds and investment banks make. I suppose this is the internet where everyone is an expert.
>Sure. But it's coming out of the pockets of traders who in the aggregate would make even more.
i.e. traders like pension funds, who will end up passing the costs on to pensioners.
i.e. traders like pension funds, who will end up passing the costs on to pensioners.
How actively to pension funds trade? The HFT squeeze harms people who jump in and out of positions quickly. Don't pension funds buy and hold, and thus benefit from reduced transaction costs? One of the hardest things to do in the market --- shopping huge blocks --- is simultaneously something HFT is good at and something that inflicts costs on institutional buy-and-hold investors.
"In fact, we can show that the spreads must widen to be larger than the tax itself being applied. If there’s a tax of 3 bps on a trade then no one’s going to trade at a spread of less than 3 bps."
6bps. To market make a spread you have to buy AND sell. Tax is charged twice at each end.
The intermediaries are charged the tax twice, which means the end consumer (investors, pension funds, whatever) will be charged (at least) three times. Once directly, and twice indirectly because market makers will have to widen their spreads by at least that amount.
6bps. To market make a spread you have to buy AND sell. Tax is charged twice at each end.
The intermediaries are charged the tax twice, which means the end consumer (investors, pension funds, whatever) will be charged (at least) three times. Once directly, and twice indirectly because market makers will have to widen their spreads by at least that amount.
Bit of a red herring to say this matters to individual investors though - compared to income tax it is meaningless, and if the share is expected to pay long term dividends it is not big.
It discourages day-trading on stock, but it won't do too much damage to mid/long term investors. It might actually encourage companies to make good mid-long term decisions.
EDIT and the two endpoints can trade directly with a spread smaller than 6 bps if they are that price sensitive.
It discourages day-trading on stock, but it won't do too much damage to mid/long term investors. It might actually encourage companies to make good mid-long term decisions.
EDIT and the two endpoints can trade directly with a spread smaller than 6 bps if they are that price sensitive.
What do shares have to do with anything? They are a small part of the picture. The spread on the e-mini S&P is currently 0.25, and it is trading at 1800. So 1/7200 is roughly 1.5 bps. This will increase the spread by (at least) 6 bps to 7.5bps, then charge you another 3. So spreads five times bigger. Instead of trading say 1810.00/1810.25, it will be trading 1810.00/1811.25. Do you get it yet? No one will trade. And the comical part is that they project supposed revenues based on current trading volumes.
Also, I've missed the best part so far, when I mentioned that you get charged three times in my first post, that was just to get into a trade. So end-user will get charged at least 6 times per roundtrip (twice directly, four times indirectly through widened spreads).
Also, I've missed the best part so far, when I mentioned that you get charged three times in my first post, that was just to get into a trade. So end-user will get charged at least 6 times per roundtrip (twice directly, four times indirectly through widened spreads).
It's kind of irrelevant anyway, since any financial transactions tax would be at least a couple of orders of magnitude less than 3 bps. i.e. - "harmful" for HFT, but practically irrelevant for anybody who doesn't do extremely frequent trades.
Somebody's pretty angry. Gooooood :)
I see no serious argument in this text. I mean, my god, if we tax them, their prices will rise?! I've never heard of anything like that! :D And everything is so weakly argumented, just a couple of expert terms are thrown around, while the majority of the text deals with attacking segments of opposing views he disagrees with. All in all, very emotional and weak.
And I love his explanation of how this Great Recession came to be. One of the most manipulatively simplified descriptions I've ever heard.
I see no serious argument in this text. I mean, my god, if we tax them, their prices will rise?! I've never heard of anything like that! :D And everything is so weakly argumented, just a couple of expert terms are thrown around, while the majority of the text deals with attacking segments of opposing views he disagrees with. All in all, very emotional and weak.
And I love his explanation of how this Great Recession came to be. One of the most manipulatively simplified descriptions I've ever heard.
It's a non-solution to a problem that doesn't even exist. The real "problem" as I understand it is that some people get information sooner than others and can profit from it, creating incentives to get information faster and faster even though there is little benefit to the rest of the economy for doing so. I doubt the total cost is that huge though.
I'm not sure if it's possible to fix that, but one idea would be to do trades in discrete increments of a few seconds or whatever. Similar to how exchanges close overnight and companies can release important information, and everyone can be prepared by the next day when they start trading again.
I'm not sure if it's possible to fix that, but one idea would be to do trades in discrete increments of a few seconds or whatever. Similar to how exchanges close overnight and companies can release important information, and everyone can be prepared by the next day when they start trading again.
Making money from pure trading revolves around information asymmetry, and ability to store goods - most of the time this is really good, because it helps to motivate people with clever ideas to put them into practice.
The problem with HFT is that practically speaking, the value of a company can't change in timeframes shorter than a couple of hours (barring exceptional circumstances like a big announcement). So a HFT firm is not actually benefiting from information asymmetry about the product of the company being traded or real-world conditions, it is benefiting from information asymmetry about the conditions at the exchange. In theory this is transferring money from subject-matter experts to experts in how exchange servers & the local fiberoptic grid works.
I'd be alone in a room of HF traders, but this isn't useful economic activity vs. subject matter experts making money.
I don't understand all the arguments about 'liquidity', I don't see why a slight price spread is a bad thing; provided that I can sell stock in an hour or so. There isn't a magic 'efficient price' determined by the gods of the market - it is whatever the buyer is willing to pay.
The problem with HFT is that practically speaking, the value of a company can't change in timeframes shorter than a couple of hours (barring exceptional circumstances like a big announcement). So a HFT firm is not actually benefiting from information asymmetry about the product of the company being traded or real-world conditions, it is benefiting from information asymmetry about the conditions at the exchange. In theory this is transferring money from subject-matter experts to experts in how exchange servers & the local fiberoptic grid works.
I'd be alone in a room of HF traders, but this isn't useful economic activity vs. subject matter experts making money.
I don't understand all the arguments about 'liquidity', I don't see why a slight price spread is a bad thing; provided that I can sell stock in an hour or so. There isn't a magic 'efficient price' determined by the gods of the market - it is whatever the buyer is willing to pay.
I don't think that's entirely correct. They are profiting from information asymmetry. Markets change slightly and they know it 1 millisecond before everyone else. In that millisecond they buy or sell and profit from the price change. This is stuff that would have been done anyways by regular traders. It's just the high speed traders are now faster and so do it first.
As far as I can tell that isn't hurting anyone more than normal arbitrage.
As far as I can tell that isn't hurting anyone more than normal arbitrage.
>It's a non-solution to a problem that doesn't even exist. The real "problem" as I understand it is that some people get information sooner than others and can profit from it
That's effectively describing the problem is a slightly reformulated way. HFT basically gives traders priority access to the market - they can receive outside information at the same time as you and just react to it quicker.
Moreover, they have priority access to information about how others in the market are behaving.
>I'm not sure if it's possible to fix that, but one idea would be to do trades in discrete increments of a few seconds or whatever.
That simply changes the race from about being the quickest trader to being first in the queue during the increments.
That's effectively describing the problem is a slightly reformulated way. HFT basically gives traders priority access to the market - they can receive outside information at the same time as you and just react to it quicker.
Moreover, they have priority access to information about how others in the market are behaving.
>I'm not sure if it's possible to fix that, but one idea would be to do trades in discrete increments of a few seconds or whatever.
That simply changes the race from about being the quickest trader to being first in the queue during the increments.
>That simply changes the race from about being the quickest trader to being first in the queue during the increments.
True, it would have to be in a nondeterministic order. I posted another possible solution above, randomly fuzz the time trades are executed to within a few seconds after they are received. Completely disrupting any millisecond advantages.
I just realized the problem with that is someone could just send millions of trades through and increase the probability one of them is executed first. So maybe not.
True, it would have to be in a nondeterministic order. I posted another possible solution above, randomly fuzz the time trades are executed to within a few seconds after they are received. Completely disrupting any millisecond advantages.
I just realized the problem with that is someone could just send millions of trades through and increase the probability one of them is executed first. So maybe not.
You can have very different opinion about friction depending on where it is. You won't use the same lube that you use on your crankshaft on your brakes. At least I hope so - the last time I saw "My brakes are screeching I greased them" was hilarious, but that is what bumpers are for.
So we want lower barriers to entry in trading and moving capital to the productive sectors of the economy and smarter trades. That is why the transaction tax could be helpful - we want to move the largest amount of capital to the economy and not the maximum possible numbers of transactions.
So we want lower barriers to entry in trading and moving capital to the productive sectors of the economy and smarter trades. That is why the transaction tax could be helpful - we want to move the largest amount of capital to the economy and not the maximum possible numbers of transactions.
Your analogy and the argument after it make no sense to me. Barriers to entry won't be lowered by this, nor will trades be smarter.
> The real "problem" as I understand it is that some people get information sooner than others and can profit from it
That's backwards. Exactly synchronising the dissemination of information is a hard problem. HFT leverages even small sub-second differences.
Even simple physical factors (i.e. the speed of light) mean that being closer to the exchange is highly desirable as this will mean getting the information sooner. People did not create the phsyics of that problem.
That's backwards. Exactly synchronising the dissemination of information is a hard problem. HFT leverages even small sub-second differences.
Even simple physical factors (i.e. the speed of light) mean that being closer to the exchange is highly desirable as this will mean getting the information sooner. People did not create the phsyics of that problem.
I'm aware of that. That's why I suggested doing trades in discrete time blocks. All trades within the time block will be executed at the end in a nondeterministic order, regardless of who was first.
It's not perfect because someone could still get information at the end of the time block before anyone else does. I can't think of a solution to that. Perhaps instead of time blocks, execute trades randomly within a short period of them being posted. Completely disrupting millisecond advantages with random noise.
It's not perfect because someone could still get information at the end of the time block before anyone else does. I can't think of a solution to that. Perhaps instead of time blocks, execute trades randomly within a short period of them being posted. Completely disrupting millisecond advantages with random noise.
I think the problem this solution tries to fix is that a lot of money have moved to "pure financial investment" from "tangible stuff", e.g. think of Warren Buffet's Gotrocks parable.
I don't know if the problem is real, and I don't know if this tax would fix it, but that is in my understanding why taxes on financial transactions are thought as useful.
I don't know if the problem is real, and I don't know if this tax would fix it, but that is in my understanding why taxes on financial transactions are thought as useful.
As far as I can tell this is aimed at HFT specifically, and wouldn't have an effect on the rest of the financial industry.
A solution that would probably be better and less easy to abuse would be to move the minimum price from a penny to like 1/100000 of a penny. It would reward those with better algorithms and it would not favor speed as much.
People trade after hours.
The general audience ( that includes me ) thinks that high frequency trading makes easy money out of nothing. But for someone to make money, another's got to loose. So has anyone heard of hft firms going bankrupt ?
You are assuming the market is a closed system, but it's not really: you aren't gambling with other people, instead the capital invested should be put to productive use. HFT helps with liquidity, though there are probably better solutions to that problem.
Honest question, why would liquidity of anything less than, say a week, be useful?
Same question for a day? An hour? A minute? A second...
Same question for a day? An hour? A minute? A second...
Suppose we made regular businesses wait an extra week to receive shipments. What if you had to wait an extra minute to launch a new server on AWS? If a fundamentals trader has put in an order to buy a stock they've presumably done so for a business reason and slowing that down slows down their business.
I'm sure not automatically trading hundreds of times per second will not impact their business (unless their business is trading faster than somebody else).
YC funded a startup that was about selling your old Apple gear quicker than you could on EBay. That's an example of why you'd want more liquidity.
A stock market isn't a closed system because events from real life increase or decrease the global value traded in that market. But when you're trading at thousands of orders per seconds, then real life hasn't any impact, and so i assumed a market could be approximated as a closed system.
Market makers have been making money for as long as markets have existed. In financial markets, there are now fewer of them, competing for smaller profits, and they use computers to trade.
Knight Capital Group went bankrupt, it wasn't due to HFT, but was caused by bad electronic trading.
http://pythonsweetness.tumblr.com/post/64740079543/how-to-lo...
http://pythonsweetness.tumblr.com/post/64740079543/how-to-lo...
But for someone to make money, another's got to loose.
That's not true, unless you believe you "lose" everytime you buy something. You can buy and sell risk and time, for money. These may be intangibles, but they still have value.
That's not true, unless you believe you "lose" everytime you buy something. You can buy and sell risk and time, for money. These may be intangibles, but they still have value.
> But for someone to make money, another's got to loose.
That's not really putting it well. For someone to buy then another has to sell. If you're selling just as they're buying then you're not losing.
That's not really putting it well. For someone to buy then another has to sell. If you're selling just as they're buying then you're not losing.
Well by that logic all trades are bad since someone always loses money.
The interesting thing I find about HFT discussions on HN is the mindset "it's computers, therefore I fully understand it".
The big problem with the research around financial transaction tax is that most of the academics working on it are completely clueless - they have no real idea how a lot of the financial world works operationally in practice.
For example one of the major papers made a estimate for the total daily volume of the forex trading; it was lower than the volume that a single mid-tier investment bank would do.
Most papers also ignore standard practices like deal netting that banks do to reduce organic transaction costs.
For example one of the major papers made a estimate for the total daily volume of the forex trading; it was lower than the volume that a single mid-tier investment bank would do.
Most papers also ignore standard practices like deal netting that banks do to reduce organic transaction costs.
He sets up a number of straw men which completely miss the POINT of the financial transactions tax.
>In very brief form, it wasn’t high speed trading, nor any of >the markets where that occurs, which led to the crash.
In very brief form, the financial transactions tax is NOT about preventing another crash (other regulations are needed for this). It's about preventing HFT operators from effectively levying a tax on the rest of the participants in the equities market (e.g. pensions and value investors).
>Reducing speculation increases price volatility
Absurd. In fact, high levels of capital flows correlate with financial crises (i.e. they're a cause of volatility): http://www.crei.cat/people/broner/BDES%20pub.pdf
This can be seen in HFT by looking at the flash crash. Volatility gone nuts. Did that ever happen before HFT?
>the tax itself will not in fact raise any net revenues
Again it's NOT THE POINT of the tax to raise revenues, it's to discourage HFT: http://www.nakedcapitalism.com/2013/11/robin-hood-tax-how-re...
>and yet will have a cost to both the workers in the form of lower wages and pensioners in lower pensions.
Not only false, the opposite is true.
The profits that HFT firms make have to come from SOMEwhere, correct? Well, they come from you. Specifically, large investors (pension funds), insurance companies, value investors, etc. Other participants in the market.
HFT takes money directly from pension funds who are executing large orders, by 'skimming' off the orders they make. Their profits are not made out of thin air.
>So an FTT would indeed drive up costs for individual investors making the >critics correct on this very point then?
Nope. FTT is infinitesimally tiny % of a transaction. Unless you're executing millions upon millions of transactions a day that's an infinitesimally tiny amount. In which case you're NOT an individual investor, you're doing HFT... the exact kind of behavior this tax is intended to cut down on.
>Sigh. The argument is now that it’s not going to cost people very much >because we’ve decided not to count that cost which is going to be the >largest for people.
Firstly, HFT WITHDRAWS liquidity precisely when it is needed the most. Most algos will freeze up during times of market distress. So yeah, they're not helping when the markets are ACTUALLY suffering from a lack of liquidity.
Secondly, they're adding trading volume, not liquidity. It was never hard to actually sell or buy a stock before HFT. They're not cutting down on spreads (that's what market makers do - and HFT is NOT market making).
When the markets are operating normally, they're already very, very, very liquid (as was the case before HFT). HFT makes little to no difference.
HFT is basically legalized front running. It should be banned somehow because it is parasitic on the other participants in the equities market. The financial transactions would cut down on that, but don't expect them to give up without a fight (as this guy is witness to).
>In very brief form, it wasn’t high speed trading, nor any of >the markets where that occurs, which led to the crash.
In very brief form, the financial transactions tax is NOT about preventing another crash (other regulations are needed for this). It's about preventing HFT operators from effectively levying a tax on the rest of the participants in the equities market (e.g. pensions and value investors).
>Reducing speculation increases price volatility
Absurd. In fact, high levels of capital flows correlate with financial crises (i.e. they're a cause of volatility): http://www.crei.cat/people/broner/BDES%20pub.pdf
This can be seen in HFT by looking at the flash crash. Volatility gone nuts. Did that ever happen before HFT?
>the tax itself will not in fact raise any net revenues
Again it's NOT THE POINT of the tax to raise revenues, it's to discourage HFT: http://www.nakedcapitalism.com/2013/11/robin-hood-tax-how-re...
>and yet will have a cost to both the workers in the form of lower wages and pensioners in lower pensions.
Not only false, the opposite is true.
The profits that HFT firms make have to come from SOMEwhere, correct? Well, they come from you. Specifically, large investors (pension funds), insurance companies, value investors, etc. Other participants in the market.
HFT takes money directly from pension funds who are executing large orders, by 'skimming' off the orders they make. Their profits are not made out of thin air.
>So an FTT would indeed drive up costs for individual investors making the >critics correct on this very point then?
Nope. FTT is infinitesimally tiny % of a transaction. Unless you're executing millions upon millions of transactions a day that's an infinitesimally tiny amount. In which case you're NOT an individual investor, you're doing HFT... the exact kind of behavior this tax is intended to cut down on.
>Sigh. The argument is now that it’s not going to cost people very much >because we’ve decided not to count that cost which is going to be the >largest for people.
Firstly, HFT WITHDRAWS liquidity precisely when it is needed the most. Most algos will freeze up during times of market distress. So yeah, they're not helping when the markets are ACTUALLY suffering from a lack of liquidity.
Secondly, they're adding trading volume, not liquidity. It was never hard to actually sell or buy a stock before HFT. They're not cutting down on spreads (that's what market makers do - and HFT is NOT market making).
When the markets are operating normally, they're already very, very, very liquid (as was the case before HFT). HFT makes little to no difference.
HFT is basically legalized front running. It should be banned somehow because it is parasitic on the other participants in the equities market. The financial transactions would cut down on that, but don't expect them to give up without a fight (as this guy is witness to).
> In very brief form, the financial transactions tax is NOT about preventing another crash (other regulations are needed for this). It's about preventing HFT operators from effectively levying a tax on the rest of the participants in the equities market (e.g. pensions and value investors).
Actually no. HFT drive down the costs for pensions and value investors. The ones that foot the bill is the traders and the market makers that have seen their margins collapse.
> This can be seen in HFT by looking at the flash crash. Volatility gone nuts. Did that ever happen before HFT?
Indeed it did. There was a flash crash in 1962 as well. The reason was similar - suddenly the market found they were out of buyers.
> The profits that HFT firms make have to come from SOMEwhere, correct?
Sure, but there are plenty of other players in the market that traditionally have been able to shave a lot more from investors.
As for your comments that HFT is not driving down spreads, there are plenty of evidence that they do. Spreads have collapsed to nothing in the 15-20 years of operating HFTs.
Mandatory reading: http://www.chrisstucchio.com/blog/2012/hft_apology.html Don't miss part 2 and 3.
Actually no. HFT drive down the costs for pensions and value investors. The ones that foot the bill is the traders and the market makers that have seen their margins collapse.
> This can be seen in HFT by looking at the flash crash. Volatility gone nuts. Did that ever happen before HFT?
Indeed it did. There was a flash crash in 1962 as well. The reason was similar - suddenly the market found they were out of buyers.
> The profits that HFT firms make have to come from SOMEwhere, correct?
Sure, but there are plenty of other players in the market that traditionally have been able to shave a lot more from investors.
As for your comments that HFT is not driving down spreads, there are plenty of evidence that they do. Spreads have collapsed to nothing in the 15-20 years of operating HFTs.
Mandatory reading: http://www.chrisstucchio.com/blog/2012/hft_apology.html Don't miss part 2 and 3.
>Actually no. HFT drive down the costs for pensions and value investors. The ones that foot the bill is the traders and the market makers that have seen their margins collapse.
As a % of profits gained from HFT, market making is small enough to not even be relevant. The more profitable strategies involve basically front running the market.
>Indeed it did. There was a flash crash in 1962 as well.
It took a YEAR for prices to rise again. That is not volatility. Or a flash crash. That is a CRASH crash.
Wanna know how long it took for prices to rise again after the flash crash? 15 minutes. THAT'S volatility. One year? Eeeeeh, not so much.
>Sure, but there are plenty of other players in the market that traditionally have been able to shave a lot more from investors.
Yes, it is not the biggest rip off the world (or indeed the equity market) has ever seen. That doesn't change anything about its fundamental nature, however.
>As for your comments that HFT is not driving down spreads, there are plenty of evidence that they do. Spreads have collapsed to nothing in the 15-20 years of operating HFTs.
Spread have declined because electronic trading reduced the transaction costs of trading.
It ought to be glaringly obvious that anything that happened 20 years ago had NOTHING to do with HFT. It didn't even exist in a limited form until 15 years ago and only really took off 5 years ago.
As a % of profits gained from HFT, market making is small enough to not even be relevant. The more profitable strategies involve basically front running the market.
>Indeed it did. There was a flash crash in 1962 as well.
It took a YEAR for prices to rise again. That is not volatility. Or a flash crash. That is a CRASH crash.
Wanna know how long it took for prices to rise again after the flash crash? 15 minutes. THAT'S volatility. One year? Eeeeeh, not so much.
>Sure, but there are plenty of other players in the market that traditionally have been able to shave a lot more from investors.
Yes, it is not the biggest rip off the world (or indeed the equity market) has ever seen. That doesn't change anything about its fundamental nature, however.
>As for your comments that HFT is not driving down spreads, there are plenty of evidence that they do. Spreads have collapsed to nothing in the 15-20 years of operating HFTs.
Spread have declined because electronic trading reduced the transaction costs of trading.
It ought to be glaringly obvious that anything that happened 20 years ago had NOTHING to do with HFT. It didn't even exist in a limited form until 15 years ago and only really took off 5 years ago.
It's about preventing HFT operators from effectively levying a tax on the rest of the participants in the equities market...HFT takes money directly from pension funds who are executing large orders, by 'skimming' off the orders they make.
Can you explain the mechanics of this "skimming" and explain how a transaction tax would prevent it? Detailed mechanics please, not vague talking points or meaningless nanex graphs.
Firstly, HFT WITHDRAWS liquidity precisely when it is needed the most. Most algos will freeze up during times of market distress.
Most algos work just fine during distress - HFTs love volatility. They are switched off during distress for regulatory reasons (broken trades).
If you buy accenture at $1 during the flash crash, sell at $40, then accenture goes up to $44, you'll find yourself with a $4 loss after the regulators break your $1 trade. That's quite a reward for helping to fix a distressed market.
Can you explain the mechanics of this "skimming" and explain how a transaction tax would prevent it? Detailed mechanics please, not vague talking points or meaningless nanex graphs.
Firstly, HFT WITHDRAWS liquidity precisely when it is needed the most. Most algos will freeze up during times of market distress.
Most algos work just fine during distress - HFTs love volatility. They are switched off during distress for regulatory reasons (broken trades).
If you buy accenture at $1 during the flash crash, sell at $40, then accenture goes up to $44, you'll find yourself with a $4 loss after the regulators break your $1 trade. That's quite a reward for helping to fix a distressed market.
>Can you explain the mechanics of this "skimming" and explain how a transaction tax would prevent it? Detailed mechanics please, not vague talking points or meaningless nanex graphs.
Here:
A classic aggressive strategy involves hunting and trapping “whales.” It is a good example of aggressive HFT strategy.
It is initiated by a “pinging” operation. This involves placing multiple orders designed to detect the presence of a market participant with a large position that it is in the process of accumulating or liquidating. “High frequency traders employ pattern recognition software to detect large institutional orders sitting in dark pools or other liquidity venues.”41 When it pings, the algorithmic trader places orders to buy and/or sell in an array of prices inside the bid/ask spread. If the potential target market participant starts walking through the orders, it becomes clear that a large position is in play that could consume all of the liquidity on one side of the market (bid or ask). Traders sometimes refer to the potential target as a “whale.” Often, a whale intends to buy or sell a large block for structural reasons and is relatively less sensitive to price than other buyers and sellers. If the trader’s order strategy reveals price insensitivity, the whale becomes a target.
For example, an investment fund might have experienced large redemptions from its investors that require liquidation of investments under the terms of the fund. The fund is compelled to sell promptly and is relatively insensitive to price. It is a properly motivated whale.
Once a whale is sighted and its price insensitivity is confirmed, it becomes clear that dominating the other side of the market will give the algorithmic trader control of the bid/ask pricing mechanism. In our example, the algorithmic trader would meet the offers of all of the bidders for the shares that the whale seeks to sell, becoming the sole and dominant purchaser in the marketplace. The algorithmic trader establishes a narrow band of absolute market power controlling the particular securities or derivatives that the whale seeks to buy or sell. The whale will be compelled to either abandon the market or transact at the price demanded by the algorithmic trader.
In an instant, the algorithmic trader cancels all “pinging” orders and buys the market in order to extract as much value as possible. It will also likely flood the trading venue with orders to create congestion and slow other market participants who are also watching and might intervene. The whale must transact at the price required by the algorithmic trader to accumulate or liquidate the position, as appropriate. When the transaction with the whale is accomplished, the quote stuffing orders are all cancelled.
In the final step, the algorithmic trader liquidates the position acquired from the whale immediately, but at a new bid/ask spread reestablished at market levels that are more competitive. The algorithmic trader intends that its profit from moving the bid/ask spread to take advantage of the whale’s price insensitive motivation will exceed the potential loss from the operation if the whale detects that it is being taken advantage of. For this reason, the strategy is most useful if all of the steps can be executed quickly, before detection is possible.
By displacing the entire side of a bid/ask spread, the HFT eliminates all meaningful depth of buying or selling interest for a short time period. As a result, the observed spread in the market is meaningless. Various studies that examine the narrowing of bid ask spreads in the modern marketplace miss the crucial point that HFT tactics like the one described are missing the point that the narrowing is an illusion.42 If the study draws the conclusion that HFT narrows spreads, it is simply misleading.
(From: http://www.nakedcapitalism.com/2013/03/yes-virginia-hft-and-...)
N.B. Price insensitivity in this context means "not knowing" what the price should be. Not "not caring". The deleterious effect on the market should nonetheless be obvious.
Here:
A classic aggressive strategy involves hunting and trapping “whales.” It is a good example of aggressive HFT strategy.
It is initiated by a “pinging” operation. This involves placing multiple orders designed to detect the presence of a market participant with a large position that it is in the process of accumulating or liquidating. “High frequency traders employ pattern recognition software to detect large institutional orders sitting in dark pools or other liquidity venues.”41 When it pings, the algorithmic trader places orders to buy and/or sell in an array of prices inside the bid/ask spread. If the potential target market participant starts walking through the orders, it becomes clear that a large position is in play that could consume all of the liquidity on one side of the market (bid or ask). Traders sometimes refer to the potential target as a “whale.” Often, a whale intends to buy or sell a large block for structural reasons and is relatively less sensitive to price than other buyers and sellers. If the trader’s order strategy reveals price insensitivity, the whale becomes a target.
For example, an investment fund might have experienced large redemptions from its investors that require liquidation of investments under the terms of the fund. The fund is compelled to sell promptly and is relatively insensitive to price. It is a properly motivated whale.
Once a whale is sighted and its price insensitivity is confirmed, it becomes clear that dominating the other side of the market will give the algorithmic trader control of the bid/ask pricing mechanism. In our example, the algorithmic trader would meet the offers of all of the bidders for the shares that the whale seeks to sell, becoming the sole and dominant purchaser in the marketplace. The algorithmic trader establishes a narrow band of absolute market power controlling the particular securities or derivatives that the whale seeks to buy or sell. The whale will be compelled to either abandon the market or transact at the price demanded by the algorithmic trader.
In an instant, the algorithmic trader cancels all “pinging” orders and buys the market in order to extract as much value as possible. It will also likely flood the trading venue with orders to create congestion and slow other market participants who are also watching and might intervene. The whale must transact at the price required by the algorithmic trader to accumulate or liquidate the position, as appropriate. When the transaction with the whale is accomplished, the quote stuffing orders are all cancelled.
In the final step, the algorithmic trader liquidates the position acquired from the whale immediately, but at a new bid/ask spread reestablished at market levels that are more competitive. The algorithmic trader intends that its profit from moving the bid/ask spread to take advantage of the whale’s price insensitive motivation will exceed the potential loss from the operation if the whale detects that it is being taken advantage of. For this reason, the strategy is most useful if all of the steps can be executed quickly, before detection is possible.
By displacing the entire side of a bid/ask spread, the HFT eliminates all meaningful depth of buying or selling interest for a short time period. As a result, the observed spread in the market is meaningless. Various studies that examine the narrowing of bid ask spreads in the modern marketplace miss the crucial point that HFT tactics like the one described are missing the point that the narrowing is an illusion.42 If the study draws the conclusion that HFT narrows spreads, it is simply misleading.
(From: http://www.nakedcapitalism.com/2013/03/yes-virginia-hft-and-...)
N.B. Price insensitivity in this context means "not knowing" what the price should be. Not "not caring". The deleterious effect on the market should nonetheless be obvious.
What you describe is predatory trading, which is a trading strategy engaged in by players at many speeds. And all you've shown is that the price impact of a whale dumping stock is now felt by the whale, not by the other players in the market.
I.e., before the big player decided to liquidate the natural price was X. After they decided to liquidate the natural price is Y < X. The market will move from X to Y, it's only a matter of when. If the whale sells at X, the other players eat the loss. If HFTs predate on the whale, the HFTs gain, other players take less of a loss, and the whale eats more of the loss.
Why is this bad? Is it somehow a desirable feature of the markets that Goldman can dump 1M shares of AAPL and the rest of us are supposed to eat the price impact?
Also, predation is unlikely to be affected by an FTT. You typically make well over 6bps from predatory strategies. It's only the low margin market making which will be affected.
I.e., before the big player decided to liquidate the natural price was X. After they decided to liquidate the natural price is Y < X. The market will move from X to Y, it's only a matter of when. If the whale sells at X, the other players eat the loss. If HFTs predate on the whale, the HFTs gain, other players take less of a loss, and the whale eats more of the loss.
Why is this bad? Is it somehow a desirable feature of the markets that Goldman can dump 1M shares of AAPL and the rest of us are supposed to eat the price impact?
Also, predation is unlikely to be affected by an FTT. You typically make well over 6bps from predatory strategies. It's only the low margin market making which will be affected.
this strategy is ineffective with the transaction tax. it should be obvious why.
the whale is normally a pension fund or some other institutional investor that doesn't have the resources of an hft. that means they get burned.
I find it somewhat amusing that you're assuming that the rest of the market needs to be protected from the pensioners by Goldman Sachs.
the whale is normally a pension fund or some other institutional investor that doesn't have the resources of an hft. that means they get burned.
I find it somewhat amusing that you're assuming that the rest of the market needs to be protected from the pensioners by Goldman Sachs.
this strategy is ineffective with the transaction tax. it should be obvious why.
Explain like I'm a 5 year old child how a 6bps tax will prevent HFTs from running a strategy generating 20-100bps of alpha. It'll certainly prevent them from running a market making strategy generating 1-2bps.
You also still haven't explained why it's better for the whale (i.e., someone large enough to move markets) to be able to make others suffer the price impact of their trades.
Explain like I'm a 5 year old child how a 6bps tax will prevent HFTs from running a strategy generating 20-100bps of alpha. It'll certainly prevent them from running a market making strategy generating 1-2bps.
You also still haven't explained why it's better for the whale (i.e., someone large enough to move markets) to be able to make others suffer the price impact of their trades.
How is the whale making others suffer? If an investment fund is forced to sell because of its terms, then it's making itself suffer. It's just that now HFT traders get to serve as the useless middle man.
Concrete example. The whale wants to dump 1MM shares which will result in a price drop from $105 to $100.
Currently the bid/ask is $104.9/105.1. If the whale sells at 104.9, the market will figure it out, and the counterparties who just bought will find the price of their shares drops to $100. A predator forces the whale to suffer more of the price impact while making price improvements for the counterparties.
I don't see a reason to prioritize the whale over the counterparties.
Currently the bid/ask is $104.9/105.1. If the whale sells at 104.9, the market will figure it out, and the counterparties who just bought will find the price of their shares drops to $100. A predator forces the whale to suffer more of the price impact while making price improvements for the counterparties.
I don't see a reason to prioritize the whale over the counterparties.
First, the "benefit" to the counterparties is infinitesimal. The predator is going to scape up the market at as lost cost as possible. Second, shares don't magically lose underlying value just because an investment fund is forced to sell. Longer term the price will go to whatever it would go anyway. Investors who bought did not lose that $5. Besides, even with HFT involved the short term price will still drop to $100 so everyone holding those shares still "suffers". Suffice it to say that this is a ridiculous argument which I'm sure you are not actually making but I'm just pointing this out. Third, because of shady HTF practices like flooding the exchange with orders, it's most likely actually hurting the counterparties, impeding their ability to adjust their price.
Now tell me, what social good did the HFT middle man bring?
Now tell me, what social good did the HFT middle man bring?
Supply goes up - price goes down. If whales weren't worried about price impact they wouldn't be hiding their offers (typically by running HFT systems of their own, or renting them) to begin with.
Third, because of shady HTF practices like flooding the exchange with orders, it's most likely actually hurting the counterparties, impeding their ability to adjust their price.
I don't understand. Counterparties want to buy and a predator is improving prices. How does this hinder them?
I'm not asserting that predation is socially good or bad. It marginally increases market efficiency and causes small players to lose less money to the big boys - that's the extent of my claims.
I just don't understand why everyone seems to think helping the big players is somehow socially beneficial. What's good for Goldman is good for America?
Third, because of shady HTF practices like flooding the exchange with orders, it's most likely actually hurting the counterparties, impeding their ability to adjust their price.
I don't understand. Counterparties want to buy and a predator is improving prices. How does this hinder them?
I'm not asserting that predation is socially good or bad. It marginally increases market efficiency and causes small players to lose less money to the big boys - that's the extent of my claims.
I just don't understand why everyone seems to think helping the big players is somehow socially beneficial. What's good for Goldman is good for America?
I see you ignored the fact that counterparties are actually only "benefiting" infinitesimally. Convenient.
> I don't understand. Counterparties want to buy and a predator is improving prices. How does this hinder them?
That's not what I said. It's not the offers themselves that are hurting, it's the intentional clogging up of the exchange by the HFT traders which in effect locks out everybody else.
> marginally increases market efficiency and causes small players to lose less money to the big boys
As in trades get executed a femtosecond earlier and for a infinitesimally different price, if you conveniently ignore shady practices like clogging up exchanges? Yea, that is most definitely worth the big bucks the HFT traders are making on the other side of the transaction. /s
> I just don't understand why everyone seems to think helping the big players is somehow socially beneficial. What's good for Goldman is good for America?
You pick Goldman Sachs as an example because you know people will have an emotional reaction, and ignore pension funds etc. This is an argument designed to run on people's emotions. Besides, Goldman Sachs, unlike pension funds, is perfectly capable and in fact does do HFT of its own.
Eradicating HFT is socially beneficial because it will (A) remove a bunch of wasted effort to be just a tiny bit faster than everybody else (B) remove the HFT middle man tax for investors who just want to trade with other investors.
> I don't understand. Counterparties want to buy and a predator is improving prices. How does this hinder them?
That's not what I said. It's not the offers themselves that are hurting, it's the intentional clogging up of the exchange by the HFT traders which in effect locks out everybody else.
> marginally increases market efficiency and causes small players to lose less money to the big boys
As in trades get executed a femtosecond earlier and for a infinitesimally different price, if you conveniently ignore shady practices like clogging up exchanges? Yea, that is most definitely worth the big bucks the HFT traders are making on the other side of the transaction. /s
> I just don't understand why everyone seems to think helping the big players is somehow socially beneficial. What's good for Goldman is good for America?
You pick Goldman Sachs as an example because you know people will have an emotional reaction, and ignore pension funds etc. This is an argument designed to run on people's emotions. Besides, Goldman Sachs, unlike pension funds, is perfectly capable and in fact does do HFT of its own.
Eradicating HFT is socially beneficial because it will (A) remove a bunch of wasted effort to be just a tiny bit faster than everybody else (B) remove the HFT middle man tax for investors who just want to trade with other investors.
You claim the benefit is "infinitesimal" and I have no idea why or how you would claim this.
It's not the offers themselves that are hurting, it's the intentional clogging up of the exchange by the HFT traders which in effect locks out everybody else.
Exchanges don't get "clogged" except in rare cases like the facebook IPO.
Goldman Sachs, unlike pension funds, is perfectly capable and in fact does do HFT
Pension funds do run HFT in order to hide their trades. They either build it themselves or rent an algo from pipeline/etc.
Look, you clearly don't know much about the topic beyond what you read on zerohedge. I'll leave you to it.
It's not the offers themselves that are hurting, it's the intentional clogging up of the exchange by the HFT traders which in effect locks out everybody else.
Exchanges don't get "clogged" except in rare cases like the facebook IPO.
Goldman Sachs, unlike pension funds, is perfectly capable and in fact does do HFT
Pension funds do run HFT in order to hide their trades. They either build it themselves or rent an algo from pipeline/etc.
Look, you clearly don't know much about the topic beyond what you read on zerohedge. I'll leave you to it.
>Secondly, they're adding trading volume, not liquidity. It was never hard to actually sell or buy a stock before HFT. They're not cutting down on spreads (that's what market makers do - and HFT is NOT market making).
Can we start distinguishing technology from strategies? HFT is the technology of inserting/amending/deleting orders extremely quickly in an exchange. There are many different financial institutions that use this with different strategies. Some are good, some are not so good. Market Makers almost all use HFT, they have to provide the best prices and update them as fast as possible when market conditions change to stay competitive. (Spacial) arbitrage is another strategy that requires HFT and is important to make markets more efficient.
> HFT is basically legalized front running.
Again, there are no relation between front running and HFT. Front running applies to brockers that use knowledge of their client's investments to make money for themselves. They might do that with or without HFT. Acting faster than a competitor on price change is not front running.
Can we start distinguishing technology from strategies? HFT is the technology of inserting/amending/deleting orders extremely quickly in an exchange. There are many different financial institutions that use this with different strategies. Some are good, some are not so good. Market Makers almost all use HFT, they have to provide the best prices and update them as fast as possible when market conditions change to stay competitive. (Spacial) arbitrage is another strategy that requires HFT and is important to make markets more efficient.
> HFT is basically legalized front running.
Again, there are no relation between front running and HFT. Front running applies to brockers that use knowledge of their client's investments to make money for themselves. They might do that with or without HFT. Acting faster than a competitor on price change is not front running.
>Again, there are no relation between front running and HFT.
>Front running applies to brockers that use knowledge of
>their client's investments to make money for themselves.
And HFT operators effectively gain knowledge of the investments of the rest of the market by placing frequent, small orders (or placing an order and then canceling it).
They then use the knowledge they've gained by seeing how the market responds to their bids.
Front running the way a broker does it is illegal. The way an HFT does it legal. It's the same principle and has the same damaging effect on the markets.
And HFT operators effectively gain knowledge of the investments of the rest of the market by placing frequent, small orders (or placing an order and then canceling it).
They then use the knowledge they've gained by seeing how the market responds to their bids.
Front running the way a broker does it is illegal. The way an HFT does it legal. It's the same principle and has the same damaging effect on the markets.
Most exchanges have public order books (i.e. available to everyone), so the information you gain with those small orders is also gained by everyone else; that's not front running.
>the information you gain with those small orders is also gained by everyone else
I'm not certain how long before the information is made public (seconds if you pay? minutes if you don't...), but I'm absolutely certain it'd be too late for anybody else to make use of it.
I'm not certain how long before the information is made public (seconds if you pay? minutes if you don't...), but I'm absolutely certain it'd be too late for anybody else to make use of it.
It's available within microseconds/milliseconds (not including time to travel over the network to wherever you are compared to the exchange's datacentre). It's made available to everyone at the same time (again, if you have a shitty connection, you'll get the information later). You use the exact same system whether you're a bank, investor, broker, hedge fund, ... The only difference is how close you are to the datacentre, how good your networking is, how optimized your trading applications are, which protocol you're using, etc.
The fact that technically, the information may be available at exactly the same time to everybody doesn't make it right (and is it really, or does the guy who initiated it get the info just a bit earlier?). What's happening is that you have a whole industry spinning its wheels to be just a little bit ahead of everybody else. This is a zero sum game. Either the other traders have to build the same kind of extremely fast systems which is just money wasting, or the high frequency traders get to skim off their profit. This is of no benefit to anybody except the high frequency traders, hence why this law was invented.
Everyone who pays for DMA is on the same multicast feed.
The article did a good job refuting the arguments in favor an FTT, up until this point:
> In fact, we can show that the spreads must widen to be larger than the tax itself being applied. If there’s a tax of 3 bps on a trade then no one’s going to trade at a spread of less than 3 bps. Why would you trade for a margin less than the tax you have to pay?
Because you think the asset is going to increase in value in the future, of course!
You might find the article's argument compelling if you are an arbitrageur. The firms spending millions on microwave antennas to trade a few milliseconds sooner might be frustrated that transactions with puny spreads are no longer profitable, due to a .03% tax.
But we (society) swallow far more than that in other markets. How many labor transactions were rendered unprofitable (aka people choosing not to work) via income tax? How many retail sales never happened, because of sales tax? And these tax rates are four orders of magnitude higher than the proposed FTT!
People buying and selling financial instruments is not four orders of magnitude more important to the economy than is labor, or buying goods. If anything, it's much less important. So I don't see why financial instruments should enjoy a privileged tax status.
> Thus all of the revenue from the tax (and as I point out in that paper, this will be less than the revenue lost from other taxes as a result of the introduction of the FTT) will have its burden, and more, upon end investors.
How? The math doesn't work out! I am a retail investor, in a high income bracket, and a .03% FTT would cost me $1-2 a month. There's no way you could get the proposed revenue figures from people like me. I have to conclude that the majority would fall on investment firms.
The example investors, whose mutual fund does $85k in transactions a year, are either quite wealthy, or are being taken for a ride.
> In fact, we can show that the spreads must widen to be larger than the tax itself being applied. If there’s a tax of 3 bps on a trade then no one’s going to trade at a spread of less than 3 bps. Why would you trade for a margin less than the tax you have to pay?
Because you think the asset is going to increase in value in the future, of course!
You might find the article's argument compelling if you are an arbitrageur. The firms spending millions on microwave antennas to trade a few milliseconds sooner might be frustrated that transactions with puny spreads are no longer profitable, due to a .03% tax.
But we (society) swallow far more than that in other markets. How many labor transactions were rendered unprofitable (aka people choosing not to work) via income tax? How many retail sales never happened, because of sales tax? And these tax rates are four orders of magnitude higher than the proposed FTT!
People buying and selling financial instruments is not four orders of magnitude more important to the economy than is labor, or buying goods. If anything, it's much less important. So I don't see why financial instruments should enjoy a privileged tax status.
> Thus all of the revenue from the tax (and as I point out in that paper, this will be less than the revenue lost from other taxes as a result of the introduction of the FTT) will have its burden, and more, upon end investors.
How? The math doesn't work out! I am a retail investor, in a high income bracket, and a .03% FTT would cost me $1-2 a month. There's no way you could get the proposed revenue figures from people like me. I have to conclude that the majority would fall on investment firms.
The example investors, whose mutual fund does $85k in transactions a year, are either quite wealthy, or are being taken for a ride.
Fun fact: banks having to hold to at least 5% of issued loans has led to market crash. 5% margin on good decisions is just too high for banks. I'd love to work in a bank, where 5% good decisions is considered achievement and not a complete ant total dumbassnes.
Why don't they set the minimum trading interval to something larger to unencourage HFT?
That doesn't really help. Many symbols already have an artificially wide spread of 1 cent (they could have lower spreads if they were allowed to). Forcing spreads wider would reduce volume and increase per-trade profit for market makers (read: HFT). I'm not sure which factor would dominate, but it would be unlikely to have a big impact on the market makers' bottom lines. On the other hand, retail investors would enjoy the privilege of paying wider spreads,
That doesn't really help if the HFT firms can simply pay to be first in line during each tick.
Depends how you implement it (a window for placing bids would be one way).
This wouldn't help either. HFT operators would race to extract as much information from the bidders during the window (e.g. by bid stuffing) and place the bid during the last possible femtosecond before it closes.
So high frequency trading somewhat helps reducing the spread which is a good thing. I can understand that. But if HFT is a fix, instead of taxing HFT why not making it a task banks would deal with and earn money from it? A percentage of the revenue enabled by HFT would go to the bank and the rest to society.