I think it is very stupid to allow a system to evolve where half the trading
  is a bunch of short-term people trying to get information one-millionth of a
  nano-second ahead of somebody else. It’s legalized front-running; I think
  it’s basically evil and it should never have been able to reach the size
  that it did ... why should all of us pay a little group of people to
  engage in legalized front-running of our orders?

To make this concrete:

Say Charlie & Warren wake up one day and decide Company X is undervalued and that they want to by 5% of it. They start buying stock. In the old pre HFT days it would take a while for the market to notice all this new demand so they could get a lower price. But now HFTs are really good at noticing this so the price rises faster.

But wait you say! This is the "front-running" that Charlie is complaining about and that's bad! He's getting screwed!

But what if you were one of the people selling to Charlie. Before HFTs made the price faster you were the one getting screwed! There was all this new demand and you didn't know about it yet so you weren't getting as good of a price as you otherwise could have.

HFTs aren't front running. They just move the stock to it's true price faster than the humans doing the job before could.

If I'm buying, the HFT buys ahead of me and resells it to me at a higher price. If I'm selling, the HFT shorts ahead of me and buys from me at a lower price.

This isn't about liquidity or efficient markets, it's about gaming the system through preferential access to data and executions. It results in higher prices for buyers and lower prices for sellers.

They cannot jump ahead of you except by offering a better price.

I wrote a blog post a while back that explains the mechanics of matching engines, you might find it helpful: http://www.chrisstucchio.com/blog/2012/hft_apology.html

There was a big trade for a while where people had different account types. the CBOT matching engine, for example, had customer orders prioritized over marketmaker or firm, so customers actually COULD jump the line.

Some companies had customer accounts specifically so they could insert orders in higher priority in the queue (the tradeoff is that customers pay for CXLs, but you can just do the math to see when you should be using which account)

to @panarky of the comment, its not on the order of microseconds -- the stuff people used to rip on were flash orders, which are exactly 30 milliseconds.

So @panarky has a bit of a point about knowing the order in advance, but its still damn hard to profit from it. The narrative of just front running trades by having order information in front is just not feasible because of the bid-ask spread (the flash orders are to try to help maintain some semblance of BBO consistency across exchanges)

So as yummyfajitas says, it's not possible to sell ahead (saying "short ahead" in that way exposes you as not really knowing the trade, btw) or buy ahead in a way that necessarily affects price.

So, basically, you're paying for your own decision.

The sellers sell at their ask price (or at my bid), it's their decision to sell. If you offer to sell something to me at $10, I haven't "screwed" you just because someone else was willing to pay $11.

It absolutely is front running. Moving the price of a stock to your advantage because you know my intentions is exactly what front running is.

Incidentally, if it's acceptable for Charlie Munger to sell in such a way that others will suffer the price impact of his trade, why is it not acceptable for HFTs to do the same thing? In both cases, it's just one trader playing short term games against other traders in order to make money.

It's not uncommon at all and I've seen it happen quite openly in many situations. It's tricky business outside of the pure electronic game.

Also what does it even mean to "Move the price of a stock to your advantage" ?

That is the definition of "front running".

I'd like to see a 1 cent tax per share per transaction. That'd dramatically limit HFT.

HideNotSlide does not cause an order to "jump to the top of the order cue[sic]." It preserves your order entry time at a price that is contra the NBBO if there is not an order at Direct Edge at the NBBO (if there is an order at Direct Edge at the NBBO the incoming HideNotSlide order is filled).

I doubt "HFT" would be dramatically limited by a transaction tax. I believe that it would lower trading volume by some amount and widen the bid/ask by some amount. The number of "HFT" firms and their trading habits would look mostly the same though.

http://www.directedge.com/Portals/0/04Support/Membership/EDG...

The point is that no special license or membership is required, although you may have to do some work to implement this type of order.

Source? I believe you but I'd like to be able to quote an authority if I'm telling someone else about this. I've gotten into this HFT debate with colleagues, and I'm pretty sure none of us knew about this nifty trick.

http://online.wsj.com/news/articles/SB1000087239639044481270...

The non-populist argument these days seems to be less about fast, electronic market making and more about whether there should be a fixed, minimum trading time, e.g. by discretizing trading into intervals of a certain length.

The fact is that would never happen. I'm all for investment.. hell, I'm all for gambling, sex, drugs and rock and roll for that matter. I don't think most things should be illegal... but labeling the stock trade and wall street as investment companies is ludicrous.

Instead of making money by choosing stocks, market makers make money by providing a concrete service to the market: they make it easier to buy and sell for people who are investing. They are more like the merchants or shipping companies of finance, rather than speculators. And there is nothing wrong with this!

In fact, calling it gambling is just wrong: most market makers actually take on very little risk! While their actions are not felt by the company directly, they are felt by people who own the stock and people who either want to buy or sell it. And knowing that it's easy to buy or sell a stock makes people more likely to participate in the markets, which is definitely a good thing.

Also, it's very important to note that even non-trivial investment strategies do not involve buying and holding on to large blobs of stock for months. Instead, you likely want to micro-manage your portfolio following some sort of mathematical model every day to minimize risk and exposure. Again, there is nothing wrong with this! But it does involve quite a bit of buying and selling stock, and the liquidity created by market makers really helps.

Viewing the stock market as solely a means to invest for long periods of time is really missing most of the picture. Your suggestion would actually increase most people's risk, leading to more gambling rather than less--or just significantly less investment over all!

I would argue that investors with a 3 month holding period are actually exerting a pretty corrosive influence on businesses: emphasising a focus on the next quarter's results at all costs.

After all, the investor needs to understand the business strategy, the operating conditions, and the particular risks and opportunities available to that business. The company and (particularly) it's management have an interest in increasing demand for the stock, so they normally oblige.

The conversation is not one-way. Stock options mean that the personal financial interests of the senior leadership team are normally well-aligned with that of the investors, so all the parties to these discussions have a mutual interest in the performance of the stock.

Investors have a mandate to maximise return and minimise risk. They have a limited ability to predict the future; an ability which drops precipitously the longer into the future they look. Investing client funds based on unreliable long-term predictions would be an irresponsible dereliction of duty on the part of the fund manager. In addition, measuring the performance of fund managers is also notoriously difficult, so there is a very human need to get as much feedback on performance as possible as quickly as possible. All of these factors combine to exert incredible pressure on the institutional investor to focus on gains in price over shorter time-spans (months rather than years).

This interest and short-term focus will naturally come across in discussions between the investor (=owner) and the senior management in the company. It takes an unusually self-aware, self-confident and self-assured management team to recognize (let alone resist) this inexorable pressure.

What I have seen far more often is smart decisions delayed to please the investors, or costly decisions taken, at all stages: before or during Series A, B or further, before or during an IPO, etc. The most common ones are related to HR: contractors costing double and won't be here when what the set up breaks rather than employees to set-up a strategic asset because, otherwise, accounting practices would show increasing long-term duties to said employees. More generally, many companies suffer from a lack of investment because of the short-term focus — this I can describe in details in repeated cases, for the dozen of more companies that I’ve worked with. The single exception was when investors used the product themselves and behaved more like end-users.

There are a lot of products, especially outside equities, where that's not at all true.

Providing liquidity in all situations might be useful, but it is an added bonus. If you don't do this, you are still a market maker.

The numbers are made up here, but that's the principle.

One is that the seller loses on additional value. The other is that the HFT has bought from a seller who would have sold to you, but sees a higher buy price and sells to that instead, so you miss your trade.

For low-volume traders these aren't huge issues, but for institutionals or others looking to make or exit a large position the costs can mount. Again: HFT wouldn't be undertaken if there wasn't value to be extracted in doing it, and that value is coming directly from other buyers and sellers, just as when you introduce a middleman to any other transaction.

It's the same kind of automation we've seen in many other industries.

That's ... an unsubtantiated assertion. Lots of evidence to suggest the situation's otherwise, at least in large part.

There was an excellent ACM paper posted to HN a few weeks back:

http://queue.acm.org/detail.cfm?ref=rss&id=2536492

http://www.stocktrading.com/HFTDennis.ppt

http://online.wsj.com/news/articles/SB1000087239639044403240...

Broker-dealer internalization, queue jumping, flash trading. Regulators are years behind the traders on methods.

Trading center proximity is a big one. The Internet travels at the speed of light (actually, somewhat less than that). Which is finite and within the bounds of algorithmic trading. The HFTs get pricing data before the general public, even if it's just a few thousandths of a second (5000 km is about 0.01 light seconds, 500km is 0.001 ls).

With HFT operating at the 250 microsecond level, 75 km is significant.

http://queue.acm.org/detail.cfm?ref=rss&id=2536492

Or just plain cheating. Remember the Chicago Faster-Than-Light trades?

http://www.theverge.com/2013/10/3/4798542/whats-faster-than-...

"Rather than buying Wigets-R-Us at $100/share, the HFT slips in with a, say, $99.99 offer to the seller, and offers you $100.01."

So, 2 possibilities, you don't say, but you are sending a limit order to buy at $100 or a market (or marketable limit, or fill-and-kill) order to buy at $100. Apparently, you seem to be suggesting that there is a seller in the market, presumably offering at $100. Now, you seem to be suggesting that the HFT sees your order before it hits the matching engine (nonsense) and also that they can somehow re-negotiate with the seller and get him to lower his limit sell to 99.99 (I'm not sure how, do they send goons around to kneecap him if he doesn't? All in the 20 milliseconds your order is on the way to the market?).

" and offers you $100.01"

...but let's assume that somehow the magic omnipotent packet-sniffing HFT knows your order is enroute to the exchange, can force market participants to lower their offers, now you're claiming that it can force you to buy at $100.01. Why didn't you send a limit buy at $100, if that's the price you wanted, you saw, and were prepared to pay?

>wrapped in condescension

If you want to write entire paragraphs about something you know nothing about, you're not really adding to the conversation are you? So you'll open yourself up to a little condescension.

I'll freely admit I find this confusing. And that's with having studied this shit in school and worked in the financial industry (in trading no less).

There are a number of methods of getting inside or around the order book, most of which involve breaking rules. But the regulators aren't even playing catch-up, they're so far behind.

HFT is very time sensitive, operating at or within the 250 microsecond window -- that's the time a light beam takes to travel 75 km. So one way of jumping in on the order is being, say, a few thousand km closer to the exchange than some other trader.

As to limit orders (and you really haven't explained how the order book avoids this), by beating others to the trade on both sides of the order, the HFT can get in and spin the equity, taking a cut, or stealing your trade (you look to buy at $100, seller is at $99.99, HFT buys at $99.99 but finds a buyer at $100.01).

The point is that by inserting themselves between other traders, by virtue of speed, HFTs skim a proft. It's small (and was enabled largely by decimalization), but can be made up for in volume.

The saving grace is that the HFTs are up against one another (at least until they start colluding), so they're weaving complexity traps against one another that wear down the advantage. Though there's the risk of more flash crashes and other disasters resulting from processes they barely understand themselves.

Or flip this around: instead of telling me how HFTs can't arbitrage their trades, tell me what's actually happening. Because HFT's like deepwater oil drilling: it's an awfully expensive hobby to be doing if there's no profit in it. Where's the profit? And who's that coming from? Because in the world of the financial market, it is a zero-sum game, where one set of traders extracting value means another set isn't getting it. It's not as if they're building widgets for a value-added proposition.

I've seen the HFT trade price-seeking patterns -- bandsaw and crop circle visualizations from NANEX (this is now a few years old, so ancient history, but):

http://www.nanex.net/FlashCrash/CCircleDay.html

The point is that by being able to generate thousands or millions of buy/sell orders, across a band of price points, the HFT is getting in on any movement faster than any slower trader.

You're also not addressing straight out fraud where book is open, which is what I understand queue jumping to be. It's one thing if everyone's playing by the rules. Something tells me that's not the case. Oh yeah. That's my former officemate doing time at Club Fed for insider trading.

What's the mechanism for matching buyers and sellers?

Does HFT provide a benefit to the HF trader? If so, from whom does that advantage accrue?

What's the net effect on a non-HFT buyer with and without the presence of HFT? For market orders? For limit orders?

What's the net effect on a non-HFT seller with and without the presence of HFT? For market orders? For limit orders?

HFT provides liquidity to all other traders, including other HFT. They are paid in either the bid-ask spread (in the case that HFT is passive) or arbitrating bid-ask spreads between different exchanges, e.g. they aggress and take out an offer on exchange A which is below the bid on exchange B, providing liquidity to the standing offer on exchange A immediately instead of letting the prices disjoin.

The answer to the last two lines are the same -- there is no meaningful difference between a buy and a sell. The net effect is more liquidity than without any short term market making, for both market and limit orders (IMO market orders should simply not exist, but that's a small aside).

http://online.wsj.com/news/articles/SB1000087239639044398920...

Relevant quote: "He became convinced exchanges were providing such an edge after he says he was offered one himself when he ran a high-speed trading firm—a way to place orders that can be filled ahead of others placed earlier. The key: a kind of order called "Hide Not Slide."

Whether it is legal is highly questionable but it appears that exchanges indeed offer this feature to sophisticated traders.

That aside, Hide not Slide orders are an interesting case. They exist only in US equity markets, and they're a great study in unintended consequences. US equities are quite fragmented (the same security can be traded on several different exchanges), so well intentioned US regulators introduced something called the NBBO (National Best Bid Offer), ostensibly to "protect investors" from getting a worse price on one exchange. What this meant is that different exchanges trading in the same product could never be "locked" - you could never have one exchange showing say 101 on the bid when another has 101 on the ask (because in theory then they are crossed and should trade). Pretend the tick size is 1 for following discussion...

This leads to a situation where every equity exchange in the US may be trading 100/102 (with an empty tick in the middle), but as long as one remaining exchange is trading 100/101, you aren't allowed to insert a bid at 101 on the other exchanges (since the interpretation of the rule is that this would be unfair on the resting 101 offer). But HFTs are all very keen to be the first to fill that 100/102 gap in the spread - to be the first on that new queue is an advantage since you get filled first. And obviously that one holdout exchange will soon get filled and the price will tick up. But the other exchanges legally can't accept a bid at 101 yet.

So exchanges started to either reject orders or "slide" them - you submit that 101 Buy and they slide it down to a 100 Buy. Which leads to this:

10 SUBMIT BUY@101

20 IF RESPONSE = "SLIDE TO 100" THEN DELETE, GOTO 10

All of a sudden the exchanges are being flooded with messages, as algos are pinging the exchange constantly wanting to put that 101 bid in. Which leads us to 'Hide not slide' - the exchanges promise to sit on your order until the NBBO ticks up and put it in the queue then. The problem is that these order types, while documented and available to all who are connected to the exchange directly, aren't usually going to be available to someone who is trading through an intermediary - a broker or some retail trading platform. So that's the story of how a well intentioned bit of regulation ended up disadvantaging US investors.

US equity markets are full of weird quirks like this, the NBBO needs to be done away with.

HFTs pay brokers for order flow so they get orders before they hit the exchange and decide to trade on them from their own book (at NBBO) or pass them on to the exchange. Besides jumping the order book at the exchange they get advance information on orders about to hit the market.

http://www.optiver.com/pdf/FSA%20consultation%20on%20PFOF%20...

I believe brokers in the US are now legally required to reveal any such arrangements to their clients.