Re:Insights into High Frequency Trading from the Virtu IPO [...
by consz on Thursday May 04, 2017 @07:54PM
(#14269973)
HFT firms make money by having sufficiently more accurate predictions of the future price than those they trade against -- here, for prediction, you can take any reasonable metric, such as the change in price in the next 10 seconds. Note that this can be done by simply being faster, as having the same prediction in 400ns that took everyone else 2000ns to discover is still having better predictions.
HFT firms typically have anywhere from little to very, very little trading risk, so long as the above conditions hold. Their actual risks are operational (How Knight blew up) or the above situation no longer holding (How Getco, Teza, etc. died).
Also, one thing I have to mention in your post -- stock exchanges were not the market makers of the past. That role was played by someone called a specialist; you can think of them as doing exactly what an HFT market maker does these days, except far, far dumber and far, far slower. Those people were typically (always?) not employed by the exchange. An exchange is simply a centralized place to display orders, not a counterparty that you trade against.
Re:Insights into High Frequency Trading from the Virtu IPO [...
by tptacek on Thursday May 04, 2017 @08:45PM
(#14270276)
They're minimizing their market risk, but the trick is doing that while making payroll. You can trade practically risklessly by quoting an unrealistically wide spread. Practically no one will trade with you, but none of your orders will sink the company.
My thinking, and why I found it interesting, is that the connotation behind showing that the company 'never has a losing day' because of the law of large numbers is that the company is taking practically no risk. I was trying to ask a question about that point; do these companies really have no risk? Are they basically printing money?
I am sure the answer is no, because no company has zero risk. I want to know where the risk is, and I figured the answer to that question is answered by answering the 'how do they make money on 51% of their trades' question.
That might not be the right question, but I don't think my question was equivalent to asking 'how do MARKET MAKERS make money on every trade', because traditional market makers (i.e. the stock exchanges) are not the same as HFTs. A stock exchange has inertia on its side to protect their profits; a competitor has to fight against the network effect to take them on. An HFT has none of that protection.