The argument usually goes like this: HFT firms provide liquidity for the market; they are usually the people on the other side of the trade when a retail investor buys stock/bonds/etc. So without the HFT firms, you wouldn't be able to trade at a good/fair price according to market conditions. Furthermore, if you buy stock from NASDAQ or NYSE or London stock exchange, you should get the same price. This idea that you should pay the same price for an asset regardless of where you buy it is enforced by HFT firms, as outlined in the article. Clearly, HFT firms need to get paid for this service, so retail investors typically pay the bid/ask spread.
I get the argument, but it feels like the societal benefit is taken away whenever it is needed, and paid for only when it isn't needed.
If I had a way of knowing when the market would have low volatility, I'd throw away the shares and become a billionaire trading options.
Saying you should wait for low volatility before trading is equivalent to saying you should wait until the price is high before selling. Both statements seem to reflect common sense but neither piece of advice can be translated into an actual strategy.
The impact of HFT market making isn't that difficult to observe - all markets which have attracted such participants have seen huge falls in spreads. The spread is a tax on everyone who buys and sells in the market so lower spreads are good for everyone. (For example the cost of buying and selling a DAX future before fees was about 70 euro just 15 years ago while the spread is now typically less than a euro.)
No, because liquidity is also about tighter spreads. Since the spread is effectively a transaction fee paid to buy or sell on exchanges, shrinking it is beneficial to most market participants.
It's kind of weird that people have such strong opinions about things they know very little about.
By the way, since the tremendous inflow of cash into index ETF, some stocks are bascially traded only by ETFs and HTF without many other market participants. I mean, what could possibly go wrong?
https://www.zerohedge.com/news/2017-04-09/horseman-global-un...
For most securities, there are very few natural buyers and sellers of a security, so they would find it very hard to transact without an intermediary market maker.
All electronic market makers are HFTers compared to regular market participants, but they run a very diverse set of strategies, with some operating at much closer to human speeds when compared to the fastest of the bunch.
Market makers provide better price and execution than traditional human market makers, and are a net positive to the market ecosystem, at least in regards to retail investors (the institional traders do sometimes get fucked).
When I looked up the stock, (I think the stock was very expensive), trading volume was like 1 Share every 6 months or so. Yes, I guess you could call this "very low" trading volume. So where would HTF come in here?
Strategies that had less efficacy at $100mm position sizes now can scale to $10bn position sizes.
I like the growth of liquidity.
This is categorically not what HFT firms are doing.
Two people on a hike see an obviously hungry mountain lion in the distance running towards them. One of them quickly starts changing his hiking shoes to running shoes; to which the other responds “do you really think these shoes will let you outrun the mountain lion?” To which the first responds: “I don’t need to outrun the mountain lion, I only need to outrun you”
Whether it’s 1ms or 1s makes no difference; for a class of strategies, any time advantage can tilt the average from “unprofitable” to “profitable” when you are faster than others - and the sums changing hands are huge (trillions notional or even thousands of trillions per day). A tiny advantage easily translates into a lot of money.
This process goes on, and on, and on. It’s why capitalism is so effective as an economic system. And also the reason why things that may not seem like they produce value actually produce extraordinary value for society.
For example: Consider a job going to the office to write on pieces of paper and then throw those pieces of paper into the incinerator so nobody will ever read what was written.
Sounds pointless. Is it "providing value"?
By your argument yes: All those people were paid and can now support their families. The paper makers made paper and advanced the state of the art in fine paper-making, as did the pen makers and the ink makers. The incinerator is looked after, and it keeps new incinerator designers in work. All the fuel which is mined to run the incinerator keeps miners busy. All the commuting to the office and back keeps train operators busy.
And yet, going to the office to write things on paper and then destroy them repeatedly does seem rather pointless.
Therefore, Markets don't need HFT firms to provide this service, they simply coopted a friendly-sounding rationale in an attempt to dismiss skeptics.
I see this situation to be very similar to the reason why the Bitcoin network burns hundreds of MWh of power per day. They do this because it is the only way to ensure everyone adheres to the market rules that were collectively declared as "fair".
Bitcoins' fairness rules work by incentivizing an arms race of who can compute hashes faster. The "conventional" stock/bond/futures markets ensure fairness by resorting to time an order was placed as the ultimate arbiter when it comes to whose orders are filled first. In both cases, there is a physics-related element that cannot be cheated by any one market participant, because nobody can transfer information faster than light and nobody can produce power out of the void.
The end product of this is "fairness" - which is extremely valuable, because without a reliable ledger, bitcoins would have no value, and without the ultimate judge of time at the stock market, there would be no stock market, because nobody would trade at a market where a specific participant could just backdate his orders.
Of course the "fairness" is not directly a product of the 300m$ investment for that ultra fast data connection. Nor is it directly a product of the MWh of power burnt for bitcoin blockchain hashes. But these two things are direct outcomes of the rules that effectively produce the fairness we want, and without accepting that we get these outcomes, these rules would not function and would not be accepted, which would void them, because they can only produce the desired "fairness" product as long as they are accepted by the market participants. Hence I consider "fairness" to be an indirect product of these two effects - and all similarly-categorized effects that don't directly seem to serve any purpose except for being actions in some kind of arms race between market participants.
One could also replace "fairness" with "trust", if that's more to your liking. The concept is the important thing, not what the product is named.
But again, those benefits are self-referential: Fairness rules for Bitcoin serve Bitcoin and fairness rules for stock exchanges serve stock exchanges. Would the wider world be very much worse off if we had no Bitcoin or stock exchanges?
> without the ultimate judge of time at the stock market, there would be no stock market
I'm also not sure about that. Yes, in principle, time is a good arbiter - however the descision to follow that rule down to microsecond precision seems like a deliberate choice to allow HFT. The article mentions front running as an attack on the trading system that would occur with inaccurate timekeeping. However, seems to me this could be circumvented: e.g., if an exchange wanted to ensure fairness but also prevent HFT (and the associated technology arms race), they could bucket orders by e.g. second resolution and then execute the orders in a bucket in random ordering. This will give predictable ordering at second resolution but would make front-running or racing impossible as the sub-second ordering would be unpredictable.
For Bitcoin? Not much. Probably we'd be better off, especially with regard to our climate. I can't see enough benefit across our entire society to offset the significant damages produced by burning all this energy into heat.
For stock exchanges? Oh yes, definitely. There's a huge bunch of research into the role of stock exchanges (and goods and futures exchanges as well, they work in a very similar way) in facilitating efficient trading of everything, from ownerships in corporations to goods and services. And there's definitely some undeniable truth to the argument that it is a good thing to have efficient trading of goods and services which is necessary for efficient production of stuff which in turn is necessary to fill our plates with food to eat, fill our medicine cabinets with antidotes to various ailments and so on and so on.
In that case I as a broker who knows that one of my clients has just channeled a big, market-moving buy order of some stock through me to the exchange would simply inject a few hundred of smaller orders that buy the same stock, but with a low limit price that's slightly above the current price, but likely below the price the stock will be traded at after the big buy order has been executed. Statistically I will then get half of my orders executed before the big one hits, the other half of them will be ignored because the limit has been exceeded, which results in a nice, nearly risk-free profit for me. I could even try to put some sell orders in there with a sell limit slightly above the estimated price after execution of the big order in an attempt to sell the same stock that I just bought in the same batch that I got them.
Similar stuff can also be done without direct knowledge about some big order coming through, but just on the assumption of such orders being placed into the market by various participants due to external events. The game just moves from being one in which everyone tries to beat the clock into one in which everyone tries to predict the orders in the next "execution batch" and how to best generate your own orders to profit from that. Since that's still a race against time (there's a limited window of time in which you need to get your orders in) the entire aspect of getting your orders to the exchange quickly is still relevant, hence there will still be massive investments into that. It's just that in such a case, you add another aspect into which people can invest massively: compute power to perform as many statistical simulations of the next execution batches' contents as possible in as little time as possible. I guess such statistical prediction stuff is already being done by HFTs today, but due to there being no clearly delimited time window granted to the HFTs that would be large enough to do very complex simulations, I guess this complex statistical modeling is done on larger timescales, like to devise trading strategies over weeks, months or years, and the modeling that produces the orders that quickly react to sudden market events is probably pretty simple because it must be absurdly fast, producing results in microseconds.
So what you would get is something very much like the Bitcoin blockchain hash race, just not for something as trivial as hashes, but for the best possible advance simulation of the next "order block". Doesn't matter in the end, though, because both are embarrassingly parallel problems and thus can and will easily be blown up to consume as much energy and hardware as you can provide. The one thing that prevents this from happening in our current trading system is the continuity of the timescale - which is exactly what you'd like to eliminate!
While it may seem like any improvements to price-time reactivity would be negligible compared to the 300mm investment, these things are simply too difficult to measure in a complex system like a global economy where any change can result in a butterfly effect. Over many years, more reactive prices could prevent arbitrageurs (who perform a critical service) from making less efficient trades. In fact, the firm who commissioned the new line is likely doing arbitrage, which is one of the key services that allows us to have a globalized economy with relatively stable prices.
If you truly want to put in the work to understand how markets work, I'd recommend running a simple forex arbitrage bot with a trivial amount of money (there are plenty of open source options that are straightforward to set up and won't make or lose you much money) to see hands on. Also, check out Matt Levine's newsletters.
But what about overall, total value to society, the economy, over the long term, not just to the few companies who won a bid.
If I just opened a new window factory, I'd absolutely be interested in as many windows breaking as possible, so I can sell more products. It would make a lot more economic sense for me to produce cheap, thin windows: I need less raw material to produce them and they will break more easily, giving me more opportunity to sell replacements.
I'm going to provide a totally contrarian viewpoint as an engineer previously employed by Wall Street -- the difference to the alternatives is simple -- one exists and the other is theoretical.
The difference is is that Wall Street pays actual paychecks to engineers to do these things. Meanwhile, as much as i'd love to work for a better railroad company or what not, I did not find any engineering jobs there (computer science and statistics in my case.) Jobs and paychecks is how I am able to make car payments and pay for my daughter's bicycle.
To continue the thought, if you really do feel dam and flood control infra is a better thing to spend money on (i feel this way), HN isnt really the place:
0. Be like Elon and start your own railroad and dam company
1. Invest your own money into a dam and infra startup
2. Lobby your senator and representative to put money into infra
Speaking down the folks who are actually giving engineers paychecks is not a great thing IMHO when there arent all that many alternatives. Same sentiment from most of my former colleagues with Physics PhDs on Wall St. Yeah, it sucks, but tell me that once you can land me a tenure track teaching position. Until then, let me eat.
Think of it instead like parcel deliveries. It should be plainly clear that delivering a package in two days is more valuable than delivering a package in a week, that delivering a package overnight even moreso. Oftentimes, an item is only valuable if we receive it as soon as possible - if we had to wait a month to receive a package, the whole arrangement might not have been worth it in the first place.
Furthermore, it is also plainly clear that delivery is worth more for more valuable items. This is typically communicated in the price of insuring a shipment, but plain common sense explains why people are willing to pay hundreds of dollars in delivery charges for automobiles but not for a box of tissues.
If you understand that logistics is valuable, that speed makes logistics more valuable, and that logistics is made more valuable by the value of the goods transported by it, then it really should not be such a stretch of the imagination to understand how the logistics of capital plays by exactly the same rules; it is only a question of degree and scale.
How do you know that advertising provides more value than it takes away?
You decided to understand tangible goods and decided not to understand ephemeral goods.
The value is no less real and the distinction is arbitrary.
The only thing happening here is an uncomfortable relationship with people making money and having complete discretion to acquire more goods and services with that money than others.
HFT has no more or less arbitrary value or merit than any ephemeral software business that you might happen to respect. SaaS, ad tech, data brokering, YC cash burning darling, etc.
Trying to rationalize its utility (“is it providing liquidity or just front running”) is just as much of a red herring.
Its just a business.
If I understand your comment correctly then your answer is essentially: it provide no value to society, but few other businesses do either.
To which I largely agree, and is the reason why myself and OP are left frustrated that society spends billions on things to improve arbitrary efficiencies while disregarding the well being of millions of people.
That’s correct, this one happens to be more lucrative and scalable (revenue increases with capital size, overhead costs are logn) when it works.
Regarding a communication network that alters the terrain for the benefit of very few people, I can see that being frustrating. The business model typically does turn into licensing of the data route and others can benefit.
Better price discovery generates some amount of 'real value', though.
Whether or not this particular investment generated 300 million dollars worth of real value is... A bit up in the air.
Lets compare to alternatives like dam and flood control infrastructure, better roads, rail, etc. I understand the real pragmatic benefits and return on investment from these. A farm field is irrigated, a home not destroyed, less fuel used in trucking, on and on. These investments generate real value because they increase the total of societal output, not just that particular factions slice of the pie. Meaning, you are finding new gold to mine, not just taking over part of your neighbors gold mine and saying you are adding value. Its not adding value to the overall economy.
Please help me, what real value does an investment like this yield for the economy as a whole? As i understand it an investment like taking part of your neighbors gold mine, not mining new ground.
Effectively they have increased their slice of the pie, in this case it is time not land, but not made the overall pie bigger.
It is interesting to think about things this way, in terms of investments that increase the carrying capacity of our economy, and those that don't.
Advertising comes to mind. The cola wars, while expensive, dont yield a net increase in cola drinking, just a relative difference between the brands. Same with beer, on and on.