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