How to not get ripped off by High Frequency Traders(chrisstucchio.com)
chrisstucchio.com
How to not get ripped off by High Frequency Traders
http://www.chrisstucchio.com/blog/2014/how_to_not_get_ripped_off_by_hft.html
19 comments
It saddens me that people lump Market Making and HFT together. Over the past 100 years, the bid-ask spread has fairly steadily decreased due to technology and this fact in isolation is uniformly a good thing for retail investors.
http://www.cxoadvisory.com/5737/big-ideas/trading-frictions-...
Other HFT methods are less clearly on net socially good.
http://www.cxoadvisory.com/5737/big-ideas/trading-frictions-...
Other HFT methods are less clearly on net socially good.
A few points:
1) This doesn't address the front-running issue. (Where different exchanges receive the buy/sell order at a different times and HFT can abuse those microsecond differences)
2) It's a universal truth that people who are better informed are harder to rip off. So that's not very persuasive. You can't reasonably expect regular people to know in which situations they'll be paying a premium for a liquidity service they may not even want.
3) It's completely fair to ask ourselves as a society if HFT groups are making a contribution to society that warrants the money they make. And if transparency with regard to HFT trading strategies leads regular people and sophisticated investors to make different decisions, then that means that the lack of transparency worked in favor of HFT. Therefore, it's reasonable to assume much of the HFT profits are just an externality. The decline of HFT is in part because investors are getting wise to the shenanigans.
1) This doesn't address the front-running issue. (Where different exchanges receive the buy/sell order at a different times and HFT can abuse those microsecond differences)
2) It's a universal truth that people who are better informed are harder to rip off. So that's not very persuasive. You can't reasonably expect regular people to know in which situations they'll be paying a premium for a liquidity service they may not even want.
3) It's completely fair to ask ourselves as a society if HFT groups are making a contribution to society that warrants the money they make. And if transparency with regard to HFT trading strategies leads regular people and sophisticated investors to make different decisions, then that means that the lack of transparency worked in favor of HFT. Therefore, it's reasonable to assume much of the HFT profits are just an externality. The decline of HFT is in part because investors are getting wise to the shenanigans.
"1) This doesn't address the front-running issue. (Where different exchanges receive the buy/sell order at a different times and HFT can abuse those microsecond differences)"
This is only an issue if your order is large enough to take out the entire liquidity of one of the exchanges. If that is the case, by definition you are not a retail investor, you are an institutional investor and part of the value add you are supposedly adding is your ability to operate in a complex market.
"2) It's a universal truth that people who are better informed are harder to rip off. So that's not very persuasive. You can't reasonably expect regular people to know in which situations they'll be paying a premium for a liquidity service they may not even want."
So informed market participants should subsidize ignorant ones?
"3) It's completely fair to ask ourselves as a society if HFT groups are making a contribution to society that warrants the money they make. And if transparency with regard to HFT trading strategies leads regular people and sophisticated investors to make different decisions, then that means that the lack of transparency worked in favor of HFT. Therefore, it's reasonable to assume much of the HFT profits are just an externality. The decline of HFT is in part because investors are getting wise to the shenanigans."
Agreed. We should also have that discussion around dark pool operators, hedge funds, and investment banks. While we are at it, lets talk about photo sharing websites and internet chat services as well.
This is only an issue if your order is large enough to take out the entire liquidity of one of the exchanges. If that is the case, by definition you are not a retail investor, you are an institutional investor and part of the value add you are supposedly adding is your ability to operate in a complex market.
"2) It's a universal truth that people who are better informed are harder to rip off. So that's not very persuasive. You can't reasonably expect regular people to know in which situations they'll be paying a premium for a liquidity service they may not even want."
So informed market participants should subsidize ignorant ones?
"3) It's completely fair to ask ourselves as a society if HFT groups are making a contribution to society that warrants the money they make. And if transparency with regard to HFT trading strategies leads regular people and sophisticated investors to make different decisions, then that means that the lack of transparency worked in favor of HFT. Therefore, it's reasonable to assume much of the HFT profits are just an externality. The decline of HFT is in part because investors are getting wise to the shenanigans."
Agreed. We should also have that discussion around dark pool operators, hedge funds, and investment banks. While we are at it, lets talk about photo sharing websites and internet chat services as well.
We already regard some profitable activities (e.g., slavery, child labor) as unacceptable, so there's no reason a priori to rule out considering whether HFT falls in the category of "too detrimental to society to allow".
Likewise, the more esoteric forms of finance (CDS) and the people who made them and continue to game the system greatly contributed to the recent recession without suffering any of its ill effects.
And furthest down the chain of societal damage are photo sharing sites and chat services, which mostly just waste time and supplant the revenue of film/phone companies.
If you're implying that considering HFT's societal worth is as silly as examining photo sharing services, you're mistaken.
Likewise, the more esoteric forms of finance (CDS) and the people who made them and continue to game the system greatly contributed to the recent recession without suffering any of its ill effects.
And furthest down the chain of societal damage are photo sharing sites and chat services, which mostly just waste time and supplant the revenue of film/phone companies.
If you're implying that considering HFT's societal worth is as silly as examining photo sharing services, you're mistaken.
"We already regard some profitable activities (e.g., slavery, child labor) as unacceptable, so there's no reason a priori to rule out considering whether HFT falls in the category of "too detrimental to society to allow""
I agree, I think a robust conversation about the pluses and minuses of electronic trading are of value, and there is nothing sacred about electronic trading activities that means they are a natural right. That conversation needs to be an informed one though, and discussions about HFT never are.
"Likewise, the more esoteric forms of finance (CDS) and the people who made them and continue to game the system greatly contributed to the recent recession without suffering any of its ill effects."
This is a point that is most aggrevating about the narrative that Michael Lewis is pushing about HFT. The people being "hurt" in his hypothesis, are in fact the people who create esoteric forms of finance. The big institutions are upset by HFT because it has cut into their profits, not because it is unfair.
"And furthest down the chain of societal damage are photo sharing sites and chat services, which mostly just waste time and supplant the revenue of film/phone companies. If you're implying that considering HFT's societal worth is as silly as examining photo sharing services, you're mistaken."
WhatsApp was sold for 19 billion dollars. That is about exactly what the entire HFT market was worth in it's very best year if you believe very inflated stats.
I agree, I think a robust conversation about the pluses and minuses of electronic trading are of value, and there is nothing sacred about electronic trading activities that means they are a natural right. That conversation needs to be an informed one though, and discussions about HFT never are.
"Likewise, the more esoteric forms of finance (CDS) and the people who made them and continue to game the system greatly contributed to the recent recession without suffering any of its ill effects."
This is a point that is most aggrevating about the narrative that Michael Lewis is pushing about HFT. The people being "hurt" in his hypothesis, are in fact the people who create esoteric forms of finance. The big institutions are upset by HFT because it has cut into their profits, not because it is unfair.
"And furthest down the chain of societal damage are photo sharing sites and chat services, which mostly just waste time and supplant the revenue of film/phone companies. If you're implying that considering HFT's societal worth is as silly as examining photo sharing services, you're mistaken."
WhatsApp was sold for 19 billion dollars. That is about exactly what the entire HFT market was worth in it's very best year if you believe very inflated stats.
"This is a point that is most aggrevating about the narrative that Michael Lewis is pushing about HFT. The people being "hurt" in his hypothesis, are in fact the people who create esoteric forms of finance. The big institutions are upset by HFT because it has cut into their profits, not because it is unfair."
Yes, this was definitely glossed over in the article. But some of those large investors are things like pension funds, which hold ordinary people's savings. I'm not sure to what extent that trickles down though. Also, what about the flash crashes?
Yes, this was definitely glossed over in the article. But some of those large investors are things like pension funds, which hold ordinary people's savings. I'm not sure to what extent that trickles down though. Also, what about the flash crashes?
Pension funds are operating more cheaply now than at any time in history. It is a myth propogated by large bank trading desks that HFT profits come from pension funds. Instead they come from trader bonuses that are no longer necessary.
As for flash crashes there are 2 answers to that question 1) they correct so fast that they impact very few people. 2) if exchanges would stop busting trades during crashes the practices that lead to them would stop.
As for flash crashes there are 2 answers to that question 1) they correct so fast that they impact very few people. 2) if exchanges would stop busting trades during crashes the practices that lead to them would stop.
1) Chris claims "The fact of the matter is that HFT’s can’t rip you off.". Front-running[1] is an example where HFT's do rip people off, simply because they didn't know it was going on. When the performance of institutional investors is harmed in this way that harms everybody with savings or a retirement fund. Not just the guys at wall street.
2) Straw man.
3) Yes, while we're at it let's change the subject to photo sharing websites instead. That sounds reasonable.
Edit:
[1] Again referring to the technically legal version of "front running" as used by Michael Lewis where HFT abuse buy/sell orders arriving at different times at the exchanges.
2) Straw man.
3) Yes, while we're at it let's change the subject to photo sharing websites instead. That sounds reasonable.
Edit:
[1] Again referring to the technically legal version of "front running" as used by Michael Lewis where HFT abuse buy/sell orders arriving at different times at the exchanges.
Front-running[0] is where a stockbroker abuses the relationship they have with a client to place their own order in front of a client's order, because they know that the client's order will move the market, and that subsequently they'll be able to close their own position at a profit.
Having a speed advantage over other market participants and using that advantage to pull your quotes on another exchange is not front-running! It's just sensible market-making, of the kind that has been doing on for hundreds of years. It's no better or worse than sending a pigeon over the English Channel in 1815[1], or using the Transatlantic Telegraph to outpace ships in 1866.
Also, shouting "straw man" is not actually an argument.
[0] http://en.wiktionary.org/wiki/front_running#English
[1] http://en.wikipedia.org/wiki/Nathan_Mayer_Rothschild#Legend
Having a speed advantage over other market participants and using that advantage to pull your quotes on another exchange is not front-running! It's just sensible market-making, of the kind that has been doing on for hundreds of years. It's no better or worse than sending a pigeon over the English Channel in 1815[1], or using the Transatlantic Telegraph to outpace ships in 1866.
Also, shouting "straw man" is not actually an argument.
[0] http://en.wiktionary.org/wiki/front_running#English
[1] http://en.wikipedia.org/wiki/Nathan_Mayer_Rothschild#Legend
Front running is a conceptual variation of the hold-up problem. Like any concept, it can be implemented in plain-vanilla as well as syngthetic variants. Non-vanilla is not dispositive.
When you tell a broker "trade on my behalf" and he trades first, that's front running because he is obligated to do what's best for you. Other market participants do not have the same duty.
To make an analogy: my boxing coach is obligated to give me good advice and he's a jerk if he doesn't. The other boxer is not being a jerk if he feints and then punches me in the face.
To make an analogy: my boxing coach is obligated to give me good advice and he's a jerk if he doesn't. The other boxer is not being a jerk if he feints and then punches me in the face.
And what if your broker routes your order through an HFT for a fee so the HFT can front-run you? That's what some say is happening. I'm still unclear if I can really believe that because it sounds so obviously illegal.
Retail brokers often have ELP programs where an HFT has the option to fill your order (and the obligation to do so a certain fraction of the time, typically 20-50%) and avoid paying routing fees.
There is little opportunity to front-run in this case since a) no one on ETrade moves large blocks b) ETrade wants to make sure the ELP program is full of benevolent market makers and c) fill rate requirements. You can always opt out of these programs (turn off "smart routing" or something similarly named), but most people don't since they typically reduce your costs.
There is little opportunity to front-run in this case since a) no one on ETrade moves large blocks b) ETrade wants to make sure the ELP program is full of benevolent market makers and c) fill rate requirements. You can always opt out of these programs (turn off "smart routing" or something similarly named), but most people don't since they typically reduce your costs.
That's what I was hoping Flashboys was going to be about. I haven't finished the book yet but so far Lewis mentions it in passing but doesn't dig into it.
> 3) Yes, while we're at it let's change the subject to photo sharing websites instead. That sounds reasonable.
The question: "does Facebook spying on teenagers to help Abercrombie & Fitch sell them crap they don't need add social value commensurate with how much money they make doing it?" isn't an attempt to change the subject, but rather a glib attempt to criticize the structure of the question. Since when do we judge compensation based on value added to society, and if that's what we do, why don't we apply that approach beyond finance?
The question: "does Facebook spying on teenagers to help Abercrombie & Fitch sell them crap they don't need add social value commensurate with how much money they make doing it?" isn't an attempt to change the subject, but rather a glib attempt to criticize the structure of the question. Since when do we judge compensation based on value added to society, and if that's what we do, why don't we apply that approach beyond finance?
I disagree. It is an attempt to change the subject from the object level: "is HFT harming society and do we need more transparency or regulation" to the meta level: "if we have to do something about HFT, then why not address X, Y, Z also?".
It's not a legitimate argument because it can be used to derail any conversion that criticizes one particular aspect of society.
It goes without saying that there are moral questions to be raised about facebook acquisitions and compensation in fields outside of finance. But it's not part of this conversation.
It's not a legitimate argument because it can be used to derail any conversion that criticizes one particular aspect of society.
It goes without saying that there are moral questions to be raised about facebook acquisitions and compensation in fields outside of finance. But it's not part of this conversation.
That's not the argument. The argument is: "if this mode of reasoning is valid, and pursuant to it we must do something about HFT, then we would also feel compelled to do something about X, Y, and Z as well. But because we don't feel compelled to do something about X, Y, and Z, that implies that the mode of reasoning is not valid."
In other words, he disagrees with the premise that compensation need bear some relation to economic value created. Empirically, that's a premise that we as a society reject.
In other words, he disagrees with the premise that compensation need bear some relation to economic value created. Empirically, that's a premise that we as a society reject.
See I think the question "is HFT harming society and do we need more transparency or regulation" is much clearer and easier to debate about than "does HFT make more money than it's value to society".
When we have that debate I'd like it to be informed about what does and does not actually happen with HFT and not bogeyman scare stories. I'd also like that debate to consider the pro's and con's of the system it replaced and the unintended consequences of any regulation we introduce.
When we have that debate I'd like it to be informed about what does and does not actually happen with HFT and not bogeyman scare stories. I'd also like that debate to consider the pro's and con's of the system it replaced and the unintended consequences of any regulation we introduce.
"Since when do we judge compensation based on value added to society, and if that's what we do, why don't we apply that approach beyond finance?"
We apply it in finance for a couple reasons. Securities exchanges are high regulated entities, at least since the Great Depression brought our country to its knees. Ever heard of the SEC, which exists to protect investors? There is no reason for HFT to be allowed at all unless it is creating a net benefit for society. Or said another way, if HFT provides a benefit only for the people doing HFT, and has a negative effect on others, then there's no reason to allow it. (An aside: My understanding is that studies have shown markets to have plenty of liquidity without HFT.)
We apply it in finance for a couple reasons. Securities exchanges are high regulated entities, at least since the Great Depression brought our country to its knees. Ever heard of the SEC, which exists to protect investors? There is no reason for HFT to be allowed at all unless it is creating a net benefit for society. Or said another way, if HFT provides a benefit only for the people doing HFT, and has a negative effect on others, then there's no reason to allow it. (An aside: My understanding is that studies have shown markets to have plenty of liquidity without HFT.)
In response to (1), I always assumed that people talking about the "little guys" being ripped off were generally talking about the little guys holding money in institutional funds whose trades were being front-run rather than the professional money managers themselves. Of course, in most cases these "little guys" are probably being ripped off far more by the fund management fee, but still...
1) It's debatable whether you can call this behaviour "abuse". It's also debatable whether you can call it "front-running". The HFT has an advantage over the rest of the market, which is that they're faster. They're faster because they've paid for faster connections and they've hired expensive developers to build fast software. They then use that advantage to propagate information between exchanges more rapidly, so that they don't get picked off by informed traders on other exchanges. The basic mechanism is exactly the same as any other market making, it's just that it happens faster.
Let's say I'm a big investor in 1960 who wants to buy 100,000 shares of MSFT (yeah, they didn't exist back then, whatever). I call up a floor broker who's standing on the trading floor at NYSE and he quotes me $49-$51 (because it's 1960 and you can drive a bus through the spread) but he can only offer me 50,000 shares. No problem, I buy from him at $51 and dial another broker at BATS in Kansas (also didn't exist in 1960) to get a quote from him too. But in the time it takes me to dial the number, the news of my trade is wired from NY to Kansas and my broker there has put his prices up in response - he now quotes me $49.50-$51.50.
What the hell? I thought it was $51 to buy? Well, it was at the time I made my first trade. But when you want to make a big trade, you don't get it all at the bbo. You expect your trade to move the market.
Exactly the same thing happens today, except that it all happens in milliseconds rather than minutes, and the spread is $0.01 instead of $2. Voice traders at banks and other big institutions (at least, the ones that didn't already adapt years ago) are getting hissy about it because they want to be able to buy everything at the prices they can see on the screen, regardless of liquidity considerations, and also they'd like a pony thank you very much.
2) 'Regular people' are not putting in orders that are large enough that they need to be routed to multiple exchanges. If I send an order for 100 shares of MSFT, it won't go anywhere near an exchange. It will get filled immediately, by my broker, at essentially the national bbo.
3) Yup, it's totally valid to ask these questions. In fact I think it would be great if the HFT industry was more transparent, and I fully expect that to happen. But that's not the same as saying that the market is rigged or labeling totally standard market-making behaviour as "abuse".
Let's say I'm a big investor in 1960 who wants to buy 100,000 shares of MSFT (yeah, they didn't exist back then, whatever). I call up a floor broker who's standing on the trading floor at NYSE and he quotes me $49-$51 (because it's 1960 and you can drive a bus through the spread) but he can only offer me 50,000 shares. No problem, I buy from him at $51 and dial another broker at BATS in Kansas (also didn't exist in 1960) to get a quote from him too. But in the time it takes me to dial the number, the news of my trade is wired from NY to Kansas and my broker there has put his prices up in response - he now quotes me $49.50-$51.50.
What the hell? I thought it was $51 to buy? Well, it was at the time I made my first trade. But when you want to make a big trade, you don't get it all at the bbo. You expect your trade to move the market.
Exactly the same thing happens today, except that it all happens in milliseconds rather than minutes, and the spread is $0.01 instead of $2. Voice traders at banks and other big institutions (at least, the ones that didn't already adapt years ago) are getting hissy about it because they want to be able to buy everything at the prices they can see on the screen, regardless of liquidity considerations, and also they'd like a pony thank you very much.
2) 'Regular people' are not putting in orders that are large enough that they need to be routed to multiple exchanges. If I send an order for 100 shares of MSFT, it won't go anywhere near an exchange. It will get filled immediately, by my broker, at essentially the national bbo.
3) Yup, it's totally valid to ask these questions. In fact I think it would be great if the HFT industry was more transparent, and I fully expect that to happen. But that's not the same as saying that the market is rigged or labeling totally standard market-making behaviour as "abuse".
You can't reasonably expect regular people to know in which situations they'll be paying a premium for a liquidity
If you cross the spread you paid for liquidity. If you don't know this, don't trade.
Trading without understanding this is like coding without knowing what memory is.
It's completely fair to ask ourselves as a society if HFT groups are making a contribution to society...
The people choosing to purchase liquidity certainly seem to think they are. Their only complaint is that is that the price is not as favorable as they'd like.
If you cross the spread you paid for liquidity. If you don't know this, don't trade.
Trading without understanding this is like coding without knowing what memory is.
It's completely fair to ask ourselves as a society if HFT groups are making a contribution to society...
The people choosing to purchase liquidity certainly seem to think they are. Their only complaint is that is that the price is not as favorable as they'd like.
Chris, can you at least read the NYT excerpt? I have to agree that your post does little to settle what may or may not be controversial, and it would be interesting to hear an informed response.
Chris, I'd love to see you do a similar article on how human traders come into play in similar situations. Isn't the point of (at least some of) them also that they add liquidity? What makes HFT worse in that regard?
> It's completely fair to ask ourselves as a society if HFT groups are making a contribution to society that warrants the money they make.
An HFT once told me his company required a huge investment to operate. Besides the infrastructure costs, the company needed cash on hand for its buy orders. Given the small profit on each trade, it needed to do many, many trades. Which necessitated a lot of buy orders, and thus a lot of cash. When all was said and done, they didn't have a particularly high return on investment. The HFT didn't give me exact numbers, but he suggested that the ballpark ROI was commensurate with that of traditional brick-and-mortar businesses. (The ROI as he quoted it counted salaries and bonuses as part of the return, so those were not disguised as costs eating away the profits.)
If the HFT was telling me the truth, then it appears that at least his firm was providing a useful service and earning modest profits for doing so. Which would make his firm not so unusual in the business world. I have no inside knowledge of other HFT firms or other niches in the finance industry.
An HFT once told me his company required a huge investment to operate. Besides the infrastructure costs, the company needed cash on hand for its buy orders. Given the small profit on each trade, it needed to do many, many trades. Which necessitated a lot of buy orders, and thus a lot of cash. When all was said and done, they didn't have a particularly high return on investment. The HFT didn't give me exact numbers, but he suggested that the ballpark ROI was commensurate with that of traditional brick-and-mortar businesses. (The ROI as he quoted it counted salaries and bonuses as part of the return, so those were not disguised as costs eating away the profits.)
If the HFT was telling me the truth, then it appears that at least his firm was providing a useful service and earning modest profits for doing so. Which would make his firm not so unusual in the business world. I have no inside knowledge of other HFT firms or other niches in the finance industry.
No, the decline of the HFT industry is because there's so many competitors they're racing to $0...
Keep in mind that many HFTs are market makers and have specific agreements with exchanges that pays them 0.005 cents per share traded, regardless. The other side of this is that they MUST stay in the market, no matter what.
Thus, when trading volume went down over last few years, many HFT firms had less income.
(And to answer another commenter in this thread, No, other investors are not "wise" to the ways of HFT, all traders save for the brokerage firms who used to collect $0.10 on each share traded (the spread before HFT) benefit.)
Thus, when trading volume went down over last few years, many HFT firms had less income.
(And to answer another commenter in this thread, No, other investors are not "wise" to the ways of HFT, all traders save for the brokerage firms who used to collect $0.10 on each share traded (the spread before HFT) benefit.)
1) I see why the person trading a bunch of shares on different exchanges all at once is unhappy about this, but this is BETTER for literally everyone else who now benefits from more accurate pricing.
3) You're aware that HFTs simply replaced slower and more expensive humans right? These computers are a lot cheaper than the humans were and, as you said, are getting cheaper by the day. Automation FTW!
3) You're aware that HFTs simply replaced slower and more expensive humans right? These computers are a lot cheaper than the humans were and, as you said, are getting cheaper by the day. Automation FTW!
1. It׳s not front-running as nobody can actually see the order book before a transaction happened. what you describe is a sort of arbitrage based on different latencies. It may be morally wrong, but it׳s totally different from front-running.
These discussions would be improved if more of the participants understood the problem of transacting in large blocks of tradable instruments. The impression HN trading discussions create is that there is a universe in which block trades are frictionless or even remotely predictable.
In fact, moving large blocks across the market isn't just an annoying detail of the markets; it's one of the basic fundamental problems of institutional trading, and a large part of the rationale for the existence of brokers. Transacting in blocks of stock is to professional trading what the CAP theorem is to distributed software development.
One of the most famous and approachable books about market structure is Larry Harris' _Trading And Exchanges_. The book is like the TCP/IP Illustrated of money. It is supremely readable and written in a style that software developers in particular will find congenial. You can get a Kindle version of it right now. I feel extremely comfortable recommending it. It is a great read.
The example of trying to move a large block of (fictitious) Smithsonian Industries is one of the opening, motivating examples the book uses to outline the challenges of trading. The inheritor of a huge chunk of Smithsonian Industries needs to sell 900,000 shares of thinly-traded stock. The example continues:
Goldman's block brokers face the following predicament. If nobody knows that they have stock to sell, they will not be able to sell it. However, if too many people know that a large block of stack is hanging over the market, speculators will push the price down. The Goldman brokers thus must be selective when approaching potential buyers.
The motivating example Lewis gives in his book is of a trader at a large investment bank who, based on their $2MM/year salary, is presumably being paid handsomely for the service of figuring out how to move blocks like that without having the market shift out from under them. In Harris' example, the Goldman traders research other owners of Smithsonian Industries and approaches them privately and individually in the hopes of placing much of the block privately at a small discount. In Lewis' example, the handsomely-paid trader sees a spot price in their blotter screen, expects to push a single button (no, really, that's how Lewis frames it) to sell at that price, and is outraged when the price moves.
There's an interesting debate to be had about HFT and, particularly, the conflicts of interest between broker-dealers and exchanges and dark pools. But it's hard to have that discussion if you start from the belief that institutional trading is supposed to be easy. The opposite is true.
In fact, moving large blocks across the market isn't just an annoying detail of the markets; it's one of the basic fundamental problems of institutional trading, and a large part of the rationale for the existence of brokers. Transacting in blocks of stock is to professional trading what the CAP theorem is to distributed software development.
One of the most famous and approachable books about market structure is Larry Harris' _Trading And Exchanges_. The book is like the TCP/IP Illustrated of money. It is supremely readable and written in a style that software developers in particular will find congenial. You can get a Kindle version of it right now. I feel extremely comfortable recommending it. It is a great read.
The example of trying to move a large block of (fictitious) Smithsonian Industries is one of the opening, motivating examples the book uses to outline the challenges of trading. The inheritor of a huge chunk of Smithsonian Industries needs to sell 900,000 shares of thinly-traded stock. The example continues:
Goldman's block brokers face the following predicament. If nobody knows that they have stock to sell, they will not be able to sell it. However, if too many people know that a large block of stack is hanging over the market, speculators will push the price down. The Goldman brokers thus must be selective when approaching potential buyers.
The motivating example Lewis gives in his book is of a trader at a large investment bank who, based on their $2MM/year salary, is presumably being paid handsomely for the service of figuring out how to move blocks like that without having the market shift out from under them. In Harris' example, the Goldman traders research other owners of Smithsonian Industries and approaches them privately and individually in the hopes of placing much of the block privately at a small discount. In Lewis' example, the handsomely-paid trader sees a spot price in their blotter screen, expects to push a single button (no, really, that's how Lewis frames it) to sell at that price, and is outraged when the price moves.
There's an interesting debate to be had about HFT and, particularly, the conflicts of interest between broker-dealers and exchanges and dark pools. But it's hard to have that discussion if you start from the belief that institutional trading is supposed to be easy. The opposite is true.
I think people forget how much front running happened in the bad old days on the stock market floor, how the NYSE organized a cartel that kept trading prices high, and that the bid/ask spread is usually a lot less than it used to be.
One thing people don't say much about HFT is that the HFT practitioners got the exchanges to add undocumented order types that let them, in some cases, take advantage of people who do limit orders as the author of this post describes. The best description of this is at
http://www.amazon.com/The-Problem-HFT-Collected-Frequency/dp...
Often when I trade stocks I like to set a limit order at a price that might be a percent or so better than the market rate. Since the price fluctuates, odds are pretty good that I'll get my fill. Now if it is just the normal Brownian motion, it's a good thing that I get my fill, but if the stock is getting hammered by an external event that is driving it way down I might have hit the limit for the wrong reason and be unhappy I got the fill. In situations like that, HFT traders have an advantage with their special order types.
I think the normal retail investor who buys and holds for a while is not hurt terribly by HFT and flash crashes(unless the market is depressed because of the fear of HFT) but you can definitely get burned if you use stop orders. If a price goes down quickly, that can trigger your stop order, causing you to sell at a bad time.
One thing people don't say much about HFT is that the HFT practitioners got the exchanges to add undocumented order types that let them, in some cases, take advantage of people who do limit orders as the author of this post describes. The best description of this is at
http://www.amazon.com/The-Problem-HFT-Collected-Frequency/dp...
Often when I trade stocks I like to set a limit order at a price that might be a percent or so better than the market rate. Since the price fluctuates, odds are pretty good that I'll get my fill. Now if it is just the normal Brownian motion, it's a good thing that I get my fill, but if the stock is getting hammered by an external event that is driving it way down I might have hit the limit for the wrong reason and be unhappy I got the fill. In situations like that, HFT traders have an advantage with their special order types.
I think the normal retail investor who buys and holds for a while is not hurt terribly by HFT and flash crashes(unless the market is depressed because of the fear of HFT) but you can definitely get burned if you use stop orders. If a price goes down quickly, that can trigger your stop order, causing you to sell at a bad time.
As usual Chris does a good job of explaining in simple terms how the markets actually work. The one thing I would have liked to see in this article is a discussion of the pro's and con's of paying for liquidity vs execution risk.
From my perspective it is almost always better to have sooner execution with a liquidity tax than an order floating in the market but I'm not sure how to quantify that as a retail stock purchaser.
From my perspective it is almost always better to have sooner execution with a liquidity tax than an order floating in the market but I'm not sure how to quantify that as a retail stock purchaser.
I am not a finance expert. What would happen if you traded stocks using a continual series of discrete uniform price auctions?
Each buyer enters a sealed bid consisting of the amount he wishes to buy, and at what price. Each seller enters a sealed offer consisting of the amount he wishes to sell, and at what price.
When the auction interval ends, the secure settlement system orders the bids and offers, and calculates the common settlement price such that every bid higher than that price can be satisfied with the offers lower than that price. Every unit in the auction is traded at that one price. Unsatisfied bids and offers could be set up to roll over to subsequent intervals, or to expire.
The settlement system takes a fee from all trades, as a fraction of the amount a buyer was willing to pay, but didn't need to, and a fraction of the amount a seller got in excess of what he wanted. The marginal buyer and seller, who were not pleasantly surprised by the interval's settlement price, pay nothing.
There is no opportunity for front running. If you bid lower than a major institution, your orders will be filled after the institution's orders. You can't re-sell to it at a higher price because it already has what it wants. Trading speed is irrelevant. All that matters is that your orders are in before the settlement interval closes, which happens on a human scale.
Why would such a system be unsuitable for our modern finance system?
Each buyer enters a sealed bid consisting of the amount he wishes to buy, and at what price. Each seller enters a sealed offer consisting of the amount he wishes to sell, and at what price.
When the auction interval ends, the secure settlement system orders the bids and offers, and calculates the common settlement price such that every bid higher than that price can be satisfied with the offers lower than that price. Every unit in the auction is traded at that one price. Unsatisfied bids and offers could be set up to roll over to subsequent intervals, or to expire.
The settlement system takes a fee from all trades, as a fraction of the amount a buyer was willing to pay, but didn't need to, and a fraction of the amount a seller got in excess of what he wanted. The marginal buyer and seller, who were not pleasantly surprised by the interval's settlement price, pay nothing.
There is no opportunity for front running. If you bid lower than a major institution, your orders will be filled after the institution's orders. You can't re-sell to it at a higher price because it already has what it wants. Trading speed is irrelevant. All that matters is that your orders are in before the settlement interval closes, which happens on a human scale.
Why would such a system be unsuitable for our modern finance system?
What scale would you use? If we choose 15 minutes, then day traders who sit at a computer screen all day have an advantage over people who have to work.
Ok then, how about once a day. Well then people without kids have an advantage as they have more time to research this stuff.
Not to be overly sarcastic, but you can't pick a discrete time period that doesn't have trading speed as a component.
Ok then, how about once a day. Well then people without kids have an advantage as they have more time to research this stuff.
Not to be overly sarcastic, but you can't pick a discrete time period that doesn't have trading speed as a component.
If you set your orders and offers to roll over through multiple intervals, you don't need to babysit them.
You are absolutely guaranteed to pay at most what you bid, and to receive at least your reserve price. You could leave them in the system for a thousand years and never be disappointed in your trade.
I can set my bid at what I think a company is worth to me, and simply leave it there until the clearing price is lower.
I would probably set the interval to one hour, with 24 auctions clearing per day, and each tradable item settling at a different position on the clock, so as to not overload my servers at any given time.
You are absolutely guaranteed to pay at most what you bid, and to receive at least your reserve price. You could leave them in the system for a thousand years and never be disappointed in your trade.
I can set my bid at what I think a company is worth to me, and simply leave it there until the clearing price is lower.
I would probably set the interval to one hour, with 24 auctions clearing per day, and each tradable item settling at a different position on the clock, so as to not overload my servers at any given time.
Right now you can get the same guarantees about price with a simple limit order.
If you don't care to watch each time period, why do you care what the time period is. If I am happy to set my price and let it roll throughout the day without change, then the existing system works just fine for me.
The issue comes from wanting to take new information into account to change the price I want to get. In that case, I do need to see the results of each auction and adjust accordingly. Once I allow for that any time period you set is unfair for someone. We just need to decide on the balance what time period has the best price discover/least overhead/is most fair to the participants we want.
My hypothesis is that the current system does this best.
If you don't care to watch each time period, why do you care what the time period is. If I am happy to set my price and let it roll throughout the day without change, then the existing system works just fine for me.
The issue comes from wanting to take new information into account to change the price I want to get. In that case, I do need to see the results of each auction and adjust accordingly. Once I allow for that any time period you set is unfair for someone. We just need to decide on the balance what time period has the best price discover/least overhead/is most fair to the participants we want.
My hypothesis is that the current system does this best.
My hypothesis is that the current system is most profitable for the people running it.
Using continuous trades, the difference between the price someone would accept/pay is usually very close to the price they do accept/pay. That's because arbitrageurs are continuously taking tiny little bites from the theoretical benefit of trade to the buyers and sellers until everyone is almost indifferent to trade, regardless of the actual price they had in mind. The trades are spread out by time, such that each one can be attacked separately (by a sufficiently fast attacker).
The system is set up to consume the big triangular areas on the supply vs demand chart that do not actually impact whether a trade takes place.
If you settle multiple trades at once rather than a continual series of individual transactions, there are fewer opportunities to take a bite out of other people's trades by being a very fast middleman.
Also, the only way to test your hypothesis is by comparing it against every other possible trading system. So I'd probably start off with a less ambitious claim, like "the current system is more fair than what Log from Blammo proposed." That way, it could be tested just by setting up the competing system and watching what happens.
Using continuous trades, the difference between the price someone would accept/pay is usually very close to the price they do accept/pay. That's because arbitrageurs are continuously taking tiny little bites from the theoretical benefit of trade to the buyers and sellers until everyone is almost indifferent to trade, regardless of the actual price they had in mind. The trades are spread out by time, such that each one can be attacked separately (by a sufficiently fast attacker).
The system is set up to consume the big triangular areas on the supply vs demand chart that do not actually impact whether a trade takes place.
If you settle multiple trades at once rather than a continual series of individual transactions, there are fewer opportunities to take a bite out of other people's trades by being a very fast middleman.
Also, the only way to test your hypothesis is by comparing it against every other possible trading system. So I'd probably start off with a less ambitious claim, like "the current system is more fair than what Log from Blammo proposed." That way, it could be tested just by setting up the competing system and watching what happens.
I actually think there are lots of trading schemes that could prevent speed being a major advantage, but discrete time auctions are not one. They just change who gets the time advantage. The only way to remove time advantage from the field would be to make it so that order time was not calculated in fill priority. There are markets that do this currently (pro-rata markets give larger orders priority over smaller ones regardless of order time). There are also markets that have tried randomized matching and other esoteric methods. Not many people liked trading this way so volume dried up.
If we really wanted to remove time priority, my favorite way would be to add near infinite price increments. Then if you wanted to pay for priority you could in an explicit way.
I'll buy that my hypothesis was overly broad. Let me rephrase it to, "The current system is way better than the previous system, and I've heard no systems that don't have obvious flaws as compared to the current system."
If we really wanted to remove time priority, my favorite way would be to add near infinite price increments. Then if you wanted to pay for priority you could in an explicit way.
I'll buy that my hypothesis was overly broad. Let me rephrase it to, "The current system is way better than the previous system, and I've heard no systems that don't have obvious flaws as compared to the current system."
It isn't just about time. If someone knows what you are willing to pay, they can engineer their trades such that you pay exactly that. When the system itself is not paid unless you pay less than you were willing to pay, there is a built in incentive to not reveal that information to potential middlemen.
In that context, trade speed doesn't matter. If arbitrageurs cannot profit by breaking your trade up into two trades with themselves as middleman, it doesn't matter how fast they are.
Aside from that, any system where trades can occur faster than information can enter your eyeball, process in the brain, and shoot down your arm to click a mouse button is one that unfairly disadvantages the unaugmented human participant.
In that context, trade speed doesn't matter. If arbitrageurs cannot profit by breaking your trade up into two trades with themselves as middleman, it doesn't matter how fast they are.
Aside from that, any system where trades can occur faster than information can enter your eyeball, process in the brain, and shoot down your arm to click a mouse button is one that unfairly disadvantages the unaugmented human participant.
Some people have proposed the round-trip time from New York to Tokyo at the speed of light as a "speed limit" for trading. That works out to something on the order of 70 ms.
At the very least, it would eliminate the advantage gained from collocating your hardware next to the exchanges' servers.
At the very least, it would eliminate the advantage gained from collocating your hardware next to the exchanges' servers.
Why would it do that? If I'm colocated and you aren't, I have 70 ms latency, you have 70 ms + the distance to your servers.
I'm not an expert, but I think the idea is that the exchange would operate on some kind of "tick" cycle, so it would not be first-come-first- serve.
If you're collocated, you can place your order sooner, but before executing any of the orders, the exchange will wait 70 ms (or whatever) before trying to reconcile them (based on an auction system or similar).
So you can have low-latency, but it won't buy you any advantage, because being fast won't allow you to front-run other orders from further away.
If you're collocated, you can place your order sooner, but before executing any of the orders, the exchange will wait 70 ms (or whatever) before trying to reconcile them (based on an auction system or similar).
So you can have low-latency, but it won't buy you any advantage, because being fast won't allow you to front-run other orders from further away.
Ok as with all discussions about introduced latency, randomized latency, etc. The issue is not so much about latency, it's about fill priority when there are more people on one side of the buy/sell book at a given price point than on the other. Who gets left out?
Most (but not all) markets currently use price then FIFO for the matching algorithm. If you don't change the matching algorithm all the fake latency in the world won't make a difference to the game. If you are going to change the matching algorithm, what are you changing it to?
Most (but not all) markets currently use price then FIFO for the matching algorithm. If you don't change the matching algorithm all the fake latency in the world won't make a difference to the game. If you are going to change the matching algorithm, what are you changing it to?
You aggregate all trade offers in a given time interval. You line them up in order of their price. Buyers are ordered highest to lowest. Sellers are ordered lowest to highest. Continue matching units until the buy price is lower than the sell price. Back up one. The average of the buy and sell prices for that unit is the clearing price. All the units to the left get traded. Everything to the right expires or rolls over to the next auction.
In case of ties, there is no tiebreaker, so any orders that can't be filled at exactly filled at the clearing price are filled as much as possible in as close to equal proportions as possible. For a variety of reasons, there will probably be a slight bias towards filling larger orders by a greater amount.
There is no FIFO. There is only participating in the auction and not. Did you get your orders in before the deadline, or not? The only way to guarantee complete fulfillment of your order is by having a better price than the marginal trader.
Having an order partially filled sucks, but it is your signal that you guessed the clearing price exactly right, and your prize is that you pay no fees whatsoever for your partially filled trade. You beat the system. You didn't beat the other traders, but you beat the system.
The more trade offers there are, the better the whole thing works. But people don't want to wait around forever, either. That's why I think clearing once an hour is a good compromise.
In case of ties, there is no tiebreaker, so any orders that can't be filled at exactly filled at the clearing price are filled as much as possible in as close to equal proportions as possible. For a variety of reasons, there will probably be a slight bias towards filling larger orders by a greater amount.
There is no FIFO. There is only participating in the auction and not. Did you get your orders in before the deadline, or not? The only way to guarantee complete fulfillment of your order is by having a better price than the marginal trader.
Having an order partially filled sucks, but it is your signal that you guessed the clearing price exactly right, and your prize is that you pay no fees whatsoever for your partially filled trade. You beat the system. You didn't beat the other traders, but you beat the system.
The more trade offers there are, the better the whole thing works. But people don't want to wait around forever, either. That's why I think clearing once an hour is a good compromise.
In another comment I mentioned the most elegant way to mitigate fifo priority gaming is to allow extremely high levels of fractional tick price. Something like 1/1000 of a penny would probably be enough.
I still think if you want to eliminate electronic market makers that is simpler and has less unintended consequences.
I still think if you want to eliminate electronic market makers that is simpler and has less unintended consequences.
As I mentioned in another comment without serious protections against it your exchange is going to bias very strongly towards many many single quantity orders (they can't be filled partially after all) and stacked orders around your last trade price.
You also are going to lose lots of large volume orders because most large order investors are less sensitive about price than they are about fill certainty.
That said the more I think about it, the more I think algo shops would love your exchange because price discovery would be so hard. When price discovery is hard there are more opportunities for the "smart" money.
You also are going to lose lots of large volume orders because most large order investors are less sensitive about price than they are about fill certainty.
That said the more I think about it, the more I think algo shops would love your exchange because price discovery would be so hard. When price discovery is hard there are more opportunities for the "smart" money.
1) No one would submit any bids until the last possible millisecond before the auction closed so that they could gather as much information as possible to inform their bid.
2) Bid/ask spreads would increase dramatically because market makers would be taking on far more risk of dramatic price changes in between auctions. This would dramatically increase costs to you, the investor.
2) Bid/ask spreads would increase dramatically because market makers would be taking on far more risk of dramatic price changes in between auctions. This would dramatically increase costs to you, the investor.
Sealed bid. No information is available except the volume and price from clearing the LAST auction.
I'm not aware of any reason why market makers would be required in such a system. Market makers are used in continuous trades such that price information can be continuously reported. There is no such need here.
Your objections seem to indicate that I did not explain my proposal such that you could easily understand my intent.
I'm not aware of any reason why market makers would be required in such a system. Market makers are used in continuous trades such that price information can be continuously reported. There is no such need here.
Your objections seem to indicate that I did not explain my proposal such that you could easily understand my intent.
Ok, with the extra comments I now understand your proposal is much more radical than I originally thought. You are suggesting a completely obscured order book. I don't know of any markets that operate that way so I don't have any proof about how well price discovery would work in that system. My instinct is that most participants would become very nervous about setting their prices and therefore the spreads would be very wide, and not much trading would occur.
That said, your system still doesn't address the priority issue. Lets say in your new bid system we got lucky and a lot of people without knowledge of the order book picked the same price for both buying and selling an instrument. But there were more people on the buy side than the sell side (or vice versa). Who gets filled and who doesn't?
That said, your system still doesn't address the priority issue. Lets say in your new bid system we got lucky and a lot of people without knowledge of the order book picked the same price for both buying and selling an instrument. But there were more people on the buy side than the sell side (or vice versa). Who gets filled and who doesn't?
If there were more numbers on the buyer side, all buyers exactly at the clearing price would have an equal fraction of their order filled.
If buyers at $10 or lower want 300, 100, and 10, and sellers at $10 or higher have 205, and the clearing price is $10, then each buyer at $10 or lower gets 50% of what he wanted.
Everyone who bid higher buys everything they wanted. Everyone who bid lower buys nothing.
Simply put, the algorithm to find the clearing price is similar to drawing supply and demand in your high school micro-economics class. The bids are put in order, highest price to lowest, forming the demand curve. The offers are put in order, lowest to highest, forming the supply curve.
At the point where they cross, if they cross, is the price and quantity that gets traded. The system knows, but does not publicly reveal, the amounts that the buyers and sellers who actually traded in this auction would have still traded at.
In continuous trades, the difference does NOT go to the buyer or seller. It usually goes to a professional middleman. Therefore, the current system is optimized to capture as much of this benefit as possible for the middleman. But it still leaves tiny sawtooth areas close to the curve that cannot be captured unless you can trade on infinitesimal time slices for arbitrarily precise fractions of a dollar.
Clearing multiple trades at once means that the arbitrageur can only capture value from the marginal buyers and sellers, if anyone, and everyone else can actually enjoy the benefit of trade. The amount taken by the exchange is one trangular area, rather than multiple rectangles, thus has no deadweight loss.
If buyers at $10 or lower want 300, 100, and 10, and sellers at $10 or higher have 205, and the clearing price is $10, then each buyer at $10 or lower gets 50% of what he wanted.
Everyone who bid higher buys everything they wanted. Everyone who bid lower buys nothing.
Simply put, the algorithm to find the clearing price is similar to drawing supply and demand in your high school micro-economics class. The bids are put in order, highest price to lowest, forming the demand curve. The offers are put in order, lowest to highest, forming the supply curve.
At the point where they cross, if they cross, is the price and quantity that gets traded. The system knows, but does not publicly reveal, the amounts that the buyers and sellers who actually traded in this auction would have still traded at.
In continuous trades, the difference does NOT go to the buyer or seller. It usually goes to a professional middleman. Therefore, the current system is optimized to capture as much of this benefit as possible for the middleman. But it still leaves tiny sawtooth areas close to the curve that cannot be captured unless you can trade on infinitesimal time slices for arbitrarily precise fractions of a dollar.
Clearing multiple trades at once means that the arbitrageur can only capture value from the marginal buyers and sellers, if anyone, and everyone else can actually enjoy the benefit of trade. The amount taken by the exchange is one trangular area, rather than multiple rectangles, thus has no deadweight loss.
I don't know of any systems that implement equal % matching algorithms but I'd expect it would encourage games where you just send in more smaller orders (hiding their relation to each other if you are particularly shady) so that you would improve your fill rates.
Your hidden book time auction idea is not one I've seen implemented. Again I think it would be very detrimental for price discovery but can't prove that.
Just trying to think of it as a market participant, how do I determine what price I should bid or offer?
I can also think of all kinds of ways for this system to be gamed. The first thing I would try if I were making markets in this system is to ladder small quantity orders right around the last trade price. Then when you get filled on these orders they would act as high/low water marks letting you zero in on the correct price.
Not sure why I would want to encourage this sort of gaming instead of an open book, but I'd certainly like to try it if you ever create your exchange.
[Edit] re-read original comment and realize it is not pro-rata matching.
Your hidden book time auction idea is not one I've seen implemented. Again I think it would be very detrimental for price discovery but can't prove that.
Just trying to think of it as a market participant, how do I determine what price I should bid or offer?
I can also think of all kinds of ways for this system to be gamed. The first thing I would try if I were making markets in this system is to ladder small quantity orders right around the last trade price. Then when you get filled on these orders they would act as high/low water marks letting you zero in on the correct price.
Not sure why I would want to encourage this sort of gaming instead of an open book, but I'd certainly like to try it if you ever create your exchange.
[Edit] re-read original comment and realize it is not pro-rata matching.
1) Sealing the bids certainly contains some information but what about, you know, the real world. Lots of things are continuing to happen in the real world that effect the value of securities. I want to incorporate as much of that information as possible into my bid so I'm gonna wait until the last possible moment to submit my bid.
2) Bid/ask spreads would increase for regular people not just market makers. If you increase the restrictions under which something can be traded that ads risk to making a trade. That will push apart spreads. The existence of market makers is orthogonal to that principal.
2) Bid/ask spreads would increase for regular people not just market makers. If you increase the restrictions under which something can be traded that ads risk to making a trade. That will push apart spreads. The existence of market makers is orthogonal to that principal.
Large bid/ask spreads benefit buyers and sellers if they are allowed to keep the benefit of trade trade for themselves.
If I would pay $10 to buy, and a seller would accept $8 to sell, and the clearing price is $9, we each benefit.
If The seller sells at $8.01 to a middleman, who sells at $9.99 to me, only the middleman benefits. He has captured almost the entire benefit of trade from us.
Spreads do not matter here. The buyer and seller agree to trust a third party cartel enforcer to keep their trade information secret for the express purpose of excluding arbitrageurs. They do this because they can then get higher prices for what they sell, and lower prices for what they buy.
If the earnings report is scheduled to be released in the middle of an auction interval, yes, you might want to wait before using the system. But you might not care. Your numbers might be based upon research rather than speculation. This system is designed to be more friendly to the people who trade based on what the goods at hand are worth to them, rather than how much money they can make speculating on movements in the price. That's the whole point.
Your objections seem to be that the people who make a lot of money in the current system can't do that as easily here. Again, that's the point. As I see it, the people making the most money are providing the least value, while also trying to pretend that no one could live without them.
What if they could all be replaced by a very short shell script?
If I would pay $10 to buy, and a seller would accept $8 to sell, and the clearing price is $9, we each benefit.
If The seller sells at $8.01 to a middleman, who sells at $9.99 to me, only the middleman benefits. He has captured almost the entire benefit of trade from us.
Spreads do not matter here. The buyer and seller agree to trust a third party cartel enforcer to keep their trade information secret for the express purpose of excluding arbitrageurs. They do this because they can then get higher prices for what they sell, and lower prices for what they buy.
If the earnings report is scheduled to be released in the middle of an auction interval, yes, you might want to wait before using the system. But you might not care. Your numbers might be based upon research rather than speculation. This system is designed to be more friendly to the people who trade based on what the goods at hand are worth to them, rather than how much money they can make speculating on movements in the price. That's the whole point.
Your objections seem to be that the people who make a lot of money in the current system can't do that as easily here. Again, that's the point. As I see it, the people making the most money are providing the least value, while also trying to pretend that no one could live without them.
What if they could all be replaced by a very short shell script?
> If I would pay $10 to buy, and a seller would accept $8 to sell, and the clearing price is $9, we each benefit.
That's not how bid/ask spreads work. You have it backwards. A big spread is when the highest anyone willing to pay is $8 and the lowest anyone is willing to sell for is $10.
Large bid/ask spreads hurt both buyers and sellers because as soon as they make a trade they are already in a hole (that they hope to make up by overall movement in the security).
That's not how bid/ask spreads work. You have it backwards. A big spread is when the highest anyone willing to pay is $8 and the lowest anyone is willing to sell for is $10.
Large bid/ask spreads hurt both buyers and sellers because as soon as they make a trade they are already in a hole (that they hope to make up by overall movement in the security).
That trade is not going to happen, man. That's another way of saying that everybody is already perfectly happy without trading at all.
If trade volume is zero, the auction reports the price as whatever the most desperate seller would accept. Anyone who wants to actually buy in the next interval should probably offer more than the value reported in the previous interval.
But since the trade orders are secret, you don't actually know how big the spread is. You only know how much traded at the last price. Again, you are very intently focused on something that has very little relevance to the proposed system.
You have no way of knowing what the spread is. That is intentionally hidden via a cartel arrangement to exclude arbitrageurs. No one trades unless everyone is happy with the trade. If no trades occur, everyone was already happy enough with what they have. That is not a problem that needs fixing.
If trade volume is zero, the auction reports the price as whatever the most desperate seller would accept. Anyone who wants to actually buy in the next interval should probably offer more than the value reported in the previous interval.
But since the trade orders are secret, you don't actually know how big the spread is. You only know how much traded at the last price. Again, you are very intently focused on something that has very little relevance to the proposed system.
You have no way of knowing what the spread is. That is intentionally hidden via a cartel arrangement to exclude arbitrageurs. No one trades unless everyone is happy with the trade. If no trades occur, everyone was already happy enough with what they have. That is not a problem that needs fixing.
OK, let me make a real world comparison. Imagine the market for collectibles in the pre eBay world. The market was much less efficient. It was much harder to match buyers with sellers. If you had a Ken Griffey baseball card to sell you probably couldn't get a great price because matching up with a buyer was harder. At the same time if you wanted to buy one you probably had to pay a higher price because you had to go to a special baseball card dealer. Spreads between what you could sell for and what you had to pay to buy were very large.
Then eBay comes along and the market is way more efficient. You can buy and sell with anyone in the world and it's (relatively) fast and easy! Bids go up, asks go down and spreads decrease! It's a win for everyone other than the middle men (baseball care dealers).
The faster and easier it is to trade, the smaller spreads are, the better pricing is, the less middle men make.
Your proposal would move the system back in the other direction because you're making trading slower & harding and impeding information flow between everyone. There is no market in which secrecy or slowness benefits the actual customer and not the middle men.
Then eBay comes along and the market is way more efficient. You can buy and sell with anyone in the world and it's (relatively) fast and easy! Bids go up, asks go down and spreads decrease! It's a win for everyone other than the middle men (baseball care dealers).
The faster and easier it is to trade, the smaller spreads are, the better pricing is, the less middle men make.
Your proposal would move the system back in the other direction because you're making trading slower & harding and impeding information flow between everyone. There is no market in which secrecy or slowness benefits the actual customer and not the middle men.
You do realize that you just said that the auction site eBay made the markets more efficient than the professional trader card dealers, don't you?
Yes. That is exactly what I said.
Isn't the entire point, that the anti-HFT folks are trying to make, that if HFT is abolished then we will still have liquidity? As in "Liquidity is not created by HFT. HFT are just an intermediary between the actual providers of liquidity and the rest of the market".
This is a sincere question, because I really do not understand how HFT "creates liquidity" when they are just buying low and selling high.
This is a sincere question, because I really do not understand how HFT "creates liquidity" when they are just buying low and selling high.
> This is a sincere question, because I really do not understand how HFT "creates liquidity" when they are just buying low and selling high.
It's a complicated issue, but I think the simplified version is: Reduced liquidity results in larger volatility.
Shorting is an easier example to look at: When a stock drops, folks with short positions cover their bets ("I've made enough money off this position, it may be near the maximum I'll make") they buy. Others notice that there is buying interest etc. However, when shorting is banned, those buys do not arrive and you would intuitively expect the stock to drop further before buyers believe there is money to be made. You could witness this dynamic during 2008-9, when the SEC banned shorting of banks.
It's a complicated issue, but I think the simplified version is: Reduced liquidity results in larger volatility.
Shorting is an easier example to look at: When a stock drops, folks with short positions cover their bets ("I've made enough money off this position, it may be near the maximum I'll make") they buy. Others notice that there is buying interest etc. However, when shorting is banned, those buys do not arrive and you would intuitively expect the stock to drop further before buyers believe there is money to be made. You could witness this dynamic during 2008-9, when the SEC banned shorting of banks.
They don't. "Creating liquidity" is the weasel term they use to justify making money off of trades that would have happened anyway without their help.
The trade clearing systems themselves create all the liquidity that anybody needs.
If anything, they insititute a tiny tax on larger trades, such that there is a tiny deadweight loss to the market every time they front-run somebody. It isn't enough to be very noticeable on a single asset, but it is a positive and nonzero amount that is destroyed each time, and that can add up. To what, I have no idea.
The trade clearing systems themselves create all the liquidity that anybody needs.
If anything, they insititute a tiny tax on larger trades, such that there is a tiny deadweight loss to the market every time they front-run somebody. It isn't enough to be very noticeable on a single asset, but it is a positive and nonzero amount that is destroyed each time, and that can add up. To what, I have no idea.
Did you read the blog post? They aren't "creating liquidity" they are "selling liquidity." And if you're asserting that nobody needs it you really need to provide an answer for the question:
Then why are people buying it?
Then why are people buying it?
Maybe they are not spending their own money?
So the people complaining about being ripped off by HFTers aren't forced to trade with them, but they do so anyways because they don't care because it's not their own money? Then why are they complaining about being ripped off?
This comment doesn't make any sense?
This comment doesn't make any sense?
If I put $10 into a 401(k) and lose $0.0001 of it because the fund manager didn't bother to protect me from fast middlemen, because it doesn't benefit him at all, am I still entitled to complain?
Sure, but you should complain to the crappy fund manager you hired to do a good job for you not the person who the fund manager was competing against.
You also might want to switch to Vanguard. They do a good job and realize that HFTers have dramatically lowered costs for them and their clients: http://www.cnbc.com/id/49434073
You also might want to switch to Vanguard. They do a good job and realize that HFTers have dramatically lowered costs for them and their clients: http://www.cnbc.com/id/49434073
They are nevertheless buying higher than everyone else and selling lower than everyone else. Otherwise their orders would never get filled.
Yeah, but if they (the HFT) are not there the only thing that seems to change (in my naive understanding) is that there is no "tax" on liquidity, but the liquidity is still there.
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[deleted](1)
For anyone interested in more information, I׳d recommend reading the comments in these two threads [0,1] from Marginal Revolution blog. Two HFT traders wrote thoroughly about HFT. I׳ve never read such an interesting and broad online discussion about HFT.
I actually spent most of yesterday׳s afternoon reading these threads.
[0] http://marginalrevolution.com/marginalrevolution/2014/04/mat... [1] http://marginalrevolution.com/marginalrevolution/2014/03/new...
[0] http://marginalrevolution.com/marginalrevolution/2014/04/mat... [1] http://marginalrevolution.com/marginalrevolution/2014/03/new...
If you're not a pension fund or other large investor, HFT's don't care about your orders.
The premise of the post is false. If a large limit order is resting on the books, that's an implied option for the HFTs.
If you place a large bid at $10.00, the HFTs will buy at $10.01. If the market starts going down, they sell to you before the price crashes more. If the price goes up, you never got your fill.
Limit orders don't protect from HFTs exploiting you. What happens is you either don't get filled (price drops to $10.01 and goes back up), or the price drops to $9.99 or less.
If you place a large bid at $10.00, the HFTs will buy at $10.01. If the market starts going down, they sell to you before the price crashes more. If the price goes up, you never got your fill.
Limit orders don't protect from HFTs exploiting you. What happens is you either don't get filled (price drops to $10.01 and goes back up), or the price drops to $9.99 or less.
I personally use limit orders. I think there is an important distinction in deciding how much will be paid for a security. It makes you think about what the security is actually worth, separate from what the market order book is saying about the security at any particular time.
Can someone explain why any of these is a bad idea?
(a) completed transaction tax;
(b) regulatory fee on offers/cancellations;
(c) insertion of random delays into offers/cancellations;
All could increase friction and reduce the speculative/arbitrage opportunities, while having little effect on those wanting to trade to hold for periods exceeding seconds.
There is a belief that the churn of HFTs/Arbs is enhancing liquidity for "real" investors. There ought to be reasonable questions what amount of churn is useful, adequate, and whether some frothy levels should be constrained in some way.
Is there any way to decide when things are excessivly liquid, in ways that lead to undesirable effects?
All could increase friction and reduce the speculative/arbitrage opportunities, while having little effect on those wanting to trade to hold for periods exceeding seconds.
There is a belief that the churn of HFTs/Arbs is enhancing liquidity for "real" investors. There ought to be reasonable questions what amount of churn is useful, adequate, and whether some frothy levels should be constrained in some way.
Is there any way to decide when things are excessivly liquid, in ways that lead to undesirable effects?
Any tax you propose will reduce the amount of the taxed thing and introduce unintended consequences. So we have to ask why do you want less transactions or orders? It won't reduce HFT activity for instance. It will just mean that HFT systems will only make more profitable trades. That means higher bid/ask spreads and higher risk limits leading to higher volatility. It also may have the unintended consequence of consolidating more volume into smaller firms.
That doesn't seem to be in anyone's best interest.
As for latency games the issue is not the overall latency it is fifo priority matching. Without changing that bouncing trading signals off of mars won't help.
That doesn't seem to be in anyone's best interest.
As for latency games the issue is not the overall latency it is fifo priority matching. Without changing that bouncing trading signals off of mars won't help.
I think a reasonable question is why we consider /more/ transactions a good thing, if a large fraction of them are for holding periods in small number of seconds.
I think I am questioning the fifo paradigm, which creates these arbitrage opportunities, especially when there are multiple fifo queues representing multiple markets. It is not clear to me that batching things in 1 sec increments, and randomizing the our ordering would be bad or unfair.
I also don't see why a modest fee that would make short-hold transactions for tiny gains is a bad thing.
Structuring the system to reward HFT latency advantages seems opposed to stability, if one believes that the market is for actual investments.
HFT seems to be a second order phenomenon that games the system, and may have come to dwarf what could be called legitimate investment.
At what point is there "enough" liquidity, and when is "too much"? I suspect the people who do HFT and other arb techniques think there is no such thing as too much, because they profit on the churn. Others see this as producing nothing of societal value, extracting real money from the system that could be used for other purposes.
I think I am questioning the fifo paradigm, which creates these arbitrage opportunities, especially when there are multiple fifo queues representing multiple markets. It is not clear to me that batching things in 1 sec increments, and randomizing the our ordering would be bad or unfair.
I also don't see why a modest fee that would make short-hold transactions for tiny gains is a bad thing.
Structuring the system to reward HFT latency advantages seems opposed to stability, if one believes that the market is for actual investments.
HFT seems to be a second order phenomenon that games the system, and may have come to dwarf what could be called legitimate investment.
At what point is there "enough" liquidity, and when is "too much"? I suspect the people who do HFT and other arb techniques think there is no such thing as too much, because they profit on the churn. Others see this as producing nothing of societal value, extracting real money from the system that could be used for other purposes.
"I think a reasonable question is why we consider /more/ transactions a good thing, if a large fraction of them are for holding periods in small number of seconds"
I don't want to put words in your mouth, but can we at least say that transaction count is not what we are actually interested in? In a vacuum we (larger society) don't care a whit about the number of transactions that occur?
"It is not clear to me that batching things in 1 sec increments, and randomizing the our ordering would be bad or unfair."
It is clear to me that batching things in 1 sec increments would be as unfair to someone as the current system (I'm sorry to not back this up, but I've been doing a ton of commenting about it in the last few days and don't have the patience I did). It's possible that this unfairness is "better" for society overall. I don't know how to quantify that.
"I also don't see why a modest fee that would make short-hold transactions for tiny gains is a bad thing."
My "expert" opinion on market making strategies is that this would increase the bid/ask spread and volatility in the market. Further my opinion is that this is a bad thing for retail investors and market makers, to the advantage of large institutional investors. I don't have the stamina to prove this assertion.
"Structuring the system to reward HFT latency advantages seems opposed to stability, if one believes that the market is for actual investments."
This is a common simplification that I think deserves a lot of thought. Many folks on Hacker News think that the market is for "investment". Usually they equate this to "bootstrapping enterprises that aren't viable without external money". This is an obvious bias for an internet forum dedicated to startups to have. In reality, the vast majority of market forces are not about that. They are about risk mitigation. So when you say that HFT "dwarfs" legitimate investment, are you saying it doesn't provide a valid mode for bootstraping enterprises, or are you saying it doesn't help with risk mitigation?
Your answer to that question means a lot for how we debate the topic. A similar answer is available for your assertion that HFT is a second order phenomenon.
As for when is there enough liquidity? I'd say when people stop paying for it. Which hasn't happened yet. Paying for liquidity is reaching a saturation point, because it has gotten so cheap. This is most obviously demonstrated by the massive loss in value that HFT groups have had in the last 5 years. If anything we have too much liquidity, and that comes from someone who's paycheck comes from an HFT.
I don't want to put words in your mouth, but can we at least say that transaction count is not what we are actually interested in? In a vacuum we (larger society) don't care a whit about the number of transactions that occur?
"It is not clear to me that batching things in 1 sec increments, and randomizing the our ordering would be bad or unfair."
It is clear to me that batching things in 1 sec increments would be as unfair to someone as the current system (I'm sorry to not back this up, but I've been doing a ton of commenting about it in the last few days and don't have the patience I did). It's possible that this unfairness is "better" for society overall. I don't know how to quantify that.
"I also don't see why a modest fee that would make short-hold transactions for tiny gains is a bad thing."
My "expert" opinion on market making strategies is that this would increase the bid/ask spread and volatility in the market. Further my opinion is that this is a bad thing for retail investors and market makers, to the advantage of large institutional investors. I don't have the stamina to prove this assertion.
"Structuring the system to reward HFT latency advantages seems opposed to stability, if one believes that the market is for actual investments."
This is a common simplification that I think deserves a lot of thought. Many folks on Hacker News think that the market is for "investment". Usually they equate this to "bootstrapping enterprises that aren't viable without external money". This is an obvious bias for an internet forum dedicated to startups to have. In reality, the vast majority of market forces are not about that. They are about risk mitigation. So when you say that HFT "dwarfs" legitimate investment, are you saying it doesn't provide a valid mode for bootstraping enterprises, or are you saying it doesn't help with risk mitigation?
Your answer to that question means a lot for how we debate the topic. A similar answer is available for your assertion that HFT is a second order phenomenon.
As for when is there enough liquidity? I'd say when people stop paying for it. Which hasn't happened yet. Paying for liquidity is reaching a saturation point, because it has gotten so cheap. This is most obviously demonstrated by the massive loss in value that HFT groups have had in the last 5 years. If anything we have too much liquidity, and that comes from someone who's paycheck comes from an HFT.
Thanks, I appreciate the answer, and am trying to be more informed.
On transaction count, I think "we" /may/ care about transaction count, if the majority of transactions are shams or gaming the trading system. To the extent that the value of the transactions turns up in statistics like GDP, then they distort "our" view of economic activity. Perhaps that is a problem with metrics that include such transactions rather than their existence.
Let's table discussion of batching or randomization.
In terms of volatility, I will proffer that HFT and program trading go hand-in-hand in my mind, and that program trading at high frequency seems to be a volatility amplifier. It's not yet clear to me why added damping friction automatically leads to wider spreads and volatility as you indicate. I accept I may be uninformed on the matter.
When I speak to "investment" I think more of capital gain and dividend than of capitalization from public offering. Over not long periods, the value of shares traded "long" usually greatly exceeds the value of the offering. That is the majority of "investment", and doesn't really relate to bootstrapping startup-ness.
I think there is a fair discussion to be had about amounts of liquidity and risk mitigation. Some reasonable questions are about whose risk is being mitigated, at what cost to whom else, whether all affected parties are willing participants or if they are left no viable alternatives.
The argument is that the "risk" being mitigated is a derivitive of "true" investment, and should be of a lower aggregate value than the underlying security. When the mitigation is exceeding the value of the asset, then that suggests the system is out of balance. Relate to aggregate CDO valuations exceeding the value of the underlying securities.
I'm not saying I accept that argument, or reject your point about risk-mitigation. I'm trying to understand the forces that should balance, and how one might judge them.
I'm not sanguine about the claim that payments for liquidity are proxies for the will of an informed market, since I'm not a Chicagoan who thinks the market is always right by definition. There can be market failures, and it seems possible that "over liquidity" may represent a market failure.
thanks.
On transaction count, I think "we" /may/ care about transaction count, if the majority of transactions are shams or gaming the trading system. To the extent that the value of the transactions turns up in statistics like GDP, then they distort "our" view of economic activity. Perhaps that is a problem with metrics that include such transactions rather than their existence.
Let's table discussion of batching or randomization.
In terms of volatility, I will proffer that HFT and program trading go hand-in-hand in my mind, and that program trading at high frequency seems to be a volatility amplifier. It's not yet clear to me why added damping friction automatically leads to wider spreads and volatility as you indicate. I accept I may be uninformed on the matter.
When I speak to "investment" I think more of capital gain and dividend than of capitalization from public offering. Over not long periods, the value of shares traded "long" usually greatly exceeds the value of the offering. That is the majority of "investment", and doesn't really relate to bootstrapping startup-ness.
I think there is a fair discussion to be had about amounts of liquidity and risk mitigation. Some reasonable questions are about whose risk is being mitigated, at what cost to whom else, whether all affected parties are willing participants or if they are left no viable alternatives.
The argument is that the "risk" being mitigated is a derivitive of "true" investment, and should be of a lower aggregate value than the underlying security. When the mitigation is exceeding the value of the asset, then that suggests the system is out of balance. Relate to aggregate CDO valuations exceeding the value of the underlying securities.
I'm not saying I accept that argument, or reject your point about risk-mitigation. I'm trying to understand the forces that should balance, and how one might judge them.
I'm not sanguine about the claim that payments for liquidity are proxies for the will of an informed market, since I'm not a Chicagoan who thinks the market is always right by definition. There can be market failures, and it seems possible that "over liquidity" may represent a market failure.
thanks.
On the transaction count issue, I agree that there may be some societal good to removing sham or gaming trades from the markets, but that is not what a transaction tax targets, it targets all transactions whether they are shams or not. Further a transaction tax raises the cost of entry for all market participants, without providing any disincentive to those making sham trades.
It's possible that HFT is a volatility amplifier, it's hard to judge though because HFT rose when other macro market forces were driving huge amounts of volatility into the markets. One thing I think most people will agree on is that market segmentation and electronic access drove down the price of trading dramatically for everyone and enabled a variety of extremely useful investment vehicles for the "retail" investor (I'm thinking of ETFs especially). Any system that has market segmentation and electronic access will also enable algorithmic trading. My opinion is that it is foolish to throw out all the positive benefits in the name of some artificial "fairness" between human and computer traders.
Chris Stucchio has a good explanation about the mechanics of market making at http://www.chrisstucchio.com/blog/2012/hft_apology.html
Understanding those mechanics we can see that any added costs that the market maker bears must be reflected in their trades and will eventually drive them to increase their spread on the order books. If enough of the market makers do this it will increase the spread which is the biggest driving cost in trading after operational costs.
Capital gains and dividends are a mechanism to make capital aquisition possible. They happen to be the attributes of the capital markets that you are most interested in but there is nothing sacred about them (in fact lots shares lose capital and many companies don't pay dividends). For many other market participants hedging against inflation risk is vastly more important than dividends for instance. My opinion is that we should enable a system that allows for as open of access as possible to these markets for as cheap a cost without bias towards whats most important to any class of market participant. It is also my opinion that HFT actually does these things and that is why they are so scary to hedge funds and big banks.
I am also not a Chicagoan (well in an economic sense) and you are right over liquidity may be some sort of market failure. As someone who sells liquidity I will tell you that the price of it is currently being propped up with legislation. If it weren't for the sub-penny rule the spreads on some commonly traded instruments would be much smaller than they currently are. I'd also say if you figured out a way to remove some of the liquidity in the system without increasing my costs I'd appreciate it as this whole competing in an efficient market thing is for the birds.
It's possible that HFT is a volatility amplifier, it's hard to judge though because HFT rose when other macro market forces were driving huge amounts of volatility into the markets. One thing I think most people will agree on is that market segmentation and electronic access drove down the price of trading dramatically for everyone and enabled a variety of extremely useful investment vehicles for the "retail" investor (I'm thinking of ETFs especially). Any system that has market segmentation and electronic access will also enable algorithmic trading. My opinion is that it is foolish to throw out all the positive benefits in the name of some artificial "fairness" between human and computer traders.
Chris Stucchio has a good explanation about the mechanics of market making at http://www.chrisstucchio.com/blog/2012/hft_apology.html
Understanding those mechanics we can see that any added costs that the market maker bears must be reflected in their trades and will eventually drive them to increase their spread on the order books. If enough of the market makers do this it will increase the spread which is the biggest driving cost in trading after operational costs.
Capital gains and dividends are a mechanism to make capital aquisition possible. They happen to be the attributes of the capital markets that you are most interested in but there is nothing sacred about them (in fact lots shares lose capital and many companies don't pay dividends). For many other market participants hedging against inflation risk is vastly more important than dividends for instance. My opinion is that we should enable a system that allows for as open of access as possible to these markets for as cheap a cost without bias towards whats most important to any class of market participant. It is also my opinion that HFT actually does these things and that is why they are so scary to hedge funds and big banks.
I am also not a Chicagoan (well in an economic sense) and you are right over liquidity may be some sort of market failure. As someone who sells liquidity I will tell you that the price of it is currently being propped up with legislation. If it weren't for the sub-penny rule the spreads on some commonly traded instruments would be much smaller than they currently are. I'd also say if you figured out a way to remove some of the liquidity in the system without increasing my costs I'd appreciate it as this whole competing in an efficient market thing is for the birds.
Thanks, I appreciate the discussion.
Your stamina on this topic is impressive kasey_junk. I've enjoyed reading your comments in the face of confusion.
Thanks for the vote of confidence.
To be honest I'd much rather talk about the pro's and con's of strong type systems or whether you can model semi real time systems on the JVM than I would the relatively uninteresting questions about FIFO matching in modern exchanges. But man people say some really ignorant things as soon as equities trading gets involved.
To be honest I'd much rather talk about the pro's and con's of strong type systems or whether you can model semi real time systems on the JVM than I would the relatively uninteresting questions about FIFO matching in modern exchanges. But man people say some really ignorant things as soon as equities trading gets involved.
I just started learning about high frequency trading. I was interested to learn about some of the lore surrounding the field. While digital algorithms are relatively new, trading algorithms, in a conceptual sense, have existed for at least hundreds of years. I don't usually throw around links to my own content, but I think this is relevant: http://codyromano.com/using-pigeons-as-algorithms/
Author would benefit from a closer reading of the M. Lewis piece. It's well researched far from trivial. What's interesting about it is that it tells the story of how outsiders modeled the various ways to rip off <institutional> traders. They did this first and the empirically pattern-matched observed behaviour. They then did both physical and social market-micro-structure studies.
Lets take a look at this section (From attached article):
The fact of the matter is that HFT’s can’t rip you off. You are never under any obligation to do business with them. In spite of that, lots of sophisticated investors voluntarily pay HFTs every day. An important question for all the critics of HFT to grapple with is, “why do sophisticated investors voluntarily pay for something useless?”
This comes right after the section on why people don't adopt obvious strategies (use limit orders, etc):
Why doesn’t everyone do this?
This is an obvious question to ask. The answer is, quite simply, execution risk. Execution risk is the risk that you place an order but your trade never actually happens.
The Analysis Lewis outlines in his book shows that HFT is specificially engineered <to create execution risk>. It engineers artificial scarcity (the opposite of liquidity). Empirical study from Lewis's book:
Finally [The Trader] complained so loudly that they sent the developers, the guys who came to RBC in the Carlin acquisition. “They told me it was because I was in New York and the markets were in New Jersey and my market data was slow,” Katsuyama says. “Then they said that it was all caused by the fact that there are thousands of people trading in the market. They’d say: ‘You aren’t the only one trying to do what you’re trying to do. There’s other events. There’s news.’ ” <If that was the case, he asked them, why did the market in any given stock dry up only when he was trying to trade in it?> [emphasis added] To make his point, he asked the developers to stand behind him and watch while he traded. “I’d say: ‘Watch closely. I am about to buy 100,000 shares of AMD. I am willing to pay $15 a share. There are currently 100,000 shares of AMD being offered at $15 a share — 10,000 on BATS, 35,000 on the New York Stock Exchange, 30,000 on Nasdaq and 25,000 on Direct Edge.’ You could see it all on the screens. We’d all sit there and stare at the screen, and I’d have my finger over the Enter button. I’d count out loud to five. . . . “ ‘One. . . . “ ‘Two. . . . See, nothing’s happened. “ ‘Three. . . . Offers are still there at 15. . . . “ ‘Four. . . . Still no movement. . . . “ ‘Five.’ Then I’d hit the Enter button, and — boom! — all hell would break loose. The offerings would all disappear, and the stock would pop higher.”
This is why it's being investigated by the FBI, in addition the other issues (front running, NPI, etc).
"There are many people in government who are very focused on this and who are concerned about it and who think it breaks the law," an FBI spokesman said. "There is a big concern that high-frequency traders are getting material nonpublic information ahead of others and trading on it."
Lets take a look at this section (From attached article):
The fact of the matter is that HFT’s can’t rip you off. You are never under any obligation to do business with them. In spite of that, lots of sophisticated investors voluntarily pay HFTs every day. An important question for all the critics of HFT to grapple with is, “why do sophisticated investors voluntarily pay for something useless?”
This comes right after the section on why people don't adopt obvious strategies (use limit orders, etc):
Why doesn’t everyone do this?
This is an obvious question to ask. The answer is, quite simply, execution risk. Execution risk is the risk that you place an order but your trade never actually happens.
The Analysis Lewis outlines in his book shows that HFT is specificially engineered <to create execution risk>. It engineers artificial scarcity (the opposite of liquidity). Empirical study from Lewis's book:
Finally [The Trader] complained so loudly that they sent the developers, the guys who came to RBC in the Carlin acquisition. “They told me it was because I was in New York and the markets were in New Jersey and my market data was slow,” Katsuyama says. “Then they said that it was all caused by the fact that there are thousands of people trading in the market. They’d say: ‘You aren’t the only one trying to do what you’re trying to do. There’s other events. There’s news.’ ” <If that was the case, he asked them, why did the market in any given stock dry up only when he was trying to trade in it?> [emphasis added] To make his point, he asked the developers to stand behind him and watch while he traded. “I’d say: ‘Watch closely. I am about to buy 100,000 shares of AMD. I am willing to pay $15 a share. There are currently 100,000 shares of AMD being offered at $15 a share — 10,000 on BATS, 35,000 on the New York Stock Exchange, 30,000 on Nasdaq and 25,000 on Direct Edge.’ You could see it all on the screens. We’d all sit there and stare at the screen, and I’d have my finger over the Enter button. I’d count out loud to five. . . . “ ‘One. . . . “ ‘Two. . . . See, nothing’s happened. “ ‘Three. . . . Offers are still there at 15. . . . “ ‘Four. . . . Still no movement. . . . “ ‘Five.’ Then I’d hit the Enter button, and — boom! — all hell would break loose. The offerings would all disappear, and the stock would pop higher.”
This is why it's being investigated by the FBI, in addition the other issues (front running, NPI, etc).
"There are many people in government who are very focused on this and who are concerned about it and who think it breaks the law," an FBI spokesman said. "There is a big concern that high-frequency traders are getting material nonpublic information ahead of others and trading on it."
Your example does exactly what the author recommends you not to do; cross the order book. In your example, you're supposed to place a limit order at 14.99.
That doesn't do anything. Then you never get any shares, and the market moves higher because there is a 100,000 shares on the order book and the market will move higher for legit reasons.
The way not to get scalped, is to place the order in a way where it arrives at all the exchanges at the same time, that way the HFT guys and their microwave data links can't peek at your order on BATS, and then beat you to the other exchanges.
The accusation is they see the 100,000 share order hit BATS, 10,000 get filed, then the HFT guys buy 90,000 shares on the other exchanges before your order gets forwarded, and you are stuck paying the HFT guys $15.02.
The way not to get scalped, is to place the order in a way where it arrives at all the exchanges at the same time, that way the HFT guys and their microwave data links can't peek at your order on BATS, and then beat you to the other exchanges.
The accusation is they see the 100,000 share order hit BATS, 10,000 get filed, then the HFT guys buy 90,000 shares on the other exchanges before your order gets forwarded, and you are stuck paying the HFT guys $15.02.
The HFT guys aren't buying 90,000 shares on the other exchanges. They're just updating their ASK price on those exchanges to slightly raise the price to reflect the new information that just hit the market. If someone wants to buy 100,000 shares RIGHT NOW it's a good sign that the price should be going up. Katsuyama/RBC were used to their proprietary information staying a secret that only they knew for longer before the HFTs jumped in and made the market respond faster.
That might be a bummer for Katsuyama/RBC but it's great for everyone else on the market who now benefit from a price that updates faster.
That might be a bummer for Katsuyama/RBC but it's great for everyone else on the market who now benefit from a price that updates faster.
How do you "update" your ASK price? They are either front running by buying the shares at $15.00-$15.01, or, if they are their own orders, then they cancel them. It is the same thing.
If someone wants to buy 100,000 shares, and the market says there are 100,000 shares available at $15, the order should complete at $15.
If someone wants to buy 100,000 shares, and the market says there are 100,000 shares available at $15, the order should complete at $15.
You update your ASK price by canceling your order and submitting a new one with a different price.
> If someone wants to buy 100,000 shares, and the market says there are 100,000 shares available at $15, the order should complete at $15.
As long as they submit their matching order while my bid is still on the books that's fine. But why should I be required to keep my order on the books for any longer than I want to?
> If someone wants to buy 100,000 shares, and the market says there are 100,000 shares available at $15, the order should complete at $15.
As long as they submit their matching order while my bid is still on the books that's fine. But why should I be required to keep my order on the books for any longer than I want to?
You should be able to cancel you order at anytime. What you shouldn't be able to do is to stiff other people's trades, and then use a microwave antenna to change your order before the other person trade arrives.
What you think is happening in the world is not what's actually happening.
What's happening:
1) A large block of shares is traded on exchange #1.
2) HFTer notices #1 and very quickly updates the price at which they are willing to buy/sell on exchange #2. No one has any sure knowledge of trades on their way to exchange #2. They can guess. They can infer. But they aren't seeing any actual trades before they hit the exchange.
What's happening:
1) A large block of shares is traded on exchange #1.
2) HFTer notices #1 and very quickly updates the price at which they are willing to buy/sell on exchange #2. No one has any sure knowledge of trades on their way to exchange #2. They can guess. They can infer. But they aren't seeing any actual trades before they hit the exchange.
Please explain how you would do this in an open outcry market.
You're talking about front-running the trade inbetween the "sell" decision and the receipt of the signal at the exchange. In otherwords, your bid/offer is in bad faith. I can advertise a car for sale and then when you walk in remove the price and mark up the trade. You cannot do this in an open outcry market. Because it would be subject to retaliation (of various kinds).
Providing bid/ask indication in bad faith is NOT liquidity. Liquidity is not layering a trade to double the volume.
HFT does not increase liquidity. It increases volume, at best. But so does front-running. The bait and switch issue and the front-running issue not interchangeble, but they are closely linked.
Market micro-structure is difficult to discuss because most people are completely ignorant of the mechanics. Its easy to pass of volume for liquidity and to disquise front-running as "market making" or speculation. It is clearly distinct.
You're talking about front-running the trade inbetween the "sell" decision and the receipt of the signal at the exchange. In otherwords, your bid/offer is in bad faith. I can advertise a car for sale and then when you walk in remove the price and mark up the trade. You cannot do this in an open outcry market. Because it would be subject to retaliation (of various kinds).
Providing bid/ask indication in bad faith is NOT liquidity. Liquidity is not layering a trade to double the volume.
HFT does not increase liquidity. It increases volume, at best. But so does front-running. The bait and switch issue and the front-running issue not interchangeble, but they are closely linked.
Market micro-structure is difficult to discuss because most people are completely ignorant of the mechanics. Its easy to pass of volume for liquidity and to disquise front-running as "market making" or speculation. It is clearly distinct.
Market makers are in the business of selling liquidity. They're saying "maybe no one else wants to buy/sell this stock but here I am and I always have a bid/ask on the table." You don't have to trade with them. But a lot of people do every day.
Why do you think those people are trading with market makers if they're doing such shady things?
I don't think you really understand the business that market makers are in. They aren't in the business of trying to front run people. They're in the business of making a penny a share on all the trades that go back and forth. But they face a big risk. When they're busy buying/selling for $50.00/$50.01 what happens when a big & smart hedge fund guy comes along who has new information and knows the price should really be $50.10. They try to buy up as many shares as possible at $50.00 and suddenly the market maker is fucked because they're no longer market making in a stable market.
So the market maker has this big challenge where they have to do a good as job as possible detecting the big & smart hedge fund guy and quickly adjusting the price so they don't get squashed. If they can't do a very good job they have to increase spreads so they make more money in the steady state to make up for their bigger losses. If they do a really good job in this detecting they can lower spreads.
It turns out that HFTers are really good market makers. You can see this because they've successfully competed against each other to the point that they can lower spreads all the way to a penny (a 10x reduction of where they used to be!).
When you look at it this way you can see that market makers aren't trying to screw the big traders, they're trying to avoid getting screwed so that they can better serve everyone else by offering lower prices (lower spreads).
The nice side effect of all of this is that price information gets better communicated to the market faster. If you happen to be randomly selling your MSFT when Mr. Big & Smart shows up you're more likely to get the best possible price due to all the information being correctly communicated to the market.
Why do you think those people are trading with market makers if they're doing such shady things?
I don't think you really understand the business that market makers are in. They aren't in the business of trying to front run people. They're in the business of making a penny a share on all the trades that go back and forth. But they face a big risk. When they're busy buying/selling for $50.00/$50.01 what happens when a big & smart hedge fund guy comes along who has new information and knows the price should really be $50.10. They try to buy up as many shares as possible at $50.00 and suddenly the market maker is fucked because they're no longer market making in a stable market.
So the market maker has this big challenge where they have to do a good as job as possible detecting the big & smart hedge fund guy and quickly adjusting the price so they don't get squashed. If they can't do a very good job they have to increase spreads so they make more money in the steady state to make up for their bigger losses. If they do a really good job in this detecting they can lower spreads.
It turns out that HFTers are really good market makers. You can see this because they've successfully competed against each other to the point that they can lower spreads all the way to a penny (a 10x reduction of where they used to be!).
When you look at it this way you can see that market makers aren't trying to screw the big traders, they're trying to avoid getting screwed so that they can better serve everyone else by offering lower prices (lower spreads).
The nice side effect of all of this is that price information gets better communicated to the market faster. If you happen to be randomly selling your MSFT when Mr. Big & Smart shows up you're more likely to get the best possible price due to all the information being correctly communicated to the market.
You're missing the point that front running is capital efficient and ~zero risk. There is no discussion of hedging strategy and cost, etc in your reply. It seems plausible that (unobserved) front-running profits could easily subsidize (observed) low-spreads as loss leaders.
What front running? Are you talking about arbitrage between exchanges or something else?
The person I want to buy the stock from is only offering the shares at 15.00 and I think that is a fair price. Why should someone jump in between the two of us and buy the stock for 15.00 then offer them to me for 15.01.
This would be like going to an open house where you here someone say "I'm going to offer $1,000 over asking" then going to the seller and offering $500 over asking. Then going to the first person and saying you'll take that offer of $1,000 over asking.
You could claim that you provided liquidity and that you helped speed up the transactions but at the end of the day you made $500 for undercutting someone who already intended to make a purchase.
This would be like going to an open house where you here someone say "I'm going to offer $1,000 over asking" then going to the seller and offering $500 over asking. Then going to the first person and saying you'll take that offer of $1,000 over asking.
You could claim that you provided liquidity and that you helped speed up the transactions but at the end of the day you made $500 for undercutting someone who already intended to make a purchase.
I didn't provide liquidity in that case, I provided risk mitigation. You see the person who said they are going to offer "1000 over asking" hasn't done it yet. Any number of things can happen before they do, and that may not ever happen. My real bid of $500 over asking is a bird in hand.
So who asked you to provide any service of risk-mitigation, liquidity injection,etc..?
This is about 2 parties that are ready to agree to a transaction and a 3rd party injecting themselves into the transaction and taking a penny of the deal.
Imagine that you go to the grocery store to buy some milk and as you are about to checkout someone buys your $5.00 milk and tells you the price is now $5.01. And that the $0.01 increase includes spoilage insurance. Maybe you like that, maybe you don't, the issue is that you had no choice in the matter.
This is about 2 parties that are ready to agree to a transaction and a 3rd party injecting themselves into the transaction and taking a penny of the deal.
Imagine that you go to the grocery store to buy some milk and as you are about to checkout someone buys your $5.00 milk and tells you the price is now $5.01. And that the $0.01 increase includes spoilage insurance. Maybe you like that, maybe you don't, the issue is that you had no choice in the matter.
In your original flawed analogy the seller of the house has every right to reject my +500 bid in order to wait for a better deal if they think one is coming along.
In your current flawed analogy you are assuming that there is a fixed price for the things you are buying when there aren't.
Let me offer my own flawed analogy to explain what is actually happening in the latency/venue arbitrage case.
You are a real estate developer who wants to redevelop a block. On that block are 10 relatively equal properties owned by 10 different people. On day 1 you go to the first owner on the block and offer 100K for his shop, he says yes. On day 2 you go to the second owner and offer the same 100k. Again a deal. On day 3 you go to the third but they won't sell for less than 200k because they've been talking with their neighbors and know that someone really wants these properties. On and on until you get to the last owner who won't take anything less than 900K which you pay. Now you can say that you are being taken advantage of but I'd argue that it is just as morally questionable for you to low ball those original property owners when you know their property is worth more than what you bought it for. Conversely, let's say you balk at that 900K and walk away from the deal. Is that last owner "out" 900k? Are they out 100k?
Now lets introduce these nefarious third parties. Let's say I notice that you are buying those properties and while you are negotiating with the third property owner, I offer 200k to all of the remaining owners at once. If they agree and I offer them to you for 300k, I make profit on the deal, you still get what you want (at a cheaper overall price) and the original owners are all paid a consistent amount for equivalent properties. Also, if half way through you decide that this deal is no longer for you and stop buying up properties, I am "stuck" with those properties that are now not worth as much as I paid for them.
In your current flawed analogy you are assuming that there is a fixed price for the things you are buying when there aren't.
Let me offer my own flawed analogy to explain what is actually happening in the latency/venue arbitrage case.
You are a real estate developer who wants to redevelop a block. On that block are 10 relatively equal properties owned by 10 different people. On day 1 you go to the first owner on the block and offer 100K for his shop, he says yes. On day 2 you go to the second owner and offer the same 100k. Again a deal. On day 3 you go to the third but they won't sell for less than 200k because they've been talking with their neighbors and know that someone really wants these properties. On and on until you get to the last owner who won't take anything less than 900K which you pay. Now you can say that you are being taken advantage of but I'd argue that it is just as morally questionable for you to low ball those original property owners when you know their property is worth more than what you bought it for. Conversely, let's say you balk at that 900K and walk away from the deal. Is that last owner "out" 900k? Are they out 100k?
Now lets introduce these nefarious third parties. Let's say I notice that you are buying those properties and while you are negotiating with the third property owner, I offer 200k to all of the remaining owners at once. If they agree and I offer them to you for 300k, I make profit on the deal, you still get what you want (at a cheaper overall price) and the original owners are all paid a consistent amount for equivalent properties. Also, if half way through you decide that this deal is no longer for you and stop buying up properties, I am "stuck" with those properties that are now not worth as much as I paid for them.
" seller of the house has every right to reject my +500 bid in order to wait for a better deal if they think one is coming along"
You know that someone else just said they were going to offer 1000 over asking. The seller doesn't know that. You have an advantage.
" you are assuming that there is a fixed price for the things you are buying when there aren't."
When Bob offers stock X for 5.00 that is fixed until he cancels that order. Just like the milk, it is 5.00 until the store changes the price.
Your analogy implies that I need all the properties on a block. That would be similar to a hostile takeover where someone needs to buy 50+% of a company to take control.
Are you aware that HFT are not making their money by detecting hostile takeovers?
You know that someone else just said they were going to offer 1000 over asking. The seller doesn't know that. You have an advantage.
" you are assuming that there is a fixed price for the things you are buying when there aren't."
When Bob offers stock X for 5.00 that is fixed until he cancels that order. Just like the milk, it is 5.00 until the store changes the price.
Your analogy implies that I need all the properties on a block. That would be similar to a hostile takeover where someone needs to buy 50+% of a company to take control.
Are you aware that HFT are not making their money by detecting hostile takeovers?
Can I hazard a guess that he is aware of how HFTs make their money, and further point out that one of the reasons he has an unusually specific amount of detail to offer about how electronic trading works is that he is in fact an electronic trading software engineer?
Further, your attempt to poke a hole in his analogy is itself flawed, because you have a poor working notion of the scarcity involved. "There aren't just 10 shares of MSFT in the market" is what you're thinking, while ignoring that there is a finite amount of MSFT offered a price compatible with your investment goal. You can't think of the total amount of MSFT that exists. To reason about the market, you have to have a notion of what you're willing to pay for it. Many people who hold MSFT are unwilling to unload it at anything near the current spot price. This stands to reason, because if they were willing to unload at that price, they wouldn't be long MSFT.
Further, your attempt to poke a hole in his analogy is itself flawed, because you have a poor working notion of the scarcity involved. "There aren't just 10 shares of MSFT in the market" is what you're thinking, while ignoring that there is a finite amount of MSFT offered a price compatible with your investment goal. You can't think of the total amount of MSFT that exists. To reason about the market, you have to have a notion of what you're willing to pay for it. Many people who hold MSFT are unwilling to unload it at anything near the current spot price. This stands to reason, because if they were willing to unload at that price, they wouldn't be long MSFT.
I guess you don't quite understand how HFT works?
The simplest example is like this:
1. Bob sees that 10,000 share of MSFT are for sell on exchange X at $50.00 and also 30,000 share are for sell on exchange Y at $50.00 and 60,000 shares are for sell on exchange Z at $50.00 2. Bob attempts to buy 100,000 shares of MSFT at $50.00. 3. The HF trader sees the 60,000 order get filled at 50.00 and reasonably assumes that someone is trying to buy more than 60,000 shares right now. 4. He buys the remaining 40,000 shares at $50.00 before Bob's trade is executed. 5. The HF trader immediately lists the 40,000 shares at 50.01
Do you understand how the HF trader is injecting himself into the transaction?
The simplest example is like this:
1. Bob sees that 10,000 share of MSFT are for sell on exchange X at $50.00 and also 30,000 share are for sell on exchange Y at $50.00 and 60,000 shares are for sell on exchange Z at $50.00 2. Bob attempts to buy 100,000 shares of MSFT at $50.00. 3. The HF trader sees the 60,000 order get filled at 50.00 and reasonably assumes that someone is trying to buy more than 60,000 shares right now. 4. He buys the remaining 40,000 shares at $50.00 before Bob's trade is executed. 5. The HF trader immediately lists the 40,000 shares at 50.01
Do you understand how the HF trader is injecting himself into the transaction?
It looks like you just gave an example of a trader buying all the liquidity of MSFT on every market with a single market order.
Good point. You should ignore the previous comment based on a technicality. Since I didn't specify that the 100,000 share purchase was not actually 3 different orders
Aside from the strange example you provided, what's funny is that you focused on a 1 cent price movement. The average bid-ask spread before high-volume electronic trading drove it down was 12 cents --- that was money in the pockets of middlemen. Before electronic trading, the spread could have been measured in dollars.
I guess you don't quite understand how HFT works? The HFTer is the one offering to sell the shares for $50.00 on exchanges X, Y & Z. He's also offering to buy for $49.99. His goal is to sit there all day long trading with dumb money making 1 cent per share he transacts.
The HFTer has a problem though. If a big & smart trader comes along with proprietary knowledge that MSFT should really be trading for $50.10 he could take a big loss. If that HFTer buys everything up for $50.00 and then the price moves to far too fast that's bad.
So the HFTer works as hard as he can to detect when this might be happening so that he can update the prices he's offering. A really big signal this might be happening is when someone eats up his whole order book on one exchange all at once. So when that happens he trys to react as fast as possible to updates pricing on the other exchanges.
He's not injecting himself into transactions, he's trying to get out of the way as fast as possible.
The HFTer has a problem though. If a big & smart trader comes along with proprietary knowledge that MSFT should really be trading for $50.10 he could take a big loss. If that HFTer buys everything up for $50.00 and then the price moves to far too fast that's bad.
So the HFTer works as hard as he can to detect when this might be happening so that he can update the prices he's offering. A really big signal this might be happening is when someone eats up his whole order book on one exchange all at once. So when that happens he trys to react as fast as possible to updates pricing on the other exchanges.
He's not injecting himself into transactions, he's trying to get out of the way as fast as possible.
TGit least is closer to what is actually happening and is much less flawed.
I still take issue with your idea that the HFT is injecting itself into some preordained transaction. Information that there is a lot of demand for something should raise the price for that thing.
Large institutional buyers already have huge information/infrastructure advantages. Why should they also be given assn exemption from market dynamics that no one else received?
I still take issue with your idea that the HFT is injecting itself into some preordained transaction. Information that there is a lot of demand for something should raise the price for that thing.
Large institutional buyers already have huge information/infrastructure advantages. Why should they also be given assn exemption from market dynamics that no one else received?
Let me see if I follow:
What you're saying here is that an institutional investor wants to buy MSFT at a price that does not reflect their new demand for 100,000 shares. That order, absent some external force that will put downward pressure on the shares (which, if so, why buy now?) will naturally raise the price of MSFT for everyone in the market.
The investor, in other words, wants something for nothing: they want to trade at a price that doesn't reflect their demand, and for some other market participant to take the hit for selling below the true demand.
What you're saying here is that an institutional investor wants to buy MSFT at a price that does not reflect their new demand for 100,000 shares. That order, absent some external force that will put downward pressure on the shares (which, if so, why buy now?) will naturally raise the price of MSFT for everyone in the market.
The investor, in other words, wants something for nothing: they want to trade at a price that doesn't reflect their demand, and for some other market participant to take the hit for selling below the true demand.
Someone pulls into a gas station that says gas is 3.99 a gallon and expects to pay 3.99 a gallon to fill up his car.
Should the price increase to 4.00 as soon as he stops in front of the pump to 'reflect the new demand'?
Should the price increase to 4.00 as soon as he stops in front of the pump to 'reflect the new demand'?
Thus assuming that someone else will always pay the spread. Tragedy of the commons ensues.
But this whole article seems to be written for retail investors. And as much as HFTs may sound scary for retail traders they make their money off institutional trading. So the larger impact to retail flow is from the response Institutional desks are forced to take to ensure they are not disadvantaged by HFTs, which then affects how institutional and retail flows are able to interact.
Ultimately a 1000 APPL.US order will get filled and who pays the $0.01 spread is largely academic as it is an inconsequentially small part of the total settlement $ paid.
But this whole article seems to be written for retail investors. And as much as HFTs may sound scary for retail traders they make their money off institutional trading. So the larger impact to retail flow is from the response Institutional desks are forced to take to ensure they are not disadvantaged by HFTs, which then affects how institutional and retail flows are able to interact.
Ultimately a 1000 APPL.US order will get filled and who pays the $0.01 spread is largely academic as it is an inconsequentially small part of the total settlement $ paid.
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> It's well researched.
On what basis do you make that assertion? Just curious...
On what basis do you make that assertion? Just curious...
There is a 10,000 word excerpt in the NYT. Read it and if you have a specific comment or critique on methodology, come back and update this thread. They may or may not be useful comments. There's enough orthogonal variation in the approaches (in terms of data collection, observed reactions of market participants, and analytic consistentcy) to not dimsiss the narrative as "trivial". But YMMV.
So "Because it is on the NYT website" is your answer?
The excerpt from the book is largely the story from a single point of view, I don't see a lot of corroborating quotes, zero footnotes, and the facts are too convenient to the narrative to be the whole of the story.
Pulling one paragraph:
> As it happened, at almost exactly the moment Carlin Financial entered Brad Katsuyama’s life, the U.S. stock market began to behave oddly. Before RBC acquired this supposed state-of-the-art electronic-trading firm, Katsuyama’s computers worked as he expected them to. Suddenly they didn’t. It used to be that when his trading screens showed 10,000 shares of Intel offered at $22 a share, it meant that he could buy 10,000 shares of Intel for $22 a share. He had only to push a button. By the spring of 2007, however, when he pushed the button to complete a trade, the offers would vanish. In his seven years as a trader, he had always been able to look at the screens on his desk and see the stock market. Now the market as it appeared on his screens was an illusion.
His trading problems coincide with changing to a new technology platform and he blames the market and not the new software? Did anyone else experience a severe degredation in their trading performance? Did Lewis even ask anyone else?
The excerpt from the book is largely the story from a single point of view, I don't see a lot of corroborating quotes, zero footnotes, and the facts are too convenient to the narrative to be the whole of the story.
Pulling one paragraph:
> As it happened, at almost exactly the moment Carlin Financial entered Brad Katsuyama’s life, the U.S. stock market began to behave oddly. Before RBC acquired this supposed state-of-the-art electronic-trading firm, Katsuyama’s computers worked as he expected them to. Suddenly they didn’t. It used to be that when his trading screens showed 10,000 shares of Intel offered at $22 a share, it meant that he could buy 10,000 shares of Intel for $22 a share. He had only to push a button. By the spring of 2007, however, when he pushed the button to complete a trade, the offers would vanish. In his seven years as a trader, he had always been able to look at the screens on his desk and see the stock market. Now the market as it appeared on his screens was an illusion.
His trading problems coincide with changing to a new technology platform and he blames the market and not the new software? Did anyone else experience a severe degredation in their trading performance? Did Lewis even ask anyone else?
NYT isn't the author. Anyway, who would believe and RBC guy? That's why he went to SAC for a quick sanity check.
But as he talked to Wall Street investors, he came to realize that they were dealing with the same problem. He had a good friend who traded stocks at a big-time hedge fund in Stamford, Conn., called SAC Capital, which was famous (and soon to be infamous) for being one step ahead of the U.S. stock market. If anyone was going to know something about the market that Katsuyama didn’t know, he figured, it would be someone there. One spring morning, he took the train up to Stamford and spent the day watching his friend trade. Right away he saw that, even though his friend was using software supplied to him by Goldman Sachs and Morgan Stanley and the other big firms, he was experiencing exactly the same problem as RBC: He would hit a button to buy or sell a stock, and the market would move away from him. “When I see this guy trading, and he was getting screwed — I now see that it isn’t just me. My frustration is the market’s frustration. And I was like, ‘Whoa, this is serious.’ ”
This dispels (according to the story) the notion that it was a firm specific or SW specific issue. Of course you could assume this is fabricated (for convenience). But the next step is harder to fabricate:
He hired Rob Park, a gifted technologist, to explain to him what actually happened inside all these new Wall Street black boxes, and together they set out to assemble a team to investigate the U.S. stock market. Once he had a team in place, Katsuyama persuaded his superiors at RBC to conduct what amounted to a series of experiments. For the next several months, he and his people would trade stocks not to make money but to test theories. RBC agreed to let his team lose up to $10,000 a day to figure out why the market in any given stock vanished the moment RBC tried to trade in it. Katsuyama asked Park to come up with some theories.
This could easily be verified independent of Katsuyama (eg, by talking to either the other principals and/or 3rd parties as RBC management). What is important, however, it it is orthogonal to anecdote. And by putting capital at risk and testing ex-ante theories, not only are they getting on firmer epistemic grounds, but they are leaving paper trails internally and externally.
As they worked through the order types, the Puzzle Masters created a taxonomy of predatory behavior in the stock market. Broadly speaking, it appeared as if there were three activities that led to a vast amount of grotesquely unfair trading.
Of course you could object to this as "fabrication". But there is evidence that they tested SW products to defeat these various strategies. These products were later bought and then spun out and backed by third party customers & investors.
Again, this could all be fabricated. But you would need elaborate conspiracy theories to explain the lack of due dilligence by the investors (not to mention Lewis).
But as he talked to Wall Street investors, he came to realize that they were dealing with the same problem. He had a good friend who traded stocks at a big-time hedge fund in Stamford, Conn., called SAC Capital, which was famous (and soon to be infamous) for being one step ahead of the U.S. stock market. If anyone was going to know something about the market that Katsuyama didn’t know, he figured, it would be someone there. One spring morning, he took the train up to Stamford and spent the day watching his friend trade. Right away he saw that, even though his friend was using software supplied to him by Goldman Sachs and Morgan Stanley and the other big firms, he was experiencing exactly the same problem as RBC: He would hit a button to buy or sell a stock, and the market would move away from him. “When I see this guy trading, and he was getting screwed — I now see that it isn’t just me. My frustration is the market’s frustration. And I was like, ‘Whoa, this is serious.’ ”
This dispels (according to the story) the notion that it was a firm specific or SW specific issue. Of course you could assume this is fabricated (for convenience). But the next step is harder to fabricate:
He hired Rob Park, a gifted technologist, to explain to him what actually happened inside all these new Wall Street black boxes, and together they set out to assemble a team to investigate the U.S. stock market. Once he had a team in place, Katsuyama persuaded his superiors at RBC to conduct what amounted to a series of experiments. For the next several months, he and his people would trade stocks not to make money but to test theories. RBC agreed to let his team lose up to $10,000 a day to figure out why the market in any given stock vanished the moment RBC tried to trade in it. Katsuyama asked Park to come up with some theories.
This could easily be verified independent of Katsuyama (eg, by talking to either the other principals and/or 3rd parties as RBC management). What is important, however, it it is orthogonal to anecdote. And by putting capital at risk and testing ex-ante theories, not only are they getting on firmer epistemic grounds, but they are leaving paper trails internally and externally.
As they worked through the order types, the Puzzle Masters created a taxonomy of predatory behavior in the stock market. Broadly speaking, it appeared as if there were three activities that led to a vast amount of grotesquely unfair trading.
Of course you could object to this as "fabrication". But there is evidence that they tested SW products to defeat these various strategies. These products were later bought and then spun out and backed by third party customers & investors.
Again, this could all be fabricated. But you would need elaborate conspiracy theories to explain the lack of due dilligence by the investors (not to mention Lewis).
Nanex explains this stuff better than I will so I'm just going to link to their research (tl;dr summary of [1] below). I will accept not all HFT participants are obligated to follow any or all of these behaviours, but they are argued in defence of all HFT activity which is patently not true.
1. They Provide liquidity, false. Or at least works on a definition of liquidity that is not what would generally be used by other market participants (institutional or retail) - specifically see pinging or using orders to determine interest [2]
2. Tighten spreads, false. Attributable in the largest part to reg NMS not directly to HFT. Spread volatility has increased.
3. Lower costs, false. Cheap trading available via discount brokers before HFTs and additional costs to other market participants operating in HFT innundated environments are ignored.
4. Studies showing positive of HFT cherry pick and are of inconsequential detail, no conclusions should be drawn without deeper analysis of the data
5. Nannex guys just have an axe to grind repudiation
Plus ignores any other negative side effects of super-high speed trading such as stock specific flash crashes, data overload, and locked / crossed markets. Appreciate some of those can also be attributed to the proliferation of protected markets post Reg NMS.
[1] http://www.nanex.net/aqck2/4594.html [2] http://www.nanex.net/aqck2/4592.html (appearing to violate SEA 9.a.1.A)
1. They Provide liquidity, false. Or at least works on a definition of liquidity that is not what would generally be used by other market participants (institutional or retail) - specifically see pinging or using orders to determine interest [2]
2. Tighten spreads, false. Attributable in the largest part to reg NMS not directly to HFT. Spread volatility has increased.
3. Lower costs, false. Cheap trading available via discount brokers before HFTs and additional costs to other market participants operating in HFT innundated environments are ignored.
4. Studies showing positive of HFT cherry pick and are of inconsequential detail, no conclusions should be drawn without deeper analysis of the data
5. Nannex guys just have an axe to grind repudiation
Plus ignores any other negative side effects of super-high speed trading such as stock specific flash crashes, data overload, and locked / crossed markets. Appreciate some of those can also be attributed to the proliferation of protected markets post Reg NMS.
[1] http://www.nanex.net/aqck2/4594.html [2] http://www.nanex.net/aqck2/4592.html (appearing to violate SEA 9.a.1.A)
Dunno, I for one value the service HFTs provide. They're the reason that I, as a small investor, can unload 50,000 dollars worth of shares in a couple seconds.
Have you ever traded a stock market with low liquidity? You can have a market sell order sitting all day... I'd rather pay the small HFT toll, I still make plenty anyhow.
Have you ever traded a stock market with low liquidity? You can have a market sell order sitting all day... I'd rather pay the small HFT toll, I still make plenty anyhow.
HFTs aren't really helping your situation at all. Other forms of liquidity generators might be, but HFTs are exploiting microsecond-level arbitrage opportunities. I've never heard of a small investor with sub-second execution requirements. In fact, I'd be curious why you needed to execute 50,000 shares in a few seconds at all. From my perspective, I'd be thrilled if I could sell a few shares over several minutes as long as I were confident I was getting a good price.
That is a completely inaccurate generalization about what HFTs do. There is a class of HFT that does latency/venue arbitration but it is a very small niche.
The vast majority of HFT volume on the other hand is traditional market making. This HFT market making is much more efficient and fair than human market making was. It is driving down the bid/ask spread to the thinnest possible levels (at least the thinnest legal levels). This is the single biggest driver to you getting the best price.
Being a retail investor right now is the best it has ever been and HFT systems are a large reason why.
The vast majority of HFT volume on the other hand is traditional market making. This HFT market making is much more efficient and fair than human market making was. It is driving down the bid/ask spread to the thinnest possible levels (at least the thinnest legal levels). This is the single biggest driver to you getting the best price.
Being a retail investor right now is the best it has ever been and HFT systems are a large reason why.
Getting quick execution is nice. It's part of getting a good price - the price I want at the time. Retail investors would normally go to the back of the line, do you think human brokers and market makers are fair?
I execute fairly quick trading strategies, I hold a stock from a day to a week, being able to sell at the peak of an up day or unload shares when the market is just beginning to move against me, as opposed to minutes or hours later is everything.
And as another poster said, most of what HFT is, is market making... (Even traditional MMs made their money on arbitrage)
I execute fairly quick trading strategies, I hold a stock from a day to a week, being able to sell at the peak of an up day or unload shares when the market is just beginning to move against me, as opposed to minutes or hours later is everything.
And as another poster said, most of what HFT is, is market making... (Even traditional MMs made their money on arbitrage)
There is a lot of 'unless you're selling 100000 shares in a hurry you shouldn't care', but if an HFT 'rips off' a pension fund I very much do care- even if I'm not personally affected I'm sure the added cost will be passed on to the state somehow.
It's sad that I as a retail investor need to spend my valuable time focusing on how not to get screwed by the exchanges that have introduced a side business which does not serve the functioning of the market and instead corrupts it.
You don't actually need to focus on this. As a retail investor your going to get filled at NBBO (National Best Bid and Offer). The people writing things that make you think otherwise are selling irrational fear.
It's no different than how local news makes people think that crime in the US is at an all time high by reporting on it all the time when, in fact, crime has been dropping for decades.
Don't buy what the fear-mongers are selling.
It's no different than how local news makes people think that crime in the US is at an all time high by reporting on it all the time when, in fact, crime has been dropping for decades.
Don't buy what the fear-mongers are selling.
You still lose with Limit Orders. Here is how. I also propose how to actually not get ripped off.
The bid price is $100, the offer price is $101.
You want to buy, but you don't want to cross the spread.
You're worried the $101 isn't actually there - i.e. if you place an order to buy for $102, either the $101 order will get pulled by the HFT trader, or the HFT trader will buy the $101 order and sell it to you at $102.
The article suggests placing a limit order without crossing the spread. i.e. Put a limit order at $100.
So you put the limit order at $100. It sits there, and doesn't move.
10 minutes later, another company in the same industry announces below expected results due to market conditions. As this company is in the same industry, its stock price is negatively affected.
Before you have time to cancel your $100 limit order, the HFT trader has already parsed the negative news and short sold the stock all the way down to $99.5, taking your order with it, you're recorded to have sold at $100.
You lose either way.
The continuous limit order market is where HFT has a lot more edge than you do. You can try to avoid placing market orders that cross the spread, as well as avoid placing limit orders that linger for too long and get taken advantage of.
There's a call auction in the morning before the stock market opens every day. No market orders are allowed. Everyone places limit orders and everyone executes at one price. There is no spread to cross. As long as enough other investors participate in the same call auction, it'll be a lot more difficult for HFT traders to take advantage of your order. (Frequency doesn't even come into play since call auctions are discrete markets, not continuous - there is only 1 open price. This negates the HFT trader's speed advantage, since speed is rendered irrelevant)
Just regurgitating stuff I've learnt with finance at university.
The bid price is $100, the offer price is $101.
You want to buy, but you don't want to cross the spread.
You're worried the $101 isn't actually there - i.e. if you place an order to buy for $102, either the $101 order will get pulled by the HFT trader, or the HFT trader will buy the $101 order and sell it to you at $102.
The article suggests placing a limit order without crossing the spread. i.e. Put a limit order at $100.
So you put the limit order at $100. It sits there, and doesn't move.
10 minutes later, another company in the same industry announces below expected results due to market conditions. As this company is in the same industry, its stock price is negatively affected.
Before you have time to cancel your $100 limit order, the HFT trader has already parsed the negative news and short sold the stock all the way down to $99.5, taking your order with it, you're recorded to have sold at $100.
You lose either way.
The continuous limit order market is where HFT has a lot more edge than you do. You can try to avoid placing market orders that cross the spread, as well as avoid placing limit orders that linger for too long and get taken advantage of.
There's a call auction in the morning before the stock market opens every day. No market orders are allowed. Everyone places limit orders and everyone executes at one price. There is no spread to cross. As long as enough other investors participate in the same call auction, it'll be a lot more difficult for HFT traders to take advantage of your order. (Frequency doesn't even come into play since call auctions are discrete markets, not continuous - there is only 1 open price. This negates the HFT trader's speed advantage, since speed is rendered irrelevant)
Just regurgitating stuff I've learnt with finance at university.
You're worried the $101 isn't actually there - i.e. if you place an order to buy for $102, either the $101 order will get pulled by the HFT trader, or the HFT trader will buy the $101 order and sell it to you at $102.
If there is a sell order @ 101 and you place a buy @ 102, the exchange will instantaneously match the orders. The exchange will then inform the HFT and you (simultaneously) that a trade occurred.
I repeatedly linked to an HFT tutorial which explains this. Please read it.
If there is a sell order @ 101 and you place a buy @ 102, the exchange will instantaneously match the orders. The exchange will then inform the HFT and you (simultaneously) that a trade occurred.
I repeatedly linked to an HFT tutorial which explains this. Please read it.
I've posted a response on your blog.
In your example, you did not get ripped off by a HFT, you priced your order incorrectly and lost money. That is the nature of investing and has nothing to do with HFT.
Further, what Chris mentions in the article is not a simple limit order, it is a specific order type (ALO) that will not pay the bid ask spread regardless of how slowly it arrives on the market. If you don't want to pay up for liquidity, this order type will do exactly that.
As for the call auction, it provides a similar functionality but worse price discovery. The prices are more acurrate through the day because it is continuous. You as an investor can decide if paying a more incorrect price is better or worse than paying for liquidity, but in neither case is it an HFT ripping you off. That said, HFT systems do participate in the open auctions...
Further, what Chris mentions in the article is not a simple limit order, it is a specific order type (ALO) that will not pay the bid ask spread regardless of how slowly it arrives on the market. If you don't want to pay up for liquidity, this order type will do exactly that.
As for the call auction, it provides a similar functionality but worse price discovery. The prices are more acurrate through the day because it is continuous. You as an investor can decide if paying a more incorrect price is better or worse than paying for liquidity, but in neither case is it an HFT ripping you off. That said, HFT systems do participate in the open auctions...
It says the ALO order does not transact with passive liquidity orders, but the point is new information coming through after you've placed your limit order can be taken advantage of by market orders sent by HFT.
I suggested Call Auction because it's a good way to avoid paying the spread, and also avoid execution risk, both at the same time. Yes, the final execution price may be made of limit orders that did not take new information into account, but the ALO order you place into the market will get stale too unless you continuous adjust it, and even if you do, the slow reaction of you and your web browser will be no match for NLP bots scanning the news.
I made a bad booboo with the "You're worried the $101 isn't actually there - i.e. if you place an order to buy for $102, either the $101 order will get pulled by the HFT trader, or the HFT trader will buy the $101 order and sell it to you at $102.", looks like I got confused by the CNBC video I watched the other day. But see the other comment why you might make a limit order will a better price than the best offer.
I suggested Call Auction because it's a good way to avoid paying the spread, and also avoid execution risk, both at the same time. Yes, the final execution price may be made of limit orders that did not take new information into account, but the ALO order you place into the market will get stale too unless you continuous adjust it, and even if you do, the slow reaction of you and your web browser will be no match for NLP bots scanning the news.
I made a bad booboo with the "You're worried the $101 isn't actually there - i.e. if you place an order to buy for $102, either the $101 order will get pulled by the HFT trader, or the HFT trader will buy the $101 order and sell it to you at $102.", looks like I got confused by the CNBC video I watched the other day. But see the other comment why you might make a limit order will a better price than the best offer.
Right. There are lots of execution strategies out there that let you choose between paying for priority and accurate pricing. The auction is one, as are stops. My instinct is that as a retail you are almost always better off buying the incredibly cheap liquidity that exists in the current market. I can't prove that though.
Your example doesn't make sense to me. Why would you place an order to buy for $102 if there is an offer for $101 ?
Prices move, so traders add a bit of leeway if they want to be sure the trade will execute. The worry with HFT is that the price will move solely in order to screw over this particular trade, rather than as a reflection of overall market conditions.
Just because there was an offer for $101 when I decided I want to buy, doesn't mean there will be an offer for $101 by the time I get around to placing my order.
It is important to recognize that under Reg NMS the market making firm must fill you at the prevailing market price (the NBBO). While they technically could sweep the market to move the market price before filling, this almost never happens for a retail order since they are so small.
For this reason, the whole discussion around HFT "front-running" isn't very topical to the retail investor buying individual stocks and it barely affects the cost of execution of funds ($0.43 per $10,000 notional value traded according to [1])
In summary, the people fanning this flame are not trying to protect retail investors... If they were, they would focus on the larger scams on the street (exhorbitant management fees for actively managed funds, for example)
[1] http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1928510