Now mulitply that by 60 holdings which are turned over 100% per year and you can see why pensions would want those mutual funds to save $6,000,000/year in liquidity costs.
(Obviously mutual funds don't just do program trades, they also negotiate directly with each other etc. but the example still stands).
I also know that HFTs are taking money out of the equation, not adding money into the equation. If they weren't, they wouldn't be doing it -- and if the only value they're adding is reducing the time that a trade takes place by minutes or seconds, then I still submit that the value added to the stock market isn't worth the ACTUAL dollar cost.
The OP pointed at the example with Fry and Zoidberg. In that case, Leela either makes $0.05/share on the transaction (which otherwise would have gone to Fry and/or Zoidberg), or takes a hit of $0.50/share. In the latter case Fry (say that's you're mutual fund) makes $0.50/share more than they would have otherwise, but that money doesn't come out of thin air -- it's lost by Leela.
But in order for HFTs to do well, they have to make more money than they lose, so for every case like the above where Fry does better than he would have otherwise there is more money lost by people who would have done better without the interference of HFTs.
So for every $100,000 saved by a mutual fund, much more is being siphoned off by HFTs, for no real added value.
Either this logic, that profit is evidence of value destruction, is flawed or capitalism doesn't work.
You assume that the capital markets are a zero sum game. But by promoting liquidity HFTs make the markets (a) more attractive to play in, and, (b) cheaper for companies to finance themselves from.
Strawman. That's not at all what I said.
In this particular case the only time the market really benefits is when the HFT isn't making money. And I didn't say that "because he's making money it's evidence of value destruction." Just that the only example OP was able to point out that was an advantage to the consumer was when the HFT was losing money.
[Citation Needed]
My thesis above is that there IS no value added. You're saying that they are being paid for value provided, but other than possibly causing the price to be updated more quickly (on the 100 millisecond scale mostly, but possibly as much as a few minutes sooner), I don't see how that provides any real value. And honestly I don't see how even helping the prices move a few minutes sooner adds any value.
In ALL the examples in the OA, if there were no HFTs and you simply WAITED a few minutes, then the people actually making trades would end up with better deals. Sure the market wouldn't be as volatile and instantaneous, but in what tangible way is that a bad thing?
So, again, how does moving prices a few seconds sooner provide value? The examples given all assume the market would be completely static without HFTs, which is obviously bogus. HFTs are only interested in stocks with minimum levels of volume, meaning there would likely already be a lot of liquidity, and they won't touch stocks with too little volume, where they'd actually be useful (OP or another HFT, correct me if I'm wrong).
I think extraordinary claims require extraordinary proof. It certainly seems to me and a lot of other people like they're stealing money from valid transactions by taking advantage of a corner case in the system; claiming that "price setting" adds value when in the very examples given they don't seem to add any net value (except when the HFTs are doing it wrong and losing money!) seems like an extraordinary claim. So where's the proof that the market wouldn't actually be better off without them?
Except for the example you choose to ignore, even after it was pointed out to you.
For a third time: If the only example that causes someone to benefit is the one where the HFT is losing money, then HFTs are motivated NOT to help people.
So no, I don't count an example where an HFT screws up as a positive. If the best you can say is that "some of my revenues are redistributed to people who otherwise wouldn't have been able to make a sale because there were no other buyers for a particular stock", well, sorry, but that pretty much proves my point.
You're claiming to be a Robin Hood, but without the whole moral justification -- you're robbing from random people and occasionally giving some of your proceeds to other random people. The latter doesn't justify the former.
Incidentally, if you feel HFTs add no value, why do people choose to pay them? In my example (and in the real markets), there is nothing stopping Fry from posting a sell order at $10.04 and not trading with Leela. So why does he?
A well-run insurance company spreads risk among all of its customers. There are NON-PROFIT insurance companies that do an excellent job of spreading that risk around (Kaiser Permanente spends 95% of its insurance dues actually paying for medical care, for example). When you buy insurance you're not EXPECTING to have a problem, but you want to be protected if you do. When someone DOES have a problem, the insurance company hasn't "screwed up" -- the entire point of insurance is to cover unexpected problems.
The only time that the insurance company could be said to have screwed up is if they're losing money overall. And in that case they'll eventually go bankrupt.
>why do people choose to pay them?
Ignorance? Given how many times I've seen advice to never (or at least only rarely) place a market order, I have no idea why anyone does.
Or possibly it's just the "greater fool" theory: They will sell to the HFT if and when they think they know better than you do.
You're claiming that the HFTs are providing insurance to the people who are buying or selling? I find that to be a stretch, since the entire point is that you look for sure bets and attempt to only sell this "insurance" to people who (in your opinion) don't need it.
And frankly most people trading in the stock markets don't know they're even "buying" this insurance. If they did, then yes, I could buy your argument. But they don't. And the ability to choose makes all the difference in this case.
I'd like to hear from someone trading stocks for a mutual fund, and whether they would "choose" to pay an HFT.
The reason that we don't have market makers standing around in pits any more -- that computers can do the trades directly -- also implies to me that we don't need those intermediaries at all. There's a lot of economic leeching that goes on in Wall Street, and I suspect that much of it is obsolete. HFTs are merely another symptom of the same problem.
The only time the HFT could be said to have screwed up is if they're losing money overall.
I find that to be a stretch, since the entire point is that you look for sure bets and attempt to only sell this "insurance" to people who (in your opinion) don't need it.
No, you look for bets with a 90% chance of collecting a $0.10 spread and a 10% chance of a $0.50 price drop (for a net profit of $0.04/trade across many trades). Actually, the odds are usually much worse than that, if your expected profit/share is greater than a penny, you are doing fantastically well. Any HFT who hunts for a sure thing isn't making any money - there are far more 51% gain, 49% loss opportunities than there are sure things.
There may be far more 51/49 opportunities. However, saying that HFTs hunting for sure things isn't making money is far from true.
I worked for a UHFT firm that had a winning percentage of more than 95% of the time. The 5% losers had VERY small losses too. All arbitrage trading. Not market making like everyone seems to be focused on in here.
This assumption is questionable. There are a vast number of market participants who do loose money.
The best start up example is the bias toward reporting companies who just got funding and not reporting all the companies that hit the dead pool.
We don't really have a good idea on the net of HFT strategies and it is just as safe to assume they net zero.
Lets just say HFT firms did net to zero, would you still have the same argument?
Sorry, crazy premise. If a particular HFT netted less than $100k/year, I'd be surprised if they kept doing it, and I've certainly heard of HFTs who made in excess of $400k/year.
>There are a vast number of market participants who do loose money.
Irrelevant. It's not about whether people ever lose money, but about whether HFTs add any real value to the market. If no one can give me real evidence that they do, then I say that the rules should be changed to make such trading unprofitable; if it went away, then the people who are actually buying stocks as a medium to long-term investment would make MORE money (on average), or at least lose less.
Mutual funds beat the bench?
Hegde funds?
Airlines? They spend a ton of money on fixed costs.
Some make money some do not.
An HFT investment likely involves someone deciding they want to create an HFT fund, going out to institutional investors and selling them on the idea that THEIR fund will be profitable.
That happens over and over and investors in these HFTs (as well as hedge funds, PE etc. all think they are picking winners who can make it work. Whether they can or not will depend on execution.
Investment in a sector, industry, or asset class does not mean there is net winning from that sector.
At the end of the day, HFT is still competitive since they are bidding against each other (hence the arms race for faster equipment). Even if the market is growing for HFT now, it does not mean it will be forever. At some point it will become mature and all that will be left is net negative HFT profitability with all the benefit going to investors in the form of liquidity.
I am not backing up HFT because I trade in HFT, I do not. I am backing it up because I find it agitating that smart people on HN look at HFT and assume because they are smart, and because they don’t understand it that it must be bad. If something in the market is happening you don’t fully understand it really pays to sit back for a second and think about it.
(I’m guilty of not doing that with a variety of topics too and I do not fully understand HFT, but I understand enough to say that I cannot say with any certainty that it is bad and lean more to saying it is net good.)
I wonder if ETFs would have ever grown as large as they had if HFT never existed (the time periods of the rise of ETF parallels to the rise of HFT.) Anybody have any insight here?
ETFs control tracking error, how closely the ETF follows the index to which it is benchmarked, by letting authorised participants (APs) arbitrage the ETF against the underlying. For example, if you are a SPY AP, you can turn in a certain quantity, called the creation unit, of S&P 500 constituent stocks and "create" the correct number of ETF units. Alternatively, you could surrender a creation unit of SPYs and the ETF trust would "destroy" those ETF units and issue you the S&P 500 constituent stocks [1].
The risk for APs increases non-linearly vis-a-vis the liquidity of the underlying. This has been empirically witnessed as a "U-shaped relationship between fund premium and market liquidity, which suggests that more active trading does lead to lower mispricing but only after a certain level of liquidity is reached" [2].
[1] http://www.londonstockexchange.com/traders-and-brokers/secur...
[2] http://onlinelibrary.wiley.com/doi/10.1111/j.1468-0416.2008....
Edit: I am assuming here that we are talking about trades that actually change my long-term position. That is, I am selling or buying those million shares for good because I am re-weighting my portfolio or something like that.
While $6M in not large by percentage, there is no reason to want to give that up.
On the other hand, imagine a world of only portfolio managers and no HFT. That is, trades happen only between portfolio managers with no middle man.
Then yes, on one day you as a portfolio manager would have to give up $6M. But where do those $6M go? Logically, they must go to another portfolio manager. By symmetry of portfolio managers, it follows that on other days, you will be the one who gains $6M. That should net out to zero on average, at least assuming that all portfolio managers are equally sophisticated.
On the other hand, the HFTs earn money, otherwise they wouldn't be in the business. Where does that money come from, if not from the portfolio managers?
So it seems that as long as you're looking at a narrow micro perspective, the story makes sense. But once you add up everything to a macro perspective, the argument vanishes.
This does not necessarily apply against algorithmic trading in general. Algorithmic trading may well serve to always have some orders in the order book even on low volume markets, since humans just cannot trade on as many markets simultaneously as a computer can. But the arms race to ever lower latencies just seems useless from the point of view of society.
HFTs will not net positive out over the long term so they are not taking away from other investors. (this is based on what I said in another comment above).
Mutual funds trade huge volume and need liquidity to take advantage of market research. Without liquidity their size would require them to stay smaller and require more investment professionals for any dollar amount they have under management. Without liquidity you would see smaller and smaller mutual funds as their capacity got capped which would lead to higher expense structures for investors.
--- As far as the arms race, I agree with you.
But the arms race to ever lower latencies just seems useless from the point of view of society.
5 years ago it made sense and helped investors, now or at some point in the future the market will reach the point of dimishing returns from incremental small gains in hardware. At the same time HFTs will be investing more in hardware than they will be netting out of the system. Soon, if not already the HFT business will be mature and they will net negative and become consolidated. At that point (if it hasn't happened already) HFTs will have benefited the market with additional liquidity but any profitability long term will be negative.