Are you under the impression that you're assigning homework to students? This comes off as really rude.
And no, I'm not going to write up a treatise on HFT for you. I don't pretend that this is an area of expertise for me. FTA:
Most HFTs run a market making strategy. What this means is they play both sides of the table - they take no position on whether a stock will go up or down. Instead, they try to offer securities both to buy and sell. If you want to buy, they will sell to you at $20.10. If you want to sell, they’ll buy from you at $20. As long as their buys and sells match don’t get too out of whack, the HFT will collect $0.10 = $20.10 - 20.00.
What is that if not "scraping pennies"? The entire goal is to jump between a buy and sell in order to skim a bit from the transaction.
e.g. Alice wants to sell at $10.00. Bob wants to buy at $10.05. They could simply trade with each other, but if Eve gets her way, Eve will buy from Alice at $10.00, and then sell to Bob for $10.05, making $0.05 on each share that would otherwise have gone to Alice.
Engaging in this is not evil, but I fail to see how it benefits anyone else.
> and why this strategy doesn't benefit the speculators the HFT is trading with?
Because when a HFT makes money, other parties involved make a little bit less. HFTs don't print money. They extract it from the market.
Also, because stock markets are not exclusively limited to speculators and HFTs.
I'm asking for an explanation that goes beyond "they make money, and I don't understand how, they must be ripping people off!"
e.g. Alice wants to sell at $10.00. Bob wants to buy at $10.05. They could simply trade with each other, but if Eve gets her way, Eve will buy from Alice at $10.00, and then sell to Bob for $10.05, making $0.05 on each share that would otherwise have gone to Alice
What's missing from your explanation is time. If you actually wrote out a specific explanation involving limit orders (like I suggested), you would immediately have seen that.
If Alice wanted to sell at $10.00 and Bob wanted to buy at $10.05, they would have already traded. The millisecond Bob's order hit the market, he would have filled Alice's order (or she would have filled his, depending on which was bigger). Eve never had any ability to participate.
If Eve played any role, there was a time delay. At 12:20, Eve put an order BUY(price=$10.00, quantity=100, time=12:20) onto the market. Alice chose to sell to her at 12:30 because she wanted to trade immediately, with no risk of her order being unfilled. After buying her stocks, Eve turned around and placed a SELL(price=$10.05, quantity=100, time=12:30:01) order. At 12:40, Bob comes along and places an order BUY($10.05, quantity=100, time=12:40), which is filled by Eve's order.
If Alice wanted to hold out for $10.05 she could have. She chose not to, because she didn't want to run the risk of Bob never showing up. Eve didn't "scrape pennies" from Alice and Bob, Alice paid her $0.05 to take the risk of Bob never showing up.
Real world investment doesn't work on a millisecond basis. It doesn't even work on a per-minute basis - at best, it works on a daily basis.
So if we were talking about how the financial markets benefit the real economy, we would say that Alice wants to sell at price X on Tuesday, and Bob wants to buy at price Y on Tuesday. And in that case, the go-between is unnecessary.
Nobody in the real economy needs instant order fulfillment when even regular bank transfers take a day to clear.
I get that more frequent dealings can help with finding "right" prices. It certainly reduces the spread. The problem is that HFT makes market access unequal.
You claim that Alice could have held out for $10.05 if she had wanted to. This is incorrect. Alice most likely does not have the infrastructure in place, and the fixed costs would be far too high for her to participate in that game. So in fact Eve did not provide any kind of useful service to Alice. Eve exploited unequal access to the market for her personal gain.
From a libertarian perspective you may say that's fine, granted. But the argument that Eve provided a service to the real economy is not as clear as you make it seem.
So there is a tradeoff there. HFT reduces spreads and perhaps helps price finding. However, for most market participants form the real economy, intra-day fluctuations dominate the spreads by orders of magnitude anyway, so reducing the spread isn't even that much of a useful service to the real economy - at least not to the extent it happens today. On the other hand, HFT makes access to the market unequal, limiting market competition.
It seems unlikely to me that the current situation is a proper balance within this tradeoff.
The need to trade instantly is very important for risk mitigation. If unexpected news comes out today that a company is the target of an adverse event like a DOJ lawsuit many market participants will want to react as fast as possible to the news. Say it takes 30 seconds for the price to fall by $10. If you could trade at the 15 second mark you would only lose $5. To an investment firm (non Market Maker or other HFT) this can be crucially important and many firms have automated systems of their own to trade.
A key point of the article that most people miss is that someone has always fulfilled the role that HFTs currently occupy. In the old days floor traders occupied this role as pointed out by the article. Floor trading was a club where you had to buy a seat to be allowed in. Depending on the market the cost of the seat might be hundreds of thousands of dollars. The traders controlled access to the markets and for some markets like Oil the only way to trade was through these floor traders. Now these floor traders took full advantage of this and kept the spreads on the instruments they traded much wider than they are today. In the early 90s you could easily pay $.20 per share to the market maker to get a fill on a liquid stock.
The realization (as pointed out by the article) that computers could do this better and faster is just like any other industry. The people most hurt by this development were the floor traders themselves. There is a movie called The Pit that explores the effect that computerized trading had on floor traders in Chicago. Today if I want to trade MSFT the spread on BATS's BZX exchange was just $0.01. To me, another market participant I consider it to be much better to pay a penny to Getco rather than $.20 to a floor trader.
The colocation business as it has evolved has made market access more equal, not less. Today anyone can pay to colocate a server at NASDAQ, NYSE, BATS, etc... I know longer have to buy a floor seat to be able to trade there. Now there are real market barriers to entry but they are not structural. Just as you can't go build a Google competitor given that you don't have all the historical search traffic data and the infrastructure to compete with them, HFT firms have made significant investments in infrastructure of their own. If you had sufficient capital for technology development you could compete with any other HFT firm.
Yes there are people hurt by HFT, just like anything else when new players with greater efficiency emerge. However the average investor who is not competing with these firms is not harmed. The floor traders were, just like telephone operators before them.
This type of risk mitigation is important to whom, exactly? When the type of unexpected news you mention comes in, somebody is going to take a hit, yes. Who should take that hit? What are the criteria according to which you make that decision in the first place?
In the scenario you outline, say the price falls by $10, somebody is going to take that loss no matter what. Without rapid trade, the original holder of the paper is probably going to take the full loss. In your scenario with rapid trade, they found some "fool" who was prepared to buy the paper at an intermediate price, and so the original owner lost less. So from the perspective of the original owner that is certainly a benefit. But is it a benefit for society? That is an entirely different question.
One could argue that the only reason they lost less is that they were faster in reacting to a certain piece of news, on a timescale of minutes, which is entirely irrelevant to the real economy.
Your point about HFT replacing floor trading is a valid point, but all it really proves is that barriers to entry into the market must be low. There is nothing inherent requiring high frequency trading. The job could just as well be done by lower frequency algorithmic trading, with a matching algorithm that runs on e.g. a 5 minute heartbeat.
Yes, the spreads are going to be bigger. Then again, intraday movements dominate spreads by orders of magnitude anyway, so from the perspective of the real economy, why should I care about how small the spreads are?
In capitalist systems winners are assigned based on open and fair competition, but then again there are other political views and systems.
The way many traders argue, they seem to have little shame saying that they want the system to give them a hand when they have made a bad decision.
> If unexpected news comes out today that a company is the target of an adverse event like a DOJ lawsuit many market participants will want to react as fast as possible to the news.
No, I think the first thing you want to do is kick yourself in the butt for investing in a company that went down like this. If you invest in an oil company and it has a huge spill, the stock will go down and you will lose money. Don't like that? Don't invest in oil companies with a lousy safety record. Or invest yourself in making sure that the company that you gave your precious liquidity doesn't mess it up.
I would further claim that there are very few truly "unexpected" news. Traders are just a little too much in love with not really caring about what they invest in. At least not as much as they are in love with the money they make or the image that they are the "market makers" who provide the liquidity that we all need.
A DOJ lawsuit happens for a reason. Oil spills happen for a reason. If you have made a bet, you are the one who has to provide reasons for your bet. I cannot believe there are that many people who argue they should be able to rip off as many people as possible once their bet has gone sour. That the one thing they really need is to be able to rip others off as fast as possible. And that all this is somehow reasonable and useful.
I understand nobody really likes being the loser, but that's how capitalism works - filtering out the bad apples by having them go down in flames. Well, that's what it's supposed to be like, anyways.
> Arms races are fair, but they waste resources.
Amen.
Thank you for making my point in such an awesomely succinct way. This is exactly what I was trying to get at.
One slight correction: I think the movie about floor traders in Chicago is called "Floored". There is another another movie about floor traders in NY called "The Pit".
Investment happens on a timescale of months or years. But when I make the decision to exchange one investment for another (I include "cash" as an investment) I want to be able to make that exchange rapidly. If someone wants to jump on my offer in mere milliseconds, I'll take it. Maybe I could've gotten a few more cents by waiting for an offer minutes or hours later, but that's not the game I'm playing. If I cared about those last few cents I'd price my asset a little higher and wait for a better deal. Since I don't think it's worth the wait, I'll let the HFT have those few cents for the convenience of letting me clear my trade immediately so I can move on with my day.
Even regular bank transfers, i.e. transferring money from one checking account to another checking account, usually take a day to clear over here. I am talking about regular bank accounts in Germany, by the way. The economy manages to run just fine with this system.
As long as something as basic and fundamental as simply moving money from point A to point B is that slow, I really don't buy the argument that the real economy needs transactions on financial markets to clear that quickly. What's the point of having a trade clear in milliseconds if it takes me a day to transfer the money to a different account?
The same applies to equities - once the trade is made, the wheels are in motion. But actually transferring the securities takes up to 3 days.
One might ask "why is this important if the transfer itself takes days?"
The main reason is that it gives you certainty and closure. You try to make a trade for + or - X shares of Y at $Z and you get an essentially instant response. You don't have to wait around all day just to know if you've got a deal; you don't have to poke around looking for a slightly better price; you just make the offer and see it accepted immediately, and can move on to other things. (This is the sense in which I meant the word "clear" a few posts up: the trade is cleared from your to-do list, even if the securities take some time to actually move.)
There is a cost for the service of being able to move on: the HFT will likely capture a tiny bit of profit which could have gone to you with more effort. You've traded money for time and effort.
Having the trade agreed to quickly is a big deal even if it could take days to have any tangible assets to show for it.
this is only one purpose of financial markets. the other purpose is to transfer risk. any capital that you hold is subject to risks, and as a capital owner, you really only want to be subject to the risks that you know about and can compute well. you'd like to transfer other types of risk to other parties.
> It doesn't even work on a per-minute basis - at best, it works on a daily basis
is this a joke? if AAPL releases earnings at 10am and they come in 20 cents under expectations, i can guarantee you that regardless of the presence of computers, by 10:01am, AAPL is going to trade down a lot.
> It certainly reduces the spread. The problem is that HFT makes market access unequal.
lower spreads mean that less profitable strategies can survive in the marketplace. there will actually be more market participants in this type of scenario
> You claim that Alice could have held out for $10.05 if she had wanted to. This is incorrect
what you're describing here is a limit order, the most basic type of order that everyone has access to. she puts in 10.05 in etrade, and gets filled if the market moves up to 10.05 (but not if the market moves down towards 9.95 and does not come back up).
> for most market participants form the real economy, intra-day fluctuations dominate the spreads by orders of magnitude anyway
this is exactly why latency is important (and also contradicts your earlier statements). you want your orders filled now, before the market moves away from you.
Unless the "5" key on her keyboard is broken, she could have typed 10.05 into eTrade instead of 10.00.
Sure, I can't know this, but it's a safe assumption. Whatever. Feel free to downvote and flag my post to bury it again, HN. Stay classy.
The army of PhDs from elite schools working for the financial industry are too smart not to realize that it's full of shit. How could they not see the relentless greed, and the sociopath douchebags in charge for what they are?
They'll be aware of bad/immoral/illegal things being done all around them, but hey, the salaries in finance are pretty fucking ridiculous and they get to work on challenging problems.
http://www.zerohedge.com/news/high-frequency-minutes-hft-exp...
Just like you said, in the real world, someone trading in the real economy does not make trades thousands of times per second. And I bet HFT bringing spreads down to $0.05 doesn't help anyone without a HFT machinery of their own.
But here they are, on Hacker News, bullshitting/distracting us convincingly time and time again.
I didn't say that anyone was ripped off. There's nothing inherently wrong with being a middle-man in a transaction. I just don't see that HFTs are adding any real value.
> What's missing from your explanation is time.
You're pretending that Alice and Bob placed their orders 20 minutes apart. That's not the game HFTs play. HFTs are playing games of milliseconds. It's not 12:20 and 12:40. It's 12:20:00.200 and 12:20:00.450. If Eve had taken the day off, Alice would have traded with Bob, and it would have looked just as immediate to both of them. And if there were a high risk that the market would tank immediately after Alice's sell order were placed, then Eve wouldn't have left her buy order on the book anyway.
If your 20-minute wait scenario were realistic, then sure, HFT would be adding meaningful liquidity. But then, it wouldn't be called high-frequency trading, and you wouldn't have written about how "speed matters".
This comment makes sense only in the context of a message board hypothetical, because it presumes foreknowledge on Alice and Bob's part. Here, Bob showed up. Eve looks like a genius. But it was equally likely that he wasn't going to show up.
A lot of the discussions about liquidity and HFT here seem a little innumerate. They appear to work from a scale where the hypothetical Alice's ask price is "absolute zero". That's not the real scale. Obviously, instead of Bob showing up at $10.05, you're equally likely to end up with Chuck at $9.95.
If you're not equally likely to get Chuck instead of Bob, why are you selling?
Equally likely? So HFTs are flipping coins blindly and just happen to make a lot of money because they can flip quickly?
> If you're not equally likely to get Chuck instead of Bob, why are you selling?
I don't understand this question at all. I'm selling because I want to sell my stock. Maybe I'm liquidating assets to buy a house. Maybe I'm speculating that the market is going to tank. Maybe I'm just adjusting my asset allocation. I could be selling for any number of reasons, and I don't care about Bob or Chuck. I just want to sell and get the market price.
If you need liquidity and aren't confident enough in your upside to want to be exposed to the downside, you're happy to have Eve.
Note well: your hypothesis is that Alice should get something for nothing. Alice wants liquidity (ie: no downside exposure) and immediate access to the next significantly better price to hit the market. It must be nice to be Alice! :)
As for your first question: HFTs do not have crystal balls. If they did, Chris Stucchio would be a billionaire.
I feel like I need to reiterate that I don't think HFT is evil. I'm just not sure that HFTs really add that much liquidity to the market, and there is evidence that they contribute to volatility (such as the flash crash).
At 2:32 p.m., against this backdrop of unusually high volatility and thinning liquidity, a large fundamental trader (a mutual fund complex) initiated a sell program to sell a total of 75,000 EMini contracts (valued at approximately $4.1 billion) as a hedge to an existing equity position.
(From the SEC link Chris posted earlier).
I don't know whether I believe Chris that HFTs caused the market to correct much faster, but it seems clear that HFT didn't cause the crash.
> The combined selling pressure from the Sell Algorithm, HFTs and other traders drove the price of the E-Mini S&P 500 down approximately 3% in just four minutes from the beginning of 2:41 pm through the end of 2:44 pm. During this same time cross-market arbitrageurs who did buy the E-Mini S&P 500, simultaneously sold equivalent amounts in the equities markets, driving the price of SPY (an exchange-traded fund which represents the S&P 500 index) also down approximately 3%.
> Still lacking sufficient demand from fundamental buyers or cross-market arbitrageurs, 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.[9]
The primary cause was a delay in when incoming orders were time-stamped by the NYSE. Instead of stamping the orders when they arrived at the queue just before entering the market, the NYSE servers time-stamped them when they _left_ the queue and were placed in the book.
Since the queue was delayed by extreme volume (NYSE has always lagged on technology), stale prices were posted to the NYSE feed. However, it was impossible to tell that they were stale from the timestamps.
Since the market was falling rapidly, this resulted in the NYSE quoting higher prices than every other market.
Since the NYSE was quoting higher prices than every other market, arbitrageurs massively sold at the NYSE and bought on other exchanges.
Since the queue was delayed, however, the sell orders at the NYSE took a while to actually show up in the book. Meanwhile, more sell orders were placed.
Want to see something scary? Here's the result: http://www.nanex.net/20100506/FlashCrashAnalysis_Part3-1.htm...
Or it could be 12:20:00.200 and never. You are assuming Bob will show up, but at 12:20:00.200, neither Alice nor Eve know if he will or not.
If Bob shows up, Eve makes $0.05. If Bob never shows up and the price drops to $9.50, Eve loses money. Alice paid Eve $0.05 to take that risk because she felt it was worthwhile.
If Alice didn't feel this risk was worthwhile, she would have placed an order at $10.05.
But then, it wouldn't be called high-frequency trading, and you wouldn't have written about how "speed matters".
Please go reread the section on why speed matters. As I said, speed matters to Eve and Eddie (both HFT's) - because Eve placed her order at 12:20:00.000, and Eddie placed his at 12:20:00.030, Eve trades before Eddie. Alice's timing is irrelevant in this part of the game.
Sure. It could be never. But it's not 50/50 or Eve wouldn't be playing. Eve buys from Alice because she expects to immediately sell at a higher price.
> Please go reread the section on why speed matters. As I said, speed matters to Eve and Eddie (both HFT's) - because Eve placed her order at 12:20:00.000, and Eddie placed his at 12:20:00.030, Eve trades before Eddie. Alice's timing is irrelevant in this part of the game.
It's not irrelevant. A price-increasing event occurs and Eve jumps on Alice's sell order before Bob's buy comes into the system. Bob pays the same, Alice gets her asking price, and Eve pockets the difference. This is just exploiting unequal market access.
Of course it's not. Alice has a lower appetite for liquidity risk - that's why Alice chooses to pay Eve to take on this risk.
A price-increasing event occurs and Eve jumps on Alice's sell order...
First of all, there was probably no event. It's most likely that Eve had passive orders - buy at $10.00, sell at $10.05 out in the market (HFT's usually don't take liquidity, that costs too much money). Alice came along and chose to fill Eve's order.
Ignoring that, you also haven't explained how Eve's "unequal market access" plays any role in this. Why does Eve have to be a machine in this process? While being a machine helps Eve beat Eddie (another machine), if no machines were in the game then Eve could easily be a human. In fact, Eve was a human until fairly recently.
I know that market making could theoretically do this anyway, but it's a different situation when market makers have such a speed advantage. If you've got to sit on your position as long as the typical eTrade user, leaving a passive buy for $0.10 under market price picks up more risk, because you might not be able to cancel if the market shifts downward by $0.30.
In any case, though, the spread would theoretically go to the existing participants, rather that an HFT. The "market making" of the HFT still results in extracting money from the market. This could be a beneficial thing in illiquid markets, but I'm not sure it's beneficial in markets that already have high liquidity.
I can understand how upsetting HFT must have sounded to you (although to be fair, we're still shifting the good outcome from Bob to Alice in your best case) given that misunderstanding, but, no: to capture the 5 cents (more likely: 1 cent) between Alice and Bob, the HFT had to accept Alice's downside risk exposure. There was no (simple) outcome where Alice could have it both ways, scalping Bob for 5 cents in the best case but getting out at 10 cents in the worst.
I came to my understanding of this topic in a weird way (see downthread) but one resource I found extremely helpful was Larry Harris' _Trading And Exchanges: Market Microstructure For Practitioners_. It is the TCP/IP Illustrated of markets. Very well written, and well written in a way easily appreciated by programmers. Highly recommended. When I first started reading it, I literally didn't want to put the book down.
I still get the feeling that you think I'm attacking HFT. It's not "upsetting" to me. The only questions for me are whether there's more value in HFT than cost, and whether the same value could be had with lower cost. It's good to know that my Alice scenario is invalid, though. That means HFT isn't breaking what I thought was a useful scenario for sellers.
Thanks for the book recommendation. I've added it to my list.
It's a great book.
If this is what HFTs were doing, it would be understandable why they were so upsetting. But of course, HFTs can't do this, because Alice and Bob's trade is executed instantaneously in the match engine.
Could you perhaps explain the specific scenario you're talking about here? Alice, Bob, and Mallory perhaps?
12:00:00.000 - Alice - SELL $10.00
12:00:00.100 - Eve - BUY $10.00
12:00:00.200 - Eve - SELL $10.01
12:00:00.300 - Bob - BUY $10.05
(Eve could have issued her BUY order before Alice's order arrived, SELL after Bob's BUY, etc.)
If Eve stayed home for the day, Alice and Bob would have happily traded with each other and Alice probably wouldn't have minded the extra 200ms delay but would have appreciated the extra $0.05 per share. But instead Eve decided to jump in and extract a bit of money from the transaction. And again, there's nothing wrong with that. But I fail to see how Eve is adding any value to the market here. There was no lack of liquidity.
12:00:00.000 - Alice - SELL $10.00
12:00:00.100 - Eve - BUY $10.00
12:00:00.200 - Eve - SELL $10.01
12:00:00.300 - Chuck - BUY $9.95
12:00:00.400 - Chris - BUY $9.90
12:00:00.500 - Charlise - BUY $9.80
12:00:00.000 - Alice - SELL $10.00
12:00:00.300 - Chuck - BUY $9.95
12:00:00.400 - Chris - BUY $9.90
12:00:00.500 - Charlise - BUY $9.80
With HFT, some trades will go according to your first scenario; others will go according to the scenario you responded to. On net, Alice sells all her stocks to Eve and gathers in $100 every day.
If Eve stays home, instead Alice unloads perhaps six of her stocks to Bob at $10.05 each, and is still holding on to four of them. She doesn't want to end the day with $60.30 and four stocks she doesn't want, so she unloads the remaining stocks to Chuck and nets $100.10. Except that Chuck takes Mondays off, so on Monday she might end up selling to Chris and only finish with $99.90.
So what Eve (HFT) really accomplishes here is she grabs 10 cents of Alice's potential profit on most days or 10 cents of Alice's loss on Monday. Alice is happy with this arrangement because she gets the certainty of getting her $100 each day for the minimum effort. Eve is happy because she's grabbed an average profit of 6 cents per day (40 cents for T-F, -10 cents for M) in exchange for taking on a little bit of risk.
The real loser in this scenario is Freida, who is trying to do the same thing as Eve but is a little bit slower.
12:00:00.000 - Eve - BUY $10.00
12:00:00.000 - Eve - SELL $10.01
12:00:00.200 - Alice - SELL $10.00
12:00:00.300 - Bob - BUY $10.01
Here's another way to think about it:
Alice wants the ability to sell her stock whenever she wants for a "correct" price. Right? That doesn't come for free. Someone has to figure out what the correct price is. That takes effort and costs money. Humans used to do this (they were called market makers). Now computers do it because they're better/faster/cheaper at it (just like they're better at a lot of things humans used to do).
They're also cheaper at it. The cost to Alice of getting to sell whenever she wants at a good/correct price has actually gone down from what it used to be. You can see this in the shrinking spreads. It used to be we only had price accuracy to a dime or a quarter. Now it's generally down to only a penny! Even though Eve is making money Alice is getting a way better deal than she used to before someone figured out how to program Eve to do it instead of the slow and expensive Harry the Human.
Could you explain how to "scrape pennies" (as in specific mechanics, your explanation should involve limit orders or whatever), and why this strategy doesn't benefit the speculators the HFT is trading with?