Your example does exactly what the author recommends you not to do; cross the order book. In your example, you're supposed to place a limit order at 14.99.

That doesn't do anything. Then you never get any shares, and the market moves higher because there is a 100,000 shares on the order book and the market will move higher for legit reasons.

The way not to get scalped, is to place the order in a way where it arrives at all the exchanges at the same time, that way the HFT guys and their microwave data links can't peek at your order on BATS, and then beat you to the other exchanges.

The accusation is they see the 100,000 share order hit BATS, 10,000 get filed, then the HFT guys buy 90,000 shares on the other exchanges before your order gets forwarded, and you are stuck paying the HFT guys $15.02.

The HFT guys aren't buying 90,000 shares on the other exchanges. They're just updating their ASK price on those exchanges to slightly raise the price to reflect the new information that just hit the market. If someone wants to buy 100,000 shares RIGHT NOW it's a good sign that the price should be going up. Katsuyama/RBC were used to their proprietary information staying a secret that only they knew for longer before the HFTs jumped in and made the market respond faster.

That might be a bummer for Katsuyama/RBC but it's great for everyone else on the market who now benefit from a price that updates faster.

How do you "update" your ASK price? They are either front running by buying the shares at $15.00-$15.01, or, if they are their own orders, then they cancel them. It is the same thing.

If someone wants to buy 100,000 shares, and the market says there are 100,000 shares available at $15, the order should complete at $15.

You update your ASK price by canceling your order and submitting a new one with a different price.

> If someone wants to buy 100,000 shares, and the market says there are 100,000 shares available at $15, the order should complete at $15.

As long as they submit their matching order while my bid is still on the books that's fine. But why should I be required to keep my order on the books for any longer than I want to?

You should be able to cancel you order at anytime. What you shouldn't be able to do is to stiff other people's trades, and then use a microwave antenna to change your order before the other person trade arrives.

What you think is happening in the world is not what's actually happening.

What's happening:

1) A large block of shares is traded on exchange #1.

2) HFTer notices #1 and very quickly updates the price at which they are willing to buy/sell on exchange #2. No one has any sure knowledge of trades on their way to exchange #2. They can guess. They can infer. But they aren't seeing any actual trades before they hit the exchange.

Please explain how you would do this in an open outcry market.

You're talking about front-running the trade inbetween the "sell" decision and the receipt of the signal at the exchange. In otherwords, your bid/offer is in bad faith. I can advertise a car for sale and then when you walk in remove the price and mark up the trade. You cannot do this in an open outcry market. Because it would be subject to retaliation (of various kinds).

Providing bid/ask indication in bad faith is NOT liquidity. Liquidity is not layering a trade to double the volume.

HFT does not increase liquidity. It increases volume, at best. But so does front-running. The bait and switch issue and the front-running issue not interchangeble, but they are closely linked.

Market micro-structure is difficult to discuss because most people are completely ignorant of the mechanics. Its easy to pass of volume for liquidity and to disquise front-running as "market making" or speculation. It is clearly distinct.

Market makers are in the business of selling liquidity. They're saying "maybe no one else wants to buy/sell this stock but here I am and I always have a bid/ask on the table." You don't have to trade with them. But a lot of people do every day.

Why do you think those people are trading with market makers if they're doing such shady things?

I don't think you really understand the business that market makers are in. They aren't in the business of trying to front run people. They're in the business of making a penny a share on all the trades that go back and forth. But they face a big risk. When they're busy buying/selling for $50.00/$50.01 what happens when a big & smart hedge fund guy comes along who has new information and knows the price should really be $50.10. They try to buy up as many shares as possible at $50.00 and suddenly the market maker is fucked because they're no longer market making in a stable market.

So the market maker has this big challenge where they have to do a good as job as possible detecting the big & smart hedge fund guy and quickly adjusting the price so they don't get squashed. If they can't do a very good job they have to increase spreads so they make more money in the steady state to make up for their bigger losses. If they do a really good job in this detecting they can lower spreads.

It turns out that HFTers are really good market makers. You can see this because they've successfully competed against each other to the point that they can lower spreads all the way to a penny (a 10x reduction of where they used to be!).

When you look at it this way you can see that market makers aren't trying to screw the big traders, they're trying to avoid getting screwed so that they can better serve everyone else by offering lower prices (lower spreads).

The nice side effect of all of this is that price information gets better communicated to the market faster. If you happen to be randomly selling your MSFT when Mr. Big & Smart shows up you're more likely to get the best possible price due to all the information being correctly communicated to the market.

You're missing the point that front running is capital efficient and ~zero risk. There is no discussion of hedging strategy and cost, etc in your reply. It seems plausible that (unobserved) front-running profits could easily subsidize (observed) low-spreads as loss leaders.

What front running? Are you talking about arbitrage between exchanges or something else?

Anything that starts after "buy/sell" electrons are entered into a book [#] and includes a pricing mark change before "fill" hit my account. This set of trades is broader than what you might imaging, but specifically I'm interested in any trade that (1) has information incorporation; and (2) dependent logic based on (1) and (3) requires sequential execution (ie, fronting). It is not enough to say these trades are not observed. They have to be shown to be impossible (or unprofitable). There is reasonable evidence that they are both possible and profitable in Lewis's book.

# This includes both voluntary and involuntary disclosure.

OK, well I haven't read the book (only the NYT excerpt so far) but I am highly skeptical that such trades are happening. I will read the book though, and reserve judgement until then.

The person I want to buy the stock from is only offering the shares at 15.00 and I think that is a fair price. Why should someone jump in between the two of us and buy the stock for 15.00 then offer them to me for 15.01.

This would be like going to an open house where you here someone say "I'm going to offer $1,000 over asking" then going to the seller and offering $500 over asking. Then going to the first person and saying you'll take that offer of $1,000 over asking.

You could claim that you provided liquidity and that you helped speed up the transactions but at the end of the day you made $500 for undercutting someone who already intended to make a purchase.

I didn't provide liquidity in that case, I provided risk mitigation. You see the person who said they are going to offer "1000 over asking" hasn't done it yet. Any number of things can happen before they do, and that may not ever happen. My real bid of $500 over asking is a bird in hand.

So who asked you to provide any service of risk-mitigation, liquidity injection,etc..?

This is about 2 parties that are ready to agree to a transaction and a 3rd party injecting themselves into the transaction and taking a penny of the deal.

Imagine that you go to the grocery store to buy some milk and as you are about to checkout someone buys your $5.00 milk and tells you the price is now $5.01. And that the $0.01 increase includes spoilage insurance. Maybe you like that, maybe you don't, the issue is that you had no choice in the matter.

In your original flawed analogy the seller of the house has every right to reject my +500 bid in order to wait for a better deal if they think one is coming along.

In your current flawed analogy you are assuming that there is a fixed price for the things you are buying when there aren't.

Let me offer my own flawed analogy to explain what is actually happening in the latency/venue arbitrage case.

You are a real estate developer who wants to redevelop a block. On that block are 10 relatively equal properties owned by 10 different people. On day 1 you go to the first owner on the block and offer 100K for his shop, he says yes. On day 2 you go to the second owner and offer the same 100k. Again a deal. On day 3 you go to the third but they won't sell for less than 200k because they've been talking with their neighbors and know that someone really wants these properties. On and on until you get to the last owner who won't take anything less than 900K which you pay. Now you can say that you are being taken advantage of but I'd argue that it is just as morally questionable for you to low ball those original property owners when you know their property is worth more than what you bought it for. Conversely, let's say you balk at that 900K and walk away from the deal. Is that last owner "out" 900k? Are they out 100k?

Now lets introduce these nefarious third parties. Let's say I notice that you are buying those properties and while you are negotiating with the third property owner, I offer 200k to all of the remaining owners at once. If they agree and I offer them to you for 300k, I make profit on the deal, you still get what you want (at a cheaper overall price) and the original owners are all paid a consistent amount for equivalent properties. Also, if half way through you decide that this deal is no longer for you and stop buying up properties, I am "stuck" with those properties that are now not worth as much as I paid for them.

" seller of the house has every right to reject my +500 bid in order to wait for a better deal if they think one is coming along"

You know that someone else just said they were going to offer 1000 over asking. The seller doesn't know that. You have an advantage.

" you are assuming that there is a fixed price for the things you are buying when there aren't."

When Bob offers stock X for 5.00 that is fixed until he cancels that order. Just like the milk, it is 5.00 until the store changes the price.

Your analogy implies that I need all the properties on a block. That would be similar to a hostile takeover where someone needs to buy 50+% of a company to take control.

Are you aware that HFT are not making their money by detecting hostile takeovers?

Can I hazard a guess that he is aware of how HFTs make their money, and further point out that one of the reasons he has an unusually specific amount of detail to offer about how electronic trading works is that he is in fact an electronic trading software engineer?

Further, your attempt to poke a hole in his analogy is itself flawed, because you have a poor working notion of the scarcity involved. "There aren't just 10 shares of MSFT in the market" is what you're thinking, while ignoring that there is a finite amount of MSFT offered a price compatible with your investment goal. You can't think of the total amount of MSFT that exists. To reason about the market, you have to have a notion of what you're willing to pay for it. Many people who hold MSFT are unwilling to unload it at anything near the current spot price. This stands to reason, because if they were willing to unload at that price, they wouldn't be long MSFT.

I guess you don't quite understand how HFT works?

The simplest example is like this:

1. Bob sees that 10,000 share of MSFT are for sell on exchange X at $50.00 and also 30,000 share are for sell on exchange Y at $50.00 and 60,000 shares are for sell on exchange Z at $50.00 2. Bob attempts to buy 100,000 shares of MSFT at $50.00. 3. The HF trader sees the 60,000 order get filled at 50.00 and reasonably assumes that someone is trying to buy more than 60,000 shares right now. 4. He buys the remaining 40,000 shares at $50.00 before Bob's trade is executed. 5. The HF trader immediately lists the 40,000 shares at 50.01

Do you understand how the HF trader is injecting himself into the transaction?

It looks like you just gave an example of a trader buying all the liquidity of MSFT on every market with a single market order.

Good point. You should ignore the previous comment based on a technicality. Since I didn't specify that the 100,000 share purchase was not actually 3 different orders

Aside from the strange example you provided, what's funny is that you focused on a 1 cent price movement. The average bid-ask spread before high-volume electronic trading drove it down was 12 cents --- that was money in the pockets of middlemen. Before electronic trading, the spread could have been measured in dollars.

That is crazy logic. Because international telephone calls used to cost over 12 cents a minute I should let my ISP charge me 1 cent a minute whenever I use Skype internationally?

You should realize that market makers are actually providing a service that they get paid for and be happy that due to automation & competition the price for that service has dropped by an enormous amount.

I don't want that service, I want to buy something without someone else inserting themselves as a middleman.

So you'd rather put a massive amount of money into a clearing firms account so they will allow you to trade, pay the DMA, seat, & transaction fees to the exchange, pay for the software developers who connect you to the exchange, and the researchers that make sure the exchange you connect to is providing the correct prices. All those lawyer fees you pay to make sure you are in compliance with an exploding amount of regulation is a fun item to ponder as you ride the train into the office. You'd rather buy and hold shares you aren't sure are priced correctly because you don't know when the opportunity to buy them again will be. Don't forget getting the fun opportunity to explain to your employees how the exchange busted 1 half of your trade and you went from the best trading day ever to the worst, and by the way every one needs to go home cause we are out of business? Simple, start a trading company.

Maybe you'd rather just skip all the complication of computers and go back to the good old days of monopoly exchanges and pit traders. Then you get to deal with fees that are 10x of what they are now, the joy of dealing with over the phone brokers and the excellent opportunity to get to buy and sell from specialists who are given cartel status by the monopoly exchange, I'm sure they price things with the retail investor in mind right? At least you won't know how bad you are getting screwed cause there is zero transparency into the market. Sounds good? Get some legislation passed that gives NYSE and Nasdaq back their monopolies.

There is probably a third path that involves some sort of governmental agency bid out to a third party for a ridiculous contract that has massive reliability issues and doesn't innovate at all. That might be better, I don't know.

Me, even though I know way more about the dirty pool that goes on in the electronic trading space, I'll stick with sending my personal orders through a large retail broker that charges me minimal fees & expense ratios, and allows me access to the lowest bid/ask spreads in history with instantaneous execution to a broad array of risk management and investment opportunities that only big banks used to get.

I'd really like access to a massive free social network that doesn't sell my data to the highest bidder, but since I'm unwilling to bank roll that, I can either deal with the social network we have, or opt out.

Every time you place a market order, that is the service you are buying.

Then you don't have to use it. You can issue limit orders instead of market orders as described in the post that started this thread. Lots of people do want to purchase liquidity though which is why these folks exist.

(In reality, assuming you're a small retail investor, you don't even have to do what this blog post says. Your transactions are small enough they aren't going to hit the exchanges anyways.)

I know exactly what you mean with this comment, but the idea that anyone can "opt out" of the current markets is ludicrous.

I wouldn't attempt to sell titanium to the Amish for the same reason that no rationale investor attempts to sell stocks without the existing market maker system.

I guess you don't quite understand how HFT works? The HFTer is the one offering to sell the shares for $50.00 on exchanges X, Y & Z. He's also offering to buy for $49.99. His goal is to sit there all day long trading with dumb money making 1 cent per share he transacts.

The HFTer has a problem though. If a big & smart trader comes along with proprietary knowledge that MSFT should really be trading for $50.10 he could take a big loss. If that HFTer buys everything up for $50.00 and then the price moves to far too fast that's bad.

So the HFTer works as hard as he can to detect when this might be happening so that he can update the prices he's offering. A really big signal this might be happening is when someone eats up his whole order book on one exchange all at once. So when that happens he trys to react as fast as possible to updates pricing on the other exchanges.

He's not injecting himself into transactions, he's trying to get out of the way as fast as possible.

TGit least is closer to what is actually happening and is much less flawed.

I still take issue with your idea that the HFT is injecting itself into some preordained transaction. Information that there is a lot of demand for something should raise the price for that thing.

Large institutional buyers already have huge information/infrastructure advantages. Why should they also be given assn exemption from market dynamics that no one else received?

Let me see if I follow:

What you're saying here is that an institutional investor wants to buy MSFT at a price that does not reflect their new demand for 100,000 shares. That order, absent some external force that will put downward pressure on the shares (which, if so, why buy now?) will naturally raise the price of MSFT for everyone in the market.

The investor, in other words, wants something for nothing: they want to trade at a price that doesn't reflect their demand, and for some other market participant to take the hit for selling below the true demand.

Someone pulls into a gas station that says gas is 3.99 a gallon and expects to pay 3.99 a gallon to fill up his car.

Should the price increase to 4.00 as soon as he stops in front of the pump to 'reflect the new demand'?

I don't understand what you're trying to say here. Tradable instruments aren't gasoline. They don't have fixed prices. There is no universe where trading exchanges have ever worked that way.

Someone pulls into a gas station and buys all the gas they have at 3.99 a gallon. Should they be able to cross the street to the other gas station and expect to do the same thing, or can the across the street gas station raise their prices to 4.00?

Yes, in your example the third party has witnessed a change in demand and is now changing his prices.

In my example the Gas Station is doing a bait-and-switch where the price was 3.99 until you pull out your credit card. HF Traders are not doing a bait-and-switch since they are separate entities than the original seller but they are making money off the same principal as a bait and switch.

No repeatedly your analogies incorrectly assume things that are not true about the way HFT works.

In the vast majority of instances the HFT are not buying something and reselling it at an inflated price before another interested party has access to it. They are changing the price on things they themselves had already set the price for.

A closer analogy than what either of our gas stations makes is I own ten gas stations in a line down the high way. At the first one a tanker truck pulls up and takes all the gas I have at that gas station, then at another and another and another so on down the line such that I no longer have any gas.

When I go to replenish my stocks I find out that some big company needs tons of gas and has driven the price well above the 3.99 I was selling for. This means I just took an extreme beating in the selling gas industry. I don't mind, that is a cost of doing business.

Then the next week they come and do the same thing and on and on for years. Eventually, I tell the manager of the first gas station to call all the other managers the minute a tanker truck shows up so we can adjust our prices and not get wiped out.

The big gas company now has to pay a much more appropriate rate for the gas. This drives them crazy so they go on 60 minutes and tell everyone on the planet that the game is rigged because I have this super sophisticated technology that lets me "front run" them.

You hear this and start thinking to yourself, man I can't trust that they are going to charge me more money for this gas as soon as I pull into the station. You start buying less gas and calling your senator. The big gas company then goes on CNBC and says, "See I told you those little gas companies were no good. Now they are eroding the faith of gas buyers in the fairness of the market place."

When in reality all that is happening is that the big gas company can no longer take advantage of me to get cheap gas.

I get what you are saying and i'm sure your analogy is correct in some cases.

Wall St. has a long history of fraud and skimmers so it is understandable to say the HTF isn't that bad relative to other things.

But we should be trying to make the markets more fair and give people more confidence that everyone isn't getting ripped off.

Thus assuming that someone else will always pay the spread. Tragedy of the commons ensues.

But this whole article seems to be written for retail investors. And as much as HFTs may sound scary for retail traders they make their money off institutional trading. So the larger impact to retail flow is from the response Institutional desks are forced to take to ensure they are not disadvantaged by HFTs, which then affects how institutional and retail flows are able to interact.

Ultimately a 1000 APPL.US order will get filled and who pays the $0.01 spread is largely academic as it is an inconsequentially small part of the total settlement $ paid.

> It's well researched.

On what basis do you make that assertion? Just curious...

There is a 10,000 word excerpt in the NYT. Read it and if you have a specific comment or critique on methodology, come back and update this thread. They may or may not be useful comments. There's enough orthogonal variation in the approaches (in terms of data collection, observed reactions of market participants, and analytic consistentcy) to not dimsiss the narrative as "trivial". But YMMV.

So "Because it is on the NYT website" is your answer?

The excerpt from the book is largely the story from a single point of view, I don't see a lot of corroborating quotes, zero footnotes, and the facts are too convenient to the narrative to be the whole of the story.

Pulling one paragraph:

> As it happened, at almost exactly the moment Carlin Financial entered Brad Katsuyama’s life, the U.S. stock market began to behave oddly. Before RBC acquired this supposed state-of-the-art electronic-trading firm, Katsuyama’s computers worked as he expected them to. Suddenly they didn’t. It used to be that when his trading screens showed 10,000 shares of Intel offered at $22 a share, it meant that he could buy 10,000 shares of Intel for $22 a share. He had only to push a button. By the spring of 2007, however, when he pushed the button to complete a trade, the offers would vanish. In his seven years as a trader, he had always been able to look at the screens on his desk and see the stock market. Now the market as it appeared on his screens was an illusion.

His trading problems coincide with changing to a new technology platform and he blames the market and not the new software? Did anyone else experience a severe degredation in their trading performance? Did Lewis even ask anyone else?

NYT isn't the author. Anyway, who would believe and RBC guy? That's why he went to SAC for a quick sanity check.

But as he talked to Wall Street investors, he came to realize that they were dealing with the same problem. He had a good friend who traded stocks at a big-time hedge fund in Stamford, Conn., called SAC Capital, which was famous (and soon to be infamous) for being one step ahead of the U.S. stock market. If anyone was going to know something about the market that Katsuyama didn’t know, he figured, it would be someone there. One spring morning, he took the train up to Stamford and spent the day watching his friend trade. Right away he saw that, even though his friend was using software supplied to him by Goldman Sachs and Morgan Stanley and the other big firms, he was experiencing exactly the same problem as RBC: He would hit a button to buy or sell a stock, and the market would move away from him. “When I see this guy trading, and he was getting screwed — I now see that it isn’t just me. My frustration is the market’s frustration. And I was like, ‘Whoa, this is serious.’ ”

This dispels (according to the story) the notion that it was a firm specific or SW specific issue. Of course you could assume this is fabricated (for convenience). But the next step is harder to fabricate:

He hired Rob Park, a gifted technologist, to explain to him what actually happened inside all these new Wall Street black boxes, and together they set out to assemble a team to investigate the U.S. stock market. Once he had a team in place, Katsuyama persuaded his superiors at RBC to conduct what amounted to a series of experiments. For the next several months, he and his people would trade stocks not to make money but to test theories. RBC agreed to let his team lose up to $10,000 a day to figure out why the market in any given stock vanished the moment RBC tried to trade in it. Katsuyama asked Park to come up with some theories.

This could easily be verified independent of Katsuyama (eg, by talking to either the other principals and/or 3rd parties as RBC management). What is important, however, it it is orthogonal to anecdote. And by putting capital at risk and testing ex-ante theories, not only are they getting on firmer epistemic grounds, but they are leaving paper trails internally and externally.

As they worked through the order types, the Puzzle Masters created a taxonomy of predatory behavior in the stock market. Broadly speaking, it appeared as if there were three activities that led to a vast amount of grotesquely unfair trading.

Of course you could object to this as "fabrication". But there is evidence that they tested SW products to defeat these various strategies. These products were later bought and then spun out and backed by third party customers & investors.

Again, this could all be fabricated. But you would need elaborate conspiracy theories to explain the lack of due dilligence by the investors (not to mention Lewis).