Your comment would be more interesting if it confronted his main point: "There is absolutely NO VALUE to High Frequency Trading. None. We need to bring our markets back to their original goals of creating capital for business. "
That's how market makers make money. They match up investors who want to buy and sell the amount they want to sell at the time they want to sell it.
Contrast to the private corporation that I own shares in, where it's taken me weeks to broker a deal to buy some more shares from another shareholder -- including face to face meetings with many of the officers of the company. We had to have an accountant do the valuation and I ended up buying exactly the number of shares the other owner wanted to sell because this would mean more financing complexity and paperwork for the hardworking officers who should be spending their time building the business.
Maybe your broker gets $10 and the market maker gets $15 but this is a bargain when you consider how much it would cost without them. Imagine trading on the New York Stock exchange when you were in San Francisco in 1860!
Many low latency (high frequency) traders are market makers. Since the first successful offer gets the trade, you've got to be the fastest to survive at this game.
One reason it's hard to make money as a trader is that as people find discover deviations from ideality and exploit them, the deviations go away. "Market neutral" strategies we quite successful through the 90's but are no longer profitable. Today I'm worried about the options market because trading in volatility may alter the relationship between implied and realized volatility and ruin another family of simple strategies that have performed well lately.
Its about what the bulk of the trading is: robots trading with robots without any regard to the stocks they are trading. The big whales are the mutual funds and they have to execute their buy/sells using special techniques of spacing trades out to try to not show what they are up to. Otherwise the HFT spots it (and they usually do) and then front runs all of the trades, just skimming pennies off. What use are they ?
The majority of the trades are not making markets at all, they are just zipping back and forth to collect pennies. If they were market makers then they would hold inventory, but they never do.
NOBODY believes the "liquidity" story. and what about flooding the market with fake bids to cause opponents to get overloaded ? or running tracer LFOs spitting out strange bid patterns just to see if they can detect another hidden program ? what does that have to with market making ? its just robot games.
I developed HFT algorithms in a previous life at a very large, well known bank. The majority of trades out there are in fact market making related. The ones that are market taking are usually at the expense of OTHER HFT algorithms, the ones that are slow and showing out dated prices.
And yes, HFT algorithms most DEFINITELY hold inventory. Some don't, but most do. It's too expensive to get hit on a bid and then try to get rid of it right away. They often hold inventory for days, weeks, even months. I know this for a fact. I can't tell you know much time is spent on worrying about and managing the inventory HFT systems accumulate.
HFT is immensely useful for large mutual funds. They replaced a broken system of high school dropouts who worked on the floor of the NYSE. Mutual funds HATED calling the floor, waiting an hour for execution, not knowing what was happening, and inevitably being taken for a ride. This is all public...go ahead and read a lot of the articles after Thain took over as president of the NYSE and gave tours of the floor to the large mutual fund managers...they were not impressed, to put it mildly.
With HFT, you have transparency and immediacy. You put in an order, and you get that price. In the old days, mutual funds called in an order, and had no idea what they would get, it would be whatever fill the NYSE trader gave them. Executing orders throughout the day makes perfect sense, and is cheaper execution in the long term. You simply get a bad price if you try to sell a billion shares of MSFT in an instant, so instead you spread it over time.
HFT does not front run in any way that is different than trading since the beginning of time. They are trying to understand if their is future demand, and adjusting their prices accordingly. You don't think that after being hit on a bid, the old NYSE floor traders didn't change their prices? They're doing the same exact thing as HFT does.
There's a ton more to say about it, but these are just to counter some of your points.
I wonder how much of the dislike for HFT comes from applying intuition about 2 party trades to a many party market. Mostly, I think people ignore that the HFT systems are competing with each other, not just arbitrarily stepping into the middle of transactions. The latter really violates intuition about fairness.
Here's an exciting company with a spread of $0.01 (at the moment anyway):
http://finance.yahoo.com/q/ecn?s=WEC+Order+Book
My selection criteria was to try to find a S&P 500 component that I wouldn't expect to be among the most highly traded S&P 500 components.
This is precisely the point about HFT. If you are a seller, there isn't always a buyer. HFT is there when there ISN'T the other side. The scenario you described is absurd. How often do a buyer / seller want to interact within the same millisecond?
They can of course. HFT does nothing to stop that. Two people can trade in the open market with each other whenever they want. The reason most of the time HFT is involved is HFT gives the best price. That's why it's become so big. They provide the best price to their customer, not attacking some "flaw" in the exchange.
One of the greatest examples of how nothing nefarious is going on is from a large multi billion dollar hedge fund I used to work at. They have both an equity investment group, as well as a HFT equity liquidity providing platform. I worked on HFT, and knew the equity guys. They always wanted to execute with us in the open market. It was so much better than what they used to have to do.
Why would one of the most sophisticated equity investors in the world want to run an operation that "skims" from the other? Because that's not what HFT does, and of course they know that. They use their own product (their HFT system) to execute their own buy orders. If that's not a testimonial, I don't know what is.
Isn't that exactly the point the GP was making?
If it's bad that one firm capitalizing on the situation of another firm making a mistake is the point, then I think he should really rethink his participation in capitalism.
The problem with the competition between HFTs is that it's turned into a ridiculous arms race to shave microseconds off the response time - how is that in any way productive?
It turns out to price an asset, like a stock, a wide variety of skills is needed. Some people focus on macro trends, like analyzing political events, oil prices, etc. Some people talk to management of the company, count cars at Wal Mart, etc. These are the micro trends.
And some people try to estimate the current supply and demand for a certain stock. That is what HFT does. So yes, it has "regards to the stocks they are trading." Just different regards. That's why specialization works so well. HFT worries about current supply/demand issues, and tries to estimate a fair price to set the market so that when the average investor comes in, and looks at a stock with a 1 cent spread, he is going to get a fair price. Over the long term, people who analyze micro and macro factors will trade with HFT, which will then force the algorithms to change the stock price to reflect their views.
Is an arms race to shave milliseconds off of trading times the most important thing in the world? Absolutely not. But is gaming the Apple app store to get your mobile app higher in the rankings any different? At least with HFT, milliseconds do matter in more situations than you can imagine. If one day you buy a stock that had bad news announced just milliseconds before, and HFT did not update that quickly so you paid a price way, way too high, you would be upset. Again, not the most important thing in the world but it does help.
The millisecond thing is highly overrated. Anyone in the industry knows that it only matters to a small degree…understanding supply demand and adjusting accordingly is the most important skill. That's why the most profitable high frequency firms don't care about what millisecond they execute in…that is one of the great ironies of this--you guys are concerned about something that not many other people who actually do this for a living are concerned about. But you guys latch on this minor point as the major one, and that is a mistake. Do developers worry about how quickly their apps load? Yes. Does it mean their product will be a success? Not necessarily. That is the same thing here. HFT shops work to make sure they aren't too behind, but focusing on that aspect is just trivial compared to the actual work they do.
It has always been in the interest of high volume traders to hide their intentions just as it has been in the interest of all other market participants (including other high volume traders) to attempt to discover those intentions. In this sense, trading now is exactly as it has always been, although it occurs at a more rapid pace.
"Otherwise the HFT spots it (and they usually do) and then front runs all of the trades, just skimming pennies off. What use are they?"
Please explain why it is bad/wrong/unlawful/unethical that other traders may act when a large trader does a bad job of hiding his intentions.
"The majority of the trades are not making markets at all, they are just zipping back and forth to collect pennies."
I don't understand. What do you mean by this?
"If they were market makers then they would hold inventory, but they never do."
I assume this to mean that you believe that the definition of "market maker" should include a reference to the length of time one holds a position. If you demand that to be called a "market maker," one has to hold a position for a minimum amount of time, then you will exclude some market participants from being so designated. I don't understand how the definition of this term is relevant to the discussion; please explain.
"NOBODY believes the "liquidity" story."
I assume that by ""liquidity" story" you mean the idea that HFT firms increase liquidity (more size with which to trade, at a better price) and that this is to be valued. Is this not the case?
"and what about flooding the market with fake bids to cause opponents to get overloaded ?"
Deliberately entering unbalanced (one-sided) orders without the intention of trading so as to manipulate the market is illegal. This vague idea is a serious infraction of SEC rules that carries significant fines and penalties. See: http://www.finra.org/Newsroom/NewsReleases/2010/P121951
"or running tracer LFOs spitting out strange bid patterns just to see if they can detect another hidden program ?"
I'm not familiar with "tracer LFOs," please explain what these are. If they are orders or order submission strategies intended to gauge market interest, do you think that they are bad/wrong/unlawful/unethical? If so, why?
They can do the trade slightly faster, and according to the rules of the market, if you place an order to sell with a limit of $50 then someone willing to buy now for $50 beats someone willing to buy a second later for $51. If that's not what you wanted, you should have made the limit $51.
Maybe we need new order types, but that would set off a slew of complaints about additional complexity. And note that eliminating the sub-penny rule would put a lot of the front-runners out of business, since they'd only be making $.001 per share rather than $.01.
We have misinvested countless millions on a system which produces the wrong answer, optimizing for millisecond latencies which benefit neither companies needing capital not investors providing it.
So when BigMutualFund decides they want to buy 50 Million Shares of MegaCorp they try to disguise their order so that the share price of MegaCorp doesn't go up to much as they make their buy. That's absolutely right.
You're also absolutely right that HFTs have made it harder to disguise this action. The HFTs "see" what's going on and start buying shares of MegaCorp at a higher price and then selling them to BigMutualFund. So BigMutualFund makes a bit less money.
So where does BigMutualFund's go? To the HFTs? NO! The HFTs aren't changing the spread width, so they aren't making more money.
You know who makes more money? The current shareholders of MegaCorp who decide that they want to sell! And that's great! Whatever information it was that made BigMutualFund think that now was the time to buy gets communicated to the market faster (in terms of the share price) because of the great work the HFTs are doing.
More efficiency for all!
But the benefits of market making tail off with frequency - would you mind waiting another hour for a deal at 518 or even a whole day? To a trader its unacceptable, to an investor, its a coffee break.
But what drives HF trading is trading - as markets become more efficient trading opportunities, as you point out, vanish. So smaller amounts of arbitrage need to be leveraged with larger amounts of cash to get the same return.
We want nice safe retail banks who make a tiny fraction on the movement of wages from company to employee to shops each year, and bundle it all up into mortgages and ATMs. They keep society oiled
By the same token we (society) wants nice safe boring market makers. Who efficiently take a tiny fraction of each trade and keep liquidity in the markets for investors.
I cannot prove it but the amount of margin gained for investors who hold for >1 year through the existence of HF trading is probably small - you can now get 515 offered quickly. 5 Years ago? 520? If that would have prevented you investing, maybe it was the wrong company.
Some HFT firms have agreements with the exchanges that require them to be in the market providing liquidity no matter what. This is not true of all HFT practitioners, but major key players are required to do so.
secondly I also dislike the justification that HFT is ok be ause it is Market making. I see it as a form of Market making trying to capture the equivalent of the consumer surplus - I was quite happy to sell my shares at 505 and old boring mRket maker would turn and sell them at 510 tomorrow - but HFT nips in buys from me at 504 and old Market maker has to take them at 506
no real liquidity has been added to the Market in that situation - a deal was ready and raring to be done and another just reduced margins. Not bad, ethically fine but not actually adding much to the system
thirdly I dislike broccolli
If you want to sell at 505, an HFT can't change that. Place a limit sell at 505.
If you're not willing to hold out for 505 and want to sell at the market price, you're a liquidity buyer paying a premium (of some sort) for getting out of the market right now.
People love to point out this scenario where the HFT buys something at $9 that a human would have paid $10 for. They never acknowledge the fact that by doing that, the HFT assumed the downside risk; the HFT is now to some extent illiquid and exposed to the market. If the price goes to $11, the HFT wins, sure. But if the price goes to $8 --- which should be equally likely, else why sell --- the HFT is fucked.
Broccoli is delicious. Here's what you do: blanch it in boiling water, just like 20-30 sec, shock it in ice water, and then dry it off. Put it in a bowl, douse it in olive oil, shake some fish sauce into it, cumin, chili flakes, maybe a little sriracha or maybe some lemon juice. Shake the bowl up. Now grill it. Yum. Eat it with sriracha mayonnaise, which is the highest calling of mayonnaise.
in the comics, when Superman is protecting Metropolis and Supergirl turns up, she cannot do anything the Man of Steel could not do - she just looks better in tight blue Lycra.
Kudos for your recipie.
Edit removed my dumb, knee jerk, unappetising broccolli recipie/comment on state of English cooking in my childhood. Nevermind.
Anyway makers have specialisms and get advantages from the exchange - they are not supposed to just bugger off home cos it's Tuesday
Most markets are not specialist markets. Specialists at the NYSE were accused of skimming hundreds of millions of dollars from customers. They're an anachronism and a much more disquieting idea than robots competing to provide the best price --- which is pretty much what most HFT systems do.
If a particular market maker can't work for some reason with some particular symbol [there are thousands of symbols], at some particular time, he would just pause. And they often do.
This is contradictory. If there is only one offer of 100 shares at an arbitrage price you take it and the arbitrage is gone. You can't leverage more money to get higher returns, you're done. Market=efficient wipe hands and walk away.
http://www.chrisstucchio.com/blog/2012/hft_whats_broken.html
http://www.chrisstucchio.com/blog/2012/subpenny_rule_respons...
http://www.chrisstucchio.com/blog/2012/bigger_ticks_more_ren...
Historically, not all market makers were designated market makers.
Some HFTs (e.g. some branches of Goldman) do act as designated market makers, receive these privileges, and are obliged to continue trading. Others do not. Same as always, just with machines replacing people.
High Frequency Trading makes trading stocks cheaper. There have always been market makers. They used to be expensive humans. Now they are cheap computers. This means that it now costs less for you to trade a stock.
So instead of being able to compete on price, market-makers compete on latency in order to be the one making all the monies, resulting in the current arms race.
Cf. this blog: http://www.chrisstucchio.com/blog/2012/subpenny_rule_respons...
That is yummifajita's blog, btw.
It does mean the market demands more knowledge; it's more sensitive now, so you can no longer do a buy or sell "at market" and expect a good price. But even if you don't know how to play the market you can go through a broker and still pay far less than you would've in the "good old days".
His main point: Wall Street doesn’t know what business it is in. Wall Street has nothing to do with creating capital for businesses, its original goal.
He's saying wall street should have an incentive to create/raise capital for businesses, not invest in marginally profitable trading strategies like HFT.
The opportunity cost of wall street investing in trading is that other pursuits like capital raising get less or no attention.
So it's not that HFT is necessarily good or bad, it's that it's a distraction that's not going away, to the detriment of other potentially more value-creating pursuits, like raising capital for new companies.
Wall street knows what business it's in...lots of them. It does bond research, equity research, investment management, sales and trading, and yes, investment banking (to raise capital to all these poor companies that can't find anyone to pay millions of dollars in fees to do)
Do people really think that there are no investment bankers who raise capital anymore? That because of HFT, a job that pays 1mm a year when you're 30 has no more interest to anybody? That there are so many humanities majors graduating from princeton and harvard that normally do client relationship investment banking but because of HFT, they are going to write algorithms and optimize OS code for latency instead?
Have people seen how many layoffs are happening in investment banking division on wall street? (where they raise the capital for companies) It is NOT A ZERO SUM GAME. HFT doing well is NOT AT THE EXPENSE OF CAPITAL RAISING.
What kind of point is this? Is it even informed by any facts?
Personally, I'm not irritated at the nerds (after all, I'm one of them) so much as I am at places like Zero Hedge and Rolling Stone which prey on the ignorance of nerds to drive up pageviews.
And Matt Taibbi was responsible for the legendary characterization of Goldman Sachs as a "great vampire squid wrapped around the face of humanity."
I get it: people like reading this stuff. That's why they write it that way. But I'm saying, like reading it or don't like reading it, a lot of the underlying facts being reported are laughable.