The short explanation is that the speed is a tool for managing risk (like most other market tools) and by removing it, you remove that ability. That risk must be priced into the market somewhere and that will be in the spread that everyone pays.
Will that be worse than what we currently have? Who knows, but what we have is working pretty well with regard to providing liquidity (it is cheaper and easier to get in more markets than ever before and the margins are as low as they have ever been on providing it), so why mess with something that has so few down sides?
> Surely there must be worse things than stock market computer systems being confused?
There are, but Bloomberg doesn't specialize in them, and they don't garner nearly the HN upvotes.
When I look at high frequency trading, it says to me that the game is rigged. It's like going on Jeopardy up against a machine contestant that always buzzes in first.
How on earth can I possibly succeed as an individual investor in a trading environment where institutional investors are so privileged? How many other ways is the ostensibly neutral marketplace overseer profiting by offering those who pay-to-play opportunities to shave pennies, nickels, dimes, and dollars from me?
And when I hear this complaint, I don't understand the rationale. Why shouldn't participants that do something professionally, invest in infrastructure, invest in research or other kinds of IP have an advantage. If they didn't that wouldn't be a market, that would be a lottery.
Quite simply, the market dynamics that make it such that you might want to be involved in it as an individual are created by the sophisticated market participants engaging in individual zero sum trades that add up to a beneficial whole and they have been for hundreds of years.
Computers have made this process more efficient and you should be celebrating your ability to trade for cheaper than ever. That you don't is a sign that you don't understand how the markets work now nor how they have ever worked.
Edit: the more I thought about this, the more I decided it was overly harsh. I think well informed participants can disagree about the values of HFT and needn't celebrate it. I do think that the idea that markets don't (or shouldn't) reward more engaged participants is fundamentally broken.
Economists have sort of argued that it was impossible to succeed in the way you're talking about since long before HFT came along. The classic explanation is presented in https://en.wikipedia.org/wiki/A_Random_Walk_Down_Wall_Street.
We're talking on the order of zero liquidity for 30% of the days (weekends and market holidays) in a given year, and severely limited liquidity outside of market hours.
If liquidity was as important as we like to say, this just wouldn't be the case.
"If liquidity was really required at the millisecond level, market participants would not accept markets being down for holidays or weekends."
But that is not the point of the millisecond (or sub) resolution. The point is so that the people that provide the liquidity during operational hours can add as much information as they can into their pricing models, thereby requiring them to take on less risk with each bit of liquidity they provide. This less risk gets passed on as savings to the rest of the market participants in the form of smaller spreads. Any increase in that resolution increases the risk to the market makers, who will therefore need to increase the spread to compensate, making trading for everyone more expensive.
This would be true if the markets were only open 4 hours a week as well, though trends are towards more 24x5 (at least) trading, not less (and I think that is a good thing).
Soft-realtime systems in C++ instead of safer garbage collected runtimes.
Parsing market data on FPGAs or Cell processors instead of in code written with emphasis on safety.
Distributed trading systems that couldn't afford the latency budget to pass everything through centralized risk management, and therefore not taking into account the entire order book before authorizing a trade. Instead a series of compromises and less optimal failsafes.
It also just lead to more expensive practices--communication between threads using spinlocks instead of the normal waking a waiting thread through a system call; basically converting the spreads we could capture into data center waste heat in order to beat out the next guy.
Artificially slowing things down a bit would have just reduced costs and increased safety for everyone.
I'd also suggest that your experience (many of which I share) do not necessarily mean that speed is making things riskier, only that your centralized risk management was not as good at lowering the cost of risk as opposed to getting fast. As for the dc energy to spread arbitrage game, that is the result of far reaching policy decisions well outside of HFT and I largely agree that energy is too cheap.
I think that any artificial slowing of the market is likely to have really bad unintentional issues. I'd much rather we incentivize the market to fixate on something we care about (ie price) rather than try to subvert the laws of the market.
One approach that appeals to me is to remove the sub-penny rule that is artificially propping up spreads.
Why? It could severely hurt market liquidity (which everyone claims is so important) if there is a mistake that sparks a panic.
> was not as good at lowering the cost of risk as opposed to getting fast
Can you reword this a bit? I don't understand what you are saying.
> I think that any artificial slowing of the market is likely to have really bad unintentional issues.
Can you give some examples?
> One approach that appeals to me is to remove the sub-penny rule that is artificially propping up spreads.
This would be a decent thing to do, it would take some money out of market making, reducing the returns fueling the latency arms race a bit. Lower returns would also give less justification for some of the risks that are taken today.
A transaction tax would help in a similar way, but work more broadly against other high volume, low latency, low value traders. Index-to-underlyings arbitragers (maybe not the best example; sub-penny would decimate (hurr) them as well), etc.
Because we've seen what happens when a very major market maker blows their risk configs, it is a headlines day but the market largely recovers quickly. I'm more interested in systematic risk and I believe that any "fix" to the speed issue in HFT is likely either just going to shuffle advantage from one group to another or have unintended consequences.
> Can you reword this a bit? I don't understand what you are saying.
It was more risky to be slow than to use a central (and assumedly better) risk system. At least that was the implicit lesson learned from a market maker not using their own systems. I understand trading incentives enough to realize that might have been short term thinking trumping long term thinking, but I'd rather adjust the incentives there as well (long term bans from trading for risk limit violators maybe?)
Further, I want market makers to be able to be innovative with some of their risk controls, as I believe that it could lead to better risk controls more broadly.
> Can you give some examples?
The most common response that people trot out to "fix" HFT is to introduce batch auctions. I believe that this a) won't remove the incentives to play speed games and b) will make it harder for market makers to price spreads appropriately leading to them making them more expensive.
A transaction tax is similar. I view transaction taxes as pass throughs that will largely be paid by non-speculative investors. That is, we actually largely don't care (I don't think) about the number of transactions, so why would we use a tax to discourage them? Lets discourage what we actually want to discourage (I'm not sure what that is by the way).
> Index-to-underlyings arbitragers
I'm not so sure. In the short term they and market makers would get wrecked, but I believe quickly they would adjust (or go out of business) and the pricing models would be better for it, and spreads would go even lower.
Knight Capital, for example, was just at the threshold where they were effectively able to be bailed out. Nothing guaranteed it. Other large market makers are owned by banks and are essentially risking capital reserves. We haven't hit a scenario where a hit to one participant has had systemic effects, but that doesn't mean it isn't a risk.
> It was more risky to be slow than to use a central
From this and some of your other comments I see you are taking the stand that every market transaction is about pricing risk, and so talking about risk separately isn't ever a useful concept. Maybe you can say that under lots of abstraction, but it seems to make it unnecessarily difficult to communicate with people who speak of it with the normal meaning.
>innovative with some of their risk controls, as I believe that it could lead to better risk controls more broadly
Decentralizing risk controls in the way I mentioned is strictly worse in every metric but latency. Or at least there was no other explicit reason why we did it.
>The most common response that people trot out to "fix" HFT is to introduce batch auctions. I believe that this a) won't remove the incentives to play speed games and b) will make it harder for market makers to price spreads appropriately leading to them making them more expensive.
I'm not necessarily proposing batches, but a significant fraction of daily trading volume already goes through the opening and closing auctions every day. When stocks are halted and re-opened, they go through auctions as well in many exchanges, just opening right back up conceivably leads to worse pricing than the auction system with published imbalances.
My point about market hours, weekends, and holidays, is that all this stuff is based more on tradition and precedent than any kind of goals. Participants that trade through microsecond latency advantages are extracting a tax on everyone else. A transaction tax takes out a lot of these opportunities, and can be used for something more productive than the waste heat result of running a bunch of spin locks in a datacenter.
I completely disagree with this and have seen no proof of it one way or the other.
One data point that convinces me lacking any proof, is that spreads are tightest in the products with the highest competition for latency. It seems that speed is bringing the tax down not up.
High enough that the firms are at least receiving a normal profit. And given the opportunity cost that all these smart people incur by working in this industry, this normal profit is rather big, and no doubt that the extraction of this normal profit has non-neglible deleterious effects on the economy.
As did the system of pit traders that it replaced. The margins and accompanied spreads are lower now than previously.
> no doubt that the extraction of this normal profit has non-neglible deleterious effects on the economy
As with any market activity, it needs to be compared with the benefits it provides.
Sorry, but a minute delay is definitely not a solution to your idea of unnatural market manipulation. Artificial delays can be seen in the Chinese equities markets - trading halts given a +/- 10% intraday move, trading halts for up to 10 trading days before news announcements, you can only see quotes every half a second -- all measures to benefit retail traders over institutional traders, a paradigm the American markets inherently oppose. HFTs solve that problem by providing retail investors the same kind of access as institutional investors.
>I know "market liquidity" is an argument for allowing HFT, but haven't hard a good explanation about why the economy would suffer so much if the ultra high frequency trading just wouldn't exist.
HFT is a natural effect of electronic trading in contract to traditional forms of market making and liquidity providing. More often than not, thin spreads are often returned back to retail investors.
Other than some anecdotal evidence of "flash crashes" [1][2], how does HFT negatively impact the market?
https://en.wikipedia.org/wiki/2010_Flash_Crash
http://www.bloomberg.com/bw/articles/2012-08-02/knight-shows...
I know "market liquidity" is an argument for allowing HFT, but haven't hard a good explanation about why the economy would suffer so much if the ultra high frequency trading just wouldn't exist.
Note: I have about as much knowledge about this as people who suggest how SpaceX should improve. Just sayin.
Of course computer systems everywhere will have issues with an extra seconds (deltas being negative that can't be etc) but most of those systems aren't trading systems. Why is it that "markets" are in the focus of this? At y2k we were worried about planes falling out of the sky. Surely there must be worse things than stock market computer systems being confused?