If you watched 60 minutes tonight, or read the book, the problem was that a large trader (the guy they profiled ran the trading desk for RBC) would make an order for a large block of stock, say 400 shares of X, and then send that out to all of the exchanges.
What would happen is it would get to the first exchange and be partly filled and when it was the HFT guys would send trades on ahead to the other exchanges faster than RBC could and buy out the stock before the RBC order got there, leaving the order only partially filled. (or filled part at one price and filled the rest at a higher price).
In the story they mention that by restructuring how they sent their trades out so that they arrived at every exchange simultaneously eliminated the possibility of the HFT guys front running them.
In order to make it possible for everyone to do that they have created their own exchange (iEX) which locks out the HFT folks (well it has them going through an extra 60km of fiber to slow down their access).
Trading communicates information to the market. Proprietary access to information is valuable. HFTs make certain information non-proprietary faster than the state of the art prior to HFTs. That changes the allocation of profits associated with that information. This is the entire ballgame. Retail traders swim placidly on the sea above totally ignorant of the krakens vs. mutant-sharks-with-lasers bloodbath happening 20000 leagues below.
It's not like in the pre-HFT days market makers would just obligingly fill institutions for whatever volume trades they wanted to execute, regardless of how ham-handedly they broadcast their intent into the market. Any estimate of "costs" to institutions from HFT needs to be measured not against some Platonic ideal scenario where market makers earn no profits, but rather against the old specialist system that it replaced. In which case I suspect the costs would come out quite a bit on the negative side of $0.
There are some practices in HFT like paying for privileged newswire access that could use some reform, but the best solution to this fragmentation issue is for large institutions to stop sending out their orders like it's the year 1995.
In an earlier thread someone used the term "legalized front running" to describe HFT, and in thread the final pieces fell into place.
Fact 1: we know that HFT companies have special hardware in place. They have effectively built FPGA's (or even ASICs) that can process incoming orders while the message is still partially on the wire. This allows them to react to new orders and executions with a latency that is below the transmission delay of the protocol packet.
Fact 2: HFT companies have built directional radio links to get their messages faster between exchanges. Speed of light is still a limiting factor, and the distance traveled between exchange A to exchange B is somewhat longer along the fiber.
Fact 3: The basic rule of trading is "buy low, sell high".
So, if you can process order information faster than than it takes to receive the entire exchange message, you can use that as an advantage against the rest of the market. The HFT systems know the current price for a stock in the system (the lowest standing price), and when they receive an execution, they know that someone else just traded at that price. They can send out a message to other exchanges to quickly buy the said stock at the said price and put out offers at a slightly higher price.
The net effect? "I just bought all of the stocks under your nose. Here's what I'm willing to sell them for you."
As long as the price they're selling the stock out is within the limit, they'll get an immediate risk-free trade. The HFT systems already had a buyer ready before making their orders.
[1]: http://ra.ziti.uni-heidelberg.de/cms/images/pdfs/High-freque...
I have no doubt about that. Very few things are new.
But if you're deploying special hardware in an attempt to cheat the speed of light and gain an advantage of mere microseconds, the system is FUBAR (or recognition).
mutual fund X places two market orders to buy and take out the current offers, one on A and one on B. Its order on A executes at $100, taking out the liquidity and making the new best offer there $100.01
HFT firm Y sees this execution and cancels their offer of $100 on exchange B and replaces it with one at $100.01 all before the order that was placed on B arrives.
This is a market fragmentation issue, Reg NMS tries to address this but doesn't really work at these timescales, because you only have to comply based on the current quotes you are getting from the exchanges, which could be many milliseconds behind (and if your system is slow to process the quotes and makes more money as a result, you won't be getting a task from your boss to speed it up).
http://en.wikipedia.org/wiki/Regulation_NMS
There are many other types of useless latency arbitrage that don't depend on market fragmentation, like trading on the difference in price between ETFs (basically a basket of stocks usually trying to match something like the makeup of the entire S&P) and the underlying individual stocks. Each time the underlyings change, the ETF price changes (within reason, risk hedging activity etc. could make the ETF temporarily get out of sync, but that is just another latency arbitrage oppurtunity). Whoever is faster wins.
It's pointless, there are datacenters full of servers running wait loops on incoming data via DMA so that they don't have to pay the latency price of a system call and context switch to the kernel. Basically burning up part of that mutual fund's money into waste heat.
As a buyer of an ETF or as a market participant looking for trading venues I needn't spend lots of resources ensuring that the prices are in sync. Those costs have been born by the specialists in those arbitrage opportunities and it is a very cut throat efficient system.
There is some value to keeping things liquid, but that value isn't tied at all to the amount of money that arbitragers get compensated. Consider that whether the latency is 1ms or 5ms, the fastest arbitrager wins. But to bring things down to 1ms from 5ms may require 10X more expense and waste, lowering the compensation to the arbitrager. In a competitive enough environment they simply burn up all of the spreads into waste heat and redundant fiber infrastructure.
It's risk-free arbitrage...exploiting the difference in price between two exchanges that will exist for only a fraction of a second knowing that the rest of the order will arrive fractions of a second after they trade.
This scenario used to play out a lot during the 2008 financial crisis. I remember loosing money because of such tricks.
No one intends to sell at a loss but that is part of the game. The problem is when market manipulators artificially cause the price to move against you thus triggering your stop loss.
If you want a mechanism to retain upside while limiting downside, it exists. It's a call option, not a stop loss order. If you don't understand the difference you should not trade.
If you could explain the specific mechanics of what you believe is "market manipulation", it would be very helpful.
It's illegal for anyone to issue an order they don't intend to complete, but the HFTs get a pass for some reason or other that must end with quite a few zeros.
This is incorrect. If you place a BUY@$100 and someone has a SELL@$100, the exchange instantaneously matches the orders and a trade is issued. You can't cancel an order which was matched.
The "price discovery" happens before the trade is placed. The instant the exchange receives the BUY@$100 order it is published to the world via the exchange's multicast quote stream.
"Issue an order they don't intend to complete" is an anachronism related to pit trading - in the pit, it's possible to throw the "I accept" hand signal at the other guy and then change your mind after trading hours during reconciliation. The FIX and OUCH protocols do not have a similar "oops I changed my mind now I'll be a jerk after hours" message.
http://www.zerohedge.com/article/its-not-market-its-hft-crop...
This only works because you don't actually have a "Sell at $X".
1) Rapidly post/cancel trades, risking a fill. 2) ??? 3) Profit!
The ??? represent the part I don't understand.
(If you are actually interested, "quote stuffing" is typically the result of algorithms interacting in unexpected ways. It's not intentional or beneficial. I've spent weeks trying to reduce the amount of it.)
Imagine this happened when ordering food. Sure, you could put in a limit (no more than x french fries and y per fry) but your price would either be run up or you'd go hungry.
My limit is the price at which I thought that stock was worth buying. If the price never falls that far, then I wouldn't want to buy it anyway.
Of course, this is not illegal (it's like any other type of trading, pushing up the value so it goes beyond what you're willing to pay) - but it's achieved by using robots in such a way that normal humans can't hope to compete.
Of course, you can build your own robots (ie your own HFT software) to take advantage of the weaknesses of existing HFT programs, but if you can do this, you would be working at an ibank as a quant of some kind.
Additionally, to push the price up in the first place, it means the HFTs have to buy all of the stock being sold below the target price, which is taking on major risk. There is no guarantee that there isn't someone simultaneously dumping big chunks of shares at given price targets.
This makes no sense to me. Are you claiming that HFT purposefully drives up the value of every single stock? How would they even do that? And why?
Multiple this millions of times.
This isn't to say they are all completely evil. They do provide liquidity as banks have walked away from equity. But there needs to be more transparency on what is going on. (For example - should it be legal to send false buy or sell signals which will be intentionally cancelled?)
Or maybe "cuts in front of you" means you wanted to buy the stock at $50, but you didn't actually place the order until the last minute because you wanted to play a speed game (and lost).
Another is to flood the exchange with orders in a bid to create congestion and slow down other market participants who might intervene.
This is why HFT in fact causes higher transaction costs on market participants. It provides the perfect way to leech.
A) On every exchange that I know of, the only way that using tiny orders gives you any information advantage is that on certain exchanges fill information is processed faster than market updates. Nothing in that fill information would allow you to determine if there is a large price insensitive market participant in the market vs lots of small price sensitive participants.
B) Nearly every exchange out there allows large participants a variety of mechanisms to hide their order flow. The simplest is iceberg orders.
C) It is a feature, not a bug that prices change in the face of large order flow. Every market in the world, electronic or otherwise works on this basic assumption.
Finally, your example about spamming quotes to create congestion on matching engines is a problem that has already been resolved. The exchanges themselves had a very high incentive to fix this. Their solution was to introduce fill ratios and to fine folks aggressively for violating them. I don't know of any main line exchanges where quote spamming can provide a legitimate latency advantage still.
I'm not picking on one commenter here. Many HNers post substanceless one-liners. Please don't do that. Re-read what you've posted and, if it adds little of substance to the discussion, delete it. Fewer substanceless comments will mean a higher signal/noise ratio for all of us.
Edit: someone pointed out to me that kasey_junk is one of the few people who actually knows what they're talking about in this thread, meaning that he/she has contributed much more signal than noise. That's probably true! I don't have time to read all the threads, even the interesting ones—especially the interesting ones. I'm sure kasey_junk couldn't care less, but I've restored the karma that his/her account lost to downvotes here.
Keep in mind that HN is going through a period of experimentation while we figure out how to address some of the longstanding problems that PG never had time to take care of. We're going to get a lot of things wrong on our path to getting things right. We're also very interested in your feedback on these experiments, so don't think the feedback is one-way. The best channel for it is [email protected].
Um, how do they do that, exactly? The major equity exchanges are all FIFO on every tick price. If you put a limit order in for $49.99 before somebody else, and an offer crosses your bid, you'll get filled before they do, period.
Exchange A: 25 @ 49.99 Exchange B: 20 @ 49.98 Exchange C: 60 @ 49.97
You expect your order to get filled with all shares from C and B and just 20 from A at the highest price, the problem is Exchange A is closest to you, B is 50 miles away, and C is 800 miles away in Chicago.
The HFT bot sees your order arriving at Exchange A, since they have a fastest link to B and C, they buy the orders there and put them on sell to you at $49.99 just a few milliseconds before your order arrives.
If you really wanted to pay $49.97 then you should have put in that order instead.
Either way, this problem can be solved much more simply by the application of some simple order timing algorithms than by regulations attempting, in effect, to repeal the speed of light.