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Comment by reverend_gonzo | Hacker News Reader

Before HFT, there was only a few market makers, which meant the bid-ask was high (if you wanted to buy or sell right now, you'd pay more), liquidity was low (it'd be harder for you to get in or out of a large position and in hard times it would take longer for the market to recover - See 80s crash vs flash crash).

With HFT, there's a lot more competition over the bid ask spread. Trading firms are essentially in an increasingly expensive fight over pennies, which is good for everybody else, since it's cheaper prices, more liquidity, and a more efficient market.

The people it's bad for is the old-school style brokers (which are effectively gone now) and large investmant banks who have a fundamental view on the market (they need to be smarter about executing since the market is more efficient and reacts much more quickly to their buying and selling).

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> The people it's bad for is the old-school style brokers (which are effectively gone now) and large investmant banks who have a fundamental view on the market (they need to be smarter about executing since the market is more efficient and reacts much more quickly to their buying and selling).

What about index funds rebalancing their portfolios? (Honest question)

The Chief Investment Officer at Vanguard, of VFINX fame and widely considered to be among the most trustworthy fund companies, stated that HFT had improved things for firms like theirs.

Index funds, or really anyone with long horizon investment objectives, are major benefactors of HFT. Note, "HFT" really means nothing in modern context, but regardless, what most mean are "Electronic Market Makers". Long horizon investors benefit directly from being able to access cheap and plentiful liquidity pretty much whenever they want to. Spreads are tighter because there is now significant competition to provide that liquidity.

By "fundamental view on the market", I mean those who have done research and know that the price of something is under- or over-valued. These are generally known as informed investors. When they decide some security/commodity/etc is mispriced, they will immediately put a lot of money into that idea, ideally (for them) before the market adapts. With HFT, the market adapts a lot quicker than before, which is better for general investors (who are uninformed investors) as they get a price that's closer to the real value.

Index funds don't have a view on specific securities. They don't perform research to try to get an edge. Instead, they believe that the market is generally efficient, the and they try to lower risk by diversifying across a large portfolio of somewhat related securities, and get a return that closely matches the overall market. As such, HFT helps them by givings them better bid-ask spreads and also providing prices that are closer to the actual value of an asset.

Note that those performing fundamental analysis and buying millions of dollars worth of assets aren't SOL. They just have to be smarter about how they execute.

A nit: informed traders are the apex predators in the ecology that market makers live in. In the literature, market-making algorithms are designed around hiding from them. HFT helps informed investors even more than it helps index funds.

Which brings us to the next question: What is the social benefit of a slightly smaller bid-ask spread and a few milliseconds of faster liquidity? And are these benefits worth the massive amount of wealth extraction from the rest of us that HFTers are engaged in?

That's pretty simple to answer. The smaller the spread, the less going into the pocket of middlemen. Which is where we are now. Less going into the pockets of middlemen than ever before.

>And are these benefits worth the massive amount of wealth extraction

What "massive amount of wealth extraction"? Are you just making shit up?

> What "massive amount of wealth extraction"? Are you just making shit up?

I think he was probably just confused about how HFT works, since unless you're familiar with it it is very easy to assume it is screwing someone.

> And are these benefits worth the massive amount of wealth extraction from the rest of us that HFTers are engaged in?

Unless you were a specialist market maker or pit trader on an exchange there hasn't been any "wealth extraction". Quite the opposite, HFT has taken a system built on being tall, having good connections, and understanding an arcane set of hand signals (not to mention very high fees) and replaced it with a ruthlessly efficient automated system based on being good at writing software and planning network setups (and brought the fees down with it).

For the vast majority of market participants HFT has been a massive upgrade over the old system and dramatically lowered the cost of trading.

The book "Flash Boys" by Michael Lewis chronicles the rise of HFT, and basically argues that it doesn't really provide that much of a benefit.

http://www.amazon.com/Flash-Boys-Michael-Lewis/dp/0393244660...

Standard PSA about "Flash Boys". If you are interested in HFT you are better off quite literally not reading that book than reading it. It is very biased and largely inaccurate.

If you want to read narrative non-fiction about HFT, "Dark Pools" by Patterson, which also has its mistakes, is much better.

Are there any other resources you can recommend for learning more about HFT?

For blog post style reading 'yummyfajitas' series on HFT is good:

https://www.chrisstucchio.com/blog/2012/hft_apology.html

For technical books:

- Trading & Exchanges by Harris (a little out of date)

- Algorithmic Trading & DMA by Johnson.

On the narrative non-fiction side Dark Pools is basically it.

Great, thanks!

There are several books which speak about HFT at a high level. If you are curious about the actual mechanics of stock exchanges and (a bit about) how various parties make their money, I wrote a bit about it at http://falconair.github.io/2015/01/05/financial-exchange.htm...

I would also recommend reading "Flash Boys: Not so Fast" (http://www.amazon.com/dp/B00P0QI2M2).

Written by a high frequency trader. Are there any third parties that have deeply explored HFT and come out in defense of it?

Sure. Vanguard has the widely publicized view that HFT helps to bring down the cost to retail investors for instance

http://www.ft.com/cms/s/0/ff8c6486-cb37-11e3-ba95-00144feabd...

This is a really fun read. Thanks for pointing it out!

Suggest you read this rebuttal. Lewis' book is deeply flawed. http://www.amazon.com/Flash-Boys-Insiders-Perspective-High-F...

Middlemen have always existed in markets. The middlemen have changed, but as you rightly point out, they now take SIGNIFICANTLY LESS than they used to because competition has forced spreads down to next to nothing. You pick: pay a 0.30 spread on a NYSE listed stock or a 0.01. It's sort of a no-brainer.

The thing that most people seem to be upset about is that now market makers generally have few to no obligations to provide liquidity and they are drastically smarter than they used to be.

Ultimately, unless you are slinging enormous blocks, if you send a marketable order through a retail broker these days you are almost always going to get a better fill than the displayed market. Likewise, if you are a large trader you have to be more sophisticated about how you fill your orders, you can't just lift 100k shares even when 300k are displayed unless you do so with a semi-intelligent execution algo (note: these are everywhere these days, and not using one brings into question the trader/brokers abilities and whether they are even qualified to be in the market).

If HFT lets Vanguard lower their costs, the savings of which are passed on to their customers, that's more money in the retirement accounts of regular people.

I just got an email that the expense ratio of my Vanguard target date fund is going down, so costs were reduced somewhere.

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