Can someone explain what value HFT actually provides to society at large? Why not add a one cent tax to every trade and wipe out HFT completely?
Edit: Whoops, I'm incorrect. This is a description of market making in general, but not how HFTs do it (which have a variety of strategies). But the general premise is that the value provided is still increased liquidity. That being said, not all HFTs employ a market making strategy.
One common HFT trick is exactly the opposite of what you wrote: they'll attempt to identify probable sellers of large blocks who are disguising their actions by using smaller blocks (they can identify this by measuring latency orders arrive at different exchanges), and then using knowledge of the order books at different exchanges to buy the large block at 10.00 from the seller who was already committed to sell and then sell it at 10.02 to the buyer who was already committed to buying.
They can do this because the institutional seller is using the NBBO based on the SIP, and they're watching 200micros ahead using direct feeds.
Edit: Ah you added an explanation, thanks.
However, why do you think that "no value to society at large" is a good enough reason to tax or wipe out an industry? Taken ad absurdum, Most people on this earth do not provide any value to society at large, and never will - maybe we should wipe most of humanity?
There are thousands of examples of middlemen and industries that provide values to themselves only. What's your criteria for being a "wipe out" candidate?
Care to name a few? These are great startup opportunities.
That seems like saying that grocery stores don't provide any value because they just buy the food and then sell it to you?
Or, alternatively, like saying FEDEX doesn't provide any value because they just bring things from one place to another (buying it from one place for $0 (plus an agreement) and then selling it to you for $[0+x] (and also the fulfilment of the agreement) , or alternatively, buying it from you for an agreement and $[0-x], and selling it somewhere else for $0 and the fulfilment of the agreement)?
Doctors in New York, where it is illegal (!) for you to request a medical test, only for a doctor on your behalf - and the results go only to him (not sure if he is allowed to refuse to show them to you - but I suspect he is).
Most HOAs in the US, those in Texas being especially egregious.
Car Dealerships in states where you must go through them (Tesla has been fighting this; consider the absurdity in that Tesla is allowed to ship you a car from another state, but not sell it in that state).
Various government agencies I will not name so that I don't get on their [s]hitlist.
Whether or not we consider what the article describes as "frontrunning" - I'm not sure. Surely all these firms have bought access to the same Nasdaq direct feed, and have co-located their boxes as close to the Nasdaq servers as possible. I'm guessing the buy side and the sell side are both doing this at this point - either directly or through 3rd parties. My point is that yes, the advantage exists - but is probably getting reduced by the day. Is the retail trader going on SIP getting prayed upon? Probably, but retail traders also make up a small portion of total trades. That's not to say it isn't a problem - but they aren't the major market participants. Mutual funds are probably the biggest losers here - and they are, in turn, owned by individual investors. So there's an argument there that they are hurting individual investors that way.
To me the real question the idea that these firms are essentially riskless. I'd agree that has been the case in the past - I've seen reports of HFT firms having something like 300+ winning days. But what happens when the entire market is made of competing bots - will the efficiency the competition essentially take away any advantage that any one player might have, thus making their profit disappear?
Saying you have N number of winning days is largely immaterial as that usually means "trading profit" ie it does not account for the price of doing business and would not be considered profit in other businesses. Also, there are lots of easy to devise schemes for making a little money often, but most of them lose a lot of money occasionally.
Finally, HFT profits have already disappeared (at least in the market making space which is where these venue arbitrage volume numbers come from). It is a low margin race to the bottom that is now being propped up via legislation (the sub penny rule in equities).
I don't think the article is saying that they are front running via seeing their order - they are saying that an arbitrage opportunity exists because of the difference in speed of the two data feeds.
"Saying you have N number of winning days is largely immaterial as that usually means "trading profit" ie it does not account for the price of doing business and would not be considered profit in other businesses. Also, there are lots of easy to devise schemes for making a little money often, but most of them lose a lot of money occasionally."
Oh I agree - of course it doesn't say whether or not are, overall, making money. But that's not the point - they're saying that their systems made money 300+ days in a row. Even if that is a small trading profit, that shouldn't really be statistically possible. But you're right that the numbers may be (and likely are) a PR activity by a given HFT firm as much as anything else.
"Finally, HFT profits have already disappeared (at least in the market making space which is where these venue arbitrage volume numbers come from). It is a low margin race to the bottom that is now being propped up via legislation (the sub penny rule in equities)."
Interesting - what, specifically, about the sub-penny rule is propping that up?
What is actually going on is simply that HFT firms tend to make a lot of small uncorrelated bets on the market, each of which has a pretty unimpressive winning percentage. If you make money on 51% of trades, and make one trade per day you'll have a losing day roughly every other day. If you make 100 trades per day it will be much rarer that you have a losing day, and if you make 1000000 trades it will almost never happen.
This is simply the law of large numbers, as you increase the number of samples the realized return will converge to the expected return (which is positive), far from statistically impossible.
The risk is not that the strategy will lose money. The risk is that someone else with better infrastructure comes along and takes ALL the cake. And the infrastructure isn't cheap.
It's no different to a restaurant or a clothes shop. You can easily ensure that your price is above cost. What you can't ensure is that people will come, and you'll lose by not being able to do enough trade.
Market makers are people that take no long term view on price movements, just try to provide liquidity in the short run, collecting the spread and trying not to to accumulate positions that are too large either way. Without market makers, prices would be much more volatile (they would just move a round lot because of short term fluctuations of supply and demand with no long term predictive power).
Basically you can think that market makers charge you a small (very small in case of HFTs) fee in exchange for the risk they run for holding inventory for a little bit and in the process reduce volatility.
Before HFTs, market makers were people that had seats at exchanges, which had much more of an information advantage over normal market participants and who certainly charged much larger fees and ripped off people more. The current system, with HFTs playing that role, is by any measure better for both retail and institutional investors.
(disclaimer, am an HFT trader)
HFTs make markets when markets least need liquidity, and they consume liquidity by fleeing the markets when it is most valuable.
As such, an HFT provides service when it is least valuable, and he doesn't just stop providing the service, he actively consumes the resources when they're most needed by society.
edit: downvote me if you like, but what I'm saying is absolutely true. HFTs consume liquidity as vol increases.
First of all, HFTs have certainly taken over market making functions in today's markets, almost entirely in equities, to a lesser extent in some other asset classes.
Yes, it is true that some HFTs will stop trading during extreme volatility events (but they are not consuming volatility either, merely not providing it any more). But the same was true of human market makers of the past (there is a famous story of NASDAQ brokers simply stopping to answer their phones during crashes in the '80s, even though they were required to always make markets by regulation) - so who are you comparing them too?
The flip side is that HFTs (as any market maker) make more money when the volatility is high, so they have strong incentives to get back in there providing liquidity.
Secondly, when an HFT sells out their inventory (which is the most typical response to vol), they consume liquidity on their way out. If they held the inventory what you said would be true, but they don't.
Third, the idea of strong incentives for HFTs in the case of high vol sounds true, but isn't. HFTs flee because their models don't cover the fat tail scenarios and/or there's the concern that they'll get on the wrong side of a broken trade. Some non-HFT algos do this, but HFT basically doesn't. You're trying to steal credit from actually useful people here.
"But the same was true of human market makers of the past..."
This is my favorite part of your rant. You admit that you were lying, but then pretend it's fine because 30 years ago markets were also filled with sociopaths.
Today's real market makers are mostly algorithmic, but they're distinctly not HFT.
> This is an often repeated claim, but things do not become true by repetition.
And yet there you are, repeating lies again and again...
I guess I'd lie too, if the truth meant that my entire career was dedicated to something that is a net negative to society; if it meant admitting that my entire existence consisted of finding ways to capture value that other (better) people created.
Yeah... I'd lie too if I was you.
Firstly, not sure what you think the distinction is between HFTs as opposed and "algorithimic market makers". I think most people would equate them, for instance most would agree that firms like Virtu Financial and Knight Capital Group are both HFT firms and market makers (for instance, they are Designated Market Makers on many NYSE securities, the closest thing we have to an "official" market maker these days).
Second, HFTs definitely make more money in moderate to high vol (the current period of prolonged low vol in the markets has been pretty hard for the sector), and during those periods it seems even you agree that they are providing liquidity - and I would argue, adding value.
During extreme vol events, yes HFTs will pull out of the market, but so does everybody else. If they can manage it, they will liquidate positions, but their books are small relative to other players, I am skeptical that this is an important factor in further increasing vol, will stand corrected if you can point to me evidence it is.
If HFT is really making vol worse, then why are we not seeing higher vol since it became prevalent? Certainly, we have had periods of great macro uncertainty in the last half a dozen years, but there was no apocalypse in the market.
Finally, my point in bringing up the NASDAQ broker example, is that HFTs perform an important function as market makers. If you want to get rid of HFT and do not propose who's going to take their place, I have to assume we would go back to the old system of human market makers. I think pointing out their flaws is entirely fair.
It's easy to demonize HFTs, but nobody forces you to trade with them. It would be relatively easy to setup a darkpool that does not allow HFTs to trade there. Some people have tried this (or at least to market the notion that they tried), but inevitably they decide they need HFT liquidity and end up courting them instead.
A question for you: why should HFTs be held to the standard that they "provide to society at large"? There's hardly any business that in and of itself (ie not taxes and jobs, which HFT also does) that helps everyone in society. You go to a restaurant, who benefits? Society? I doubt it. You take a cab, who benefits? You go to a hair salon, a supermarket, a gas station, a used car shop, a clothes store, who benefits? Save for the fact that the presence of the shop gives everyone a free option to acquire the goods/service they sell (just like HFT), nobody benefits apart from the customer.