HFTs demonstrably are liquidity providers. That's a technical term with a real meaning: liquidity is the ability to trade when you want to trade in the quantity you want to trade it, and it most certainly is not a natural property of the market; in order to buy an instrument, someone has to be willing to sell it.
Meanwhile, what is a "giant money sink", and how is that what HFTs are? I see how HFTs cut out the middlemen who used to profit from volatility, but the low-tech traders they replaced were not themselves value investors.
And formal market makers accept an obligation to stay in the market and provide full-time liquidity in return for their profits. I have to question the value of displacing and de-funding them in favor of HFTs who can walk away at the worst moment (as when they exacerbated the flash crash).
If there are n people in the market moving money around in a closed system then the combined wealth of those n people is constant.
If another person joins in and is making a net profit then it must be the case that the combined wealth of the original n is decreasing.
Admittedly this relies on money not being created or destroyed, which may cause the model to be a poor approximation of reality.
> Admittedly this relies on money not being created or destroyed, which may cause the model to be a poor approximation of reality.
What investment markets provide is a way for firms to increase their productivity. Think of the farmer who has a bucket, a stream, and an acre of land. The economic pie gets a lot bigger if the farmer can secure an irrigation system.
The farmer can solicit the banker in town for a loan, or he can enter a debt offering into large market or exchange. Investors are more likely to invest if they know that they can exit their investment freely. i.e. there is liquidity, so they can sell their investment as their own needs dictate.
You can argue that getting equity pricing right helps companies with their access to capital, but once you have the pricing right at 100ms I don't understand what value HFT firms are adding by pouring money and talent into getting the pricing right at 10ns.
It seems like such an obvious win for society to mitigate the winner-take-all incentive of being first to market on a pricing disparity.
What's the win to society to "mitigate" an "incentive"? Is the problem volatility? Other forces create huge volatility. Should we penalize anything that creates volatility? Maybe we should end all program trading?
Meanwhile, you're effectively vouching for a comment that models the markets as a closed system of people dividing up a single pot of money. Isn't it plain that such a model is wrongheaded?
The main incentive is reducing time and energy devoted to a zero sum game.
A hypothetical: imagine a sunken pirate ship is discovered. Now suppose 10 crews of divers get into a race to retrieve the pirate gold. It's useful to society to bring up the gold. It might be useful to society to have a race between 2 crews to bring up the gold, to make sure the first crew doesn't dilly dally. The gain to society is $GOLD - 2 x $DIVER_COST, or perhaps $GOLD_AFTER_LONG_DELAY - 1 x $DIVER_COST. On the other hand, having 10 crews of divers all competing for the gold is pointless - the gain to society is $GOLD - 10 x $DIVER_COST, which is 8 x $DIVER_COST less than if 2 diver crews chased the gold.
HFT is basically the same situation as the race for pirate gold - a lot of smart people in a race to create a fixed amount of alpha. We might be better off if they were creating new alpha elsewhere instead of all simultaneously chasing after the same alpha.
(That's not to say I'm advocating a ban on HFT on this ground. A certain amount of effort devoted to HFT is certainly a good thing, and I doubt the government would get things right. I just don't think the market is getting things perfect either.)
What I see are a lot of people arguing that the HFTs are getting an unfair edge on other traders, as if some main street stock picker was actually in competition with an HFT prop trading shop.
My sense of it is that many of the people making this arguments believe that were it not for HFT's, people would have frictionless access to a real efficient price for any instrument they wanted to buy, when in fact they'd just be dealing with a much clunkier and less reliable set of middlemen.
As I said, a certain amount of HFT is a good thing. If I thought it was harmful, I'd quit my job as an HFT programmer and find something else [1]. I'm just pointing out that there are costs, which don't necessarily outweigh the benefits after a certain point.
[1] This was a major reason why I quit my job as a postdoc, rather than trying to become a professor. I believe college is mostly rent seeking and I don't feel it's right to participate in that.
Here are my opinions from when I was an academic (I've only been working in HFT since March 2010, full time since May 2010):
My opinion from 347 days ago: universities have vastly more problems than that. They are huge bloated organizations structured around funneling money to employees (from both students and the government) rather than educating students. The main reason people still go is for status signaling purposes, otherwise they would have been replaced long ago.
http://news.ycombinator.com/item?id=1087281
From 406 days ago: a $10 million grant; my university will take about $5 million off the top in "overhead" (to be spent on overpaid administrators, student stress counselors, the latino student center, and maybe even education).
http://news.ycombinator.com/item?id=969664
(This was roughly the period when I decided to leave academia.)
From 469 days ago: The job description of "professor" is certainly a strange beast: teacher/scientist. It makes about as much sense as actor/programmer...The perverse incentives this creates are massive. Universities hire scientists rather than teachers in order to get their hands on half the scientist's grants. Scientists waste their time masquerading as teachers... This is harmful both to science (I'm not doing research in class) and students...Actual teachers are squeezed out, since there is no room for them.
http://news.ycombinator.com/item?id=851218
From 999 days ago: Another part of the problem is that there is no incentive for cost control in the university...I'm currently teaching a "Quantitative Reasoning" class right now. Basically, take Weeks 1-2 of Prob&Stat and expand it to fill a whole semester (half a semester, due to poor planning and miscommunication). Some of this is my fault, some of it not...Plus, my students are all art/history/literature majors, and just don't need it. Everyone in the room would be better off keeping their $4,000 and not sitting through my class.
That's slippery slope logic. If the pricing is right at
1s, why pour money and talent into getting it right at
100ms?
Meanwhile, you're effectively vouching for a comment
that models the markets as a closed system of people
dividing up a single pot of money. Isn't it plain that
such a model is wrongheaded?
[1] http://economics.fundamentalfinance.com/negative-externality...
Actually, trading can and does increase the total value of the system. If I own $100 of Intel stock and you own $100 of AMD stock, exchanging half of our stock (so that we each own $50 of Intel and $50 of AMD) leaves us both better off, since we each have less risk.
One current big controversy among economists is whether the HFTs themselves have an effect on volatility (there are studies claiming all of "increases", "decreases", and "have little effect", but the evidence for any of those conclusions is weak, and it depends on exactly how you define volatility). A liquidity provider who provided added liquidity on very short time scales, but at the expense of increased volatility at longer time scales, wouldn't necessarily be advantageous for longer-term market participants. That'd be essentially trading one kind of noise for another one--- less millisecond variation, and more occasional giant aberrations, if indeed things like the May '10 "flash crash" were caused by HFTs.
From the report's punchline:
The combined selling pressure from the Sell Algorithm, HFTs and other traders drove the price of the E-Mini down approximately 3% in just four minutes from the beginning of 2:41 p.m. through the end of 2:44 p.m. ... HFTs began to quickly buy and then resell contracts to each other – generating a “hot-potato” volume effect as the same positions were rapidly passed back and forth. Between 2:45:13 and 2:45:27, HFTs traded over 27,000 contracts, which accounted for about 49 percent of the total trading volume, while buying only about 200 additional contracts net.
HFTs don't like to hold stuff at the end of the day. Or hour, nay second. Further, HFTs that stayed in (some were obligated by their market-maker contracts with major exchanges to do so) helped the recovery back up.
It will be interesting to see if this market provides better pricing for non-HFT participants.
Given that the only difference between this and a normal market is that a bunch of people offering to buy and/or sell at prices more favorable than the current inside bid/ask are banned from the market, I'm going to go out on a limb and say that no, it won't help pricing very much.
Or, rather, what it will do is move profits that would have gone to the HFT firms and shift them to people placing normal, non-speculative/exploitative/high-frequency limit orders.
Which means that really, there will be an arms race to figure out how to place orders that are as exploitative as possible without tripping the banhammer. The people that push the closest that limit will make the most money, but spreads will still likely be quite a bit higher than in an unfettered market if the rules have any teeth at all - long term value traders are not good at keeping spreads thin, I'd guess that in the current markets their effects on spreads are not even measurable at all, they are so insignificant...
Given that the only difference between this and a normal
market is that a bunch of people offering to buy and/or
sell at prices more favorable than the current inside
bid/ask are banned from the market, I'm going to go out
on a limb and say that no, it won't help pricing very
much.
Since trading on Light Pool will be more expensive and
slower for those firms, they’re not likely to use the
ECN, reducing the negative selection investors
experience, Galinov said.
Contributors, which will include long-term investors,
will receive a “significant” rebate when they trade
against orders resting in Light Pool, while neutral
firms, or those whose behavior falls between the other
groups, may or may not get one, Galinov said.
http://ai.eecs.umich.edu/people/wellman/?p=40
Article: "Firms that fail to meet standards aimed at protecting long- term investors won’t be allowed directly on the Credit Suisse venue"
So it's both: They are outright banning AND adjusting incentives.
Opportunistic firms, which Galinov says include some high- frequency trading companies, will be kicked off the platform and prevented from providing orders or executing against bids and offers directly through Light Pool. They’ll instead have to go through the Jersey City, New Jersey-based National Stock Exchange, where Light Pool will also publish its quotes.
so they can participate, but they get penalized.
It will be interesting to see if this market provides better pricing for non-HFT participants.
The HFT outfits claim they net out to better pricing for all ("liquidity benefits"), but that's somewhat hard to swallow given that they're acting as giant money sinks on the market system.