* Acting on public information, milliseconds before anybody else - which helps everybody else about as much as insider trading does.
* Acting on trading information gleaned from "bid stuffing" (making and canceling orders really quickly) - which helps everybody else about as much as front running does.
* Detecting the presence of large trades about to go through or going through and capitalizing on the price movements they cause - i.e. imposing a tax others making large trades in the stock market.
In return, they flood the market with liquidity when it is least needed and withdraw it suddenly when it is (e.g. when prices are diving).
There's literally nothing to like about HFT.
"They can do it faster, therefore it must be illegal."
Acting on trading information gleaned from "bid stuffing" (making and canceling orders really quickly) - which helps everybody else about as much as front running does.
The only people that notice this behavior are...other people capable of doing this behavior. Why should it matter to you, the long-term investor, the trading tactics computers employ at the millisecond scale?
Detecting the presence of large trades about to go through or going through and capitalizing on the price movements they cause - i.e. imposing a tax others making large trades in the stock market
This happens in any market at any timescale. Everyone capitalizes on trends.
question is, do they benefit the market as a whole? Traders do not have a right to perform HFT, and if it destabilise markets, we can take steps to reduce it (of course, there is then the issue of how to take steps without causing different problems)
Benefits of having HFT traders, is that at the cost of having them around you can have fair and level ground. So if you come to one exchange to do a transaction, you don't have to think much about exchange intrinsics, like liquidity available there, fee structure, etc. Because these differences are being arbitraged away by HFT traders.
And again, what is the alternative? Exchanges that are connected by human traders making phone calls?
In the case of stocks, for example, there has to be one ultimately authoritative copy of who owns which stocks anyway. So why not just do all the trading in the place where the authoritative copy is stored?
That would certainly seem to be more efficient from the perspective of minimizing the overall social cost.
Because it allows the exchanges to compete on features (latency, order types) and pricing (transaction fees, connectivity costs).
In the case of stocks, for example, there has to be one ultimately authoritative copy of who owns which stocks anyway. So why not just do all the trading in the place where the authoritative copy is stored?
For equities, trading and settlement are two separate steps. Trading occurs on the exchanges and, for U.S. equities, settlement is handled by the DTCC, the central counterparty for all U.S. equities trading. Handling all the specifics and details of what happens after a trade is executed is a massive industry.
For some products, trading does occur only on one exchange. Typically in futures trading, an exchange will develop a product (a contract) and that contract can only be traded on that exchange which also handles settlement.
And what if trading on that exchange will stop for a couple of days for technical reasons? What kind of problems can that create to stock of large company, that can be traded only on that exchange? Or what, if the whole exchange will go out of business? Or decide to charge arbitrary large trading fees?
Competition and diversity is generally a good thing. Tend to increase efficiency and minimize overall costs. That's valid for exchanges as well.
Also, what is the social cost you are referring to? There are a lot of people here saying that HFT doesn't provide "social value". Does it somehow provide less social value than traders screaming at each other in the pits? Similar types of trading always existed, except now it's done by computers. For what it's worth, HFT provides well-paying jobs for a lot developers and ops people and often is very supportive of the engineering community.
Given this notion, competition is a good reason for the existence of multiple exchanges, because it means companies can change which exchanges their shares are traded over. However, it is not a good justification for the fact that trading of the same stock happens on multiple exchanges.
As for the social cost, you do realize that HFT does not come for free to society. At a minimum, society must somehow pay for those well-paying jobs to developers. And what do those developers give back to society? Before you answer, please consider whether you should distinguish between algorithmic trading and HFT. I do believe that algorithmic trading is useful to society (because it can do the job that screaming traders used to do better and cheaper), but the subset of HFT is not useful.
The only things anyone ever seems to be able to answer for HFT two-fold: one, that stock prices change faster, and two, that the spread is smaller. But one point one, nobody in the real economy cares about that, and to point two, the decrease in spread also doesn't matter to anybody in the real economy, because what you really care about there is the fluctuation of the share price over a larger timescale such as one full day. I have not seen any evidence that this fluctuation is affected by HFT in any way.
I don't think there's any reason to think that exchanges' main purpose for existence is to provide service to publicly traded companies. Exchanges are just a store, and their purpose is to buy/sell stuff and make a profit. So, in that sense, having multiple exchanges selling the same stock is the same as having multiple bike stores selling the same bike...it's competition and there aren't many downsides to it.
As for the social cost, you do realize that HFT does not come for free to society. At a minimum, society must somehow pay for those well-paying jobs to developers. And what do those developers give back to society? Before you answer, please consider whether you should distinguish between algorithmic trading and HFT. I do believe that algorithmic trading is useful to society (because it can do the job that screaming traders used to do better and cheaper), but the subset of HFT is not useful.
Nothing comes for free to society. Funding a never-ending number of failing start-ups doesn't come free to society either. What is that giving back to society? Your implication is that HFT trading is somehow taking something from society that it doesn't deserve. What is it taking? Also, in terms of making distinctions: HFT is the superset and AT is the subset, not the other way around. All AT shops are HFT shops, but there are actually quite a few HFT shops that don't run algorithms and instead run based on inputs controlled by traders.
The only things anyone ever seems to be able to answer for HFT two-fold: one, that stock prices change faster, and two, that the spread is smaller. This is the crux of the whole thing. Why does anyone have to answer for HFT? This is implying that HFT is hurting people however you haven't not given any proof of this (besides that it doesn't add value). If anything, I think HFT's biggest crime (as someone else has mentioned) is that sucks some really smart people into working on problems of a rather limited scope.
This means that those who can respond faster can get into a price level sooner. Breaking this out to minute bounds doesn't mitigate their advantage in any way shape or form.
It is hard to know what the results of a change like this would be. I suspect it would make the markets much less stable as there would be less information to make accurate prices, causing huge variances on minute long ticks.
1987 was caused by portfolio insurance from major funds, not HFT (which didn't really exist then as it does now). HFT also didn't cause the mortgage crisis. That was long term consumer financing & Gov mortgage buyers & pension investors. HFT was definitely involved in the flash crash, but what were the long term implications of that? Zero. The most recent blip was caused my dissemination of bad news via a source that had been compromised. Again, not HFT.
Want to hate HFT (I do!)? Hate it because it isn't profitable (which is why I left in 2010) and because it still sucks up engineering talent like a black hole of despair.
These anti-HFT articles that occasionally come out are hilarious because the money that put HFT on the public radar simply isn't there anymore. Look at GETCO.
The question I have is why is the public so willing to accept disinformation? Residual banker hate?
Large trades move the market, full stop. That's a feature, not a bug. Moving a lot of size changes the market's estimate of the value of whatever you're moving. Splitting up large orders into smaller pieces is attempting to hide that information, why should that be a privileged operation?
If HFTs push the markets higher slightly faster because of new public info then while it might be bad for you if you are buying on that news, it's great for whoever already owns the stock and is the one selling to you.
The same applies to your 3rd point. It might be a tax on whoever initiated the large trade, but it's a benefit to whoever is on the other side of the trade. HFTs put new information into the market much faster than humans ever could making them more efficient. They're also doing it at a lower cost than human market makers ever did.
If anything, HFTs have made it cheaper to trade. Because of the way exchanges are setup, the man in the middle will always be making a cut of the trades. Now though that cut is measured in pennies rather than what used to be often 1/2 dollar spreads.
Sure some of the predatory algorithmic trading serves no benefit to anyone, but you will always have people gaming/attacking the system if there's arbitrage potential.
When markets went over to computerised trading, it was argued that the human element of open-outcry trading was vital in preserving a culture of honesty and integrity.
Critiquing HFT is myopic, because it's based on a meaningless definition of "high frequency". HFTs are doing what traders have always done. There's a legitimate argument against speculation, but it's pointless to single out speculators that deal in the very short term. Singling out the newest technology is just a cheap shot, there's no fundamental difference between trading on a millisecond horizon or a minute or hour horizon.
I'm undecided about HFT's ability to provide liquidity in the market. There are certainly some drawbacks (e.g. you have to have high capitalization to afford HFT colocation), but there might be some tangible long-term benefits as well.
But I'm more concerned about how much of a waste it all is. Jeff Hammerbacher famously quipped that "the best minds of my generation are thinking about how to make people click ads," when referring to developers pounding at the doors of google's and facebook's recruiters. HFT is similarly unfortunate. Somewhat useful maybe, but overall a depressing use of brilliant minds.
As someone who works in HFT, you have hit the nail on the head about the real problem with it. It isn't front running, or instability, or unfair trading or any of that. It is simply that so many very smart people are working on it, instead of other more useful ventures. Of course, I feel the same way about data mining social networks.
It seemed fairly clear to me that the parent wasn't saying that at all. What he was pointing out was that discussion of, and concern about, faster access to information, decision making and execution causing volatility in the market isn't new. That's not a straw man at all.
Also, as an aside, it's worth nothing that Hammerbacher only said that after making millions working at Facebook. I'm pretty sure that makes him an asshole.
* - For fairness, you could execute trades within a generation in a pseudorandom order determined by a random key, which is cryptographically committed to prior to the opening of trading, then reveal the key after the market closes to prove that you executed them in the correct order.
But you're incented to do the same thing! So if you're going to put in an order for 200 maybe I should put in an order for 400? You can see where this is going...
People worry about HFT destabilizing the market. It seems to me that would be a much greater risk if you're incentivizing people to put in crazy orders that they don't actually want to do just to grab the percentage of demand that they desire.
This seems to disincentivize putting up for sale more than the seller wants to sell, and to also disincentivize "Sybil attacks" where the seller has an incentive to create false identities for himself. (Just a thought experiment, would be happy to know what I'm missing here :-)
One trader can act faster than another, and a millisecond(s) can be shaved of with the right location of your server (co-located near the exchange).