High-Speed Trading Isn't About Efficiency—It's About Cheating

http://www.theatlantic.com/business/archive/2014/02/high-speed-trading-isnt-about-efficiency-its-about-cheating/283677/

by gz5 • 12 years ago

148 112 12 years ago

gaius5• 12 years ago

Lost me at That brings us to high-frequency trading (HFT) hedge funds. These funds use computer algorithms—a.k.a.: algobots

No-one says this. I'm not involved in HFT myself but I know a bunch of people who are, there is a jargon word, but it's not that.

cake• 12 years ago

A quick Googling reveals that some people do use algobot to talk about HFT software.

I guess it's a dumbed down idea to sell to the masses.

crntaylor• 12 years ago

You tend to hear high frequency traders refer to the code that makes pricing and trading decisions as a system, or signal, or model, or (very occasionally) algo (all refer to slightly different things) but I have never heard them refer to the code that makes trading decisions as a bot or algobot.

Source: I used to work in high frequency trading.

CoolGuySteve• 12 years ago

I'm in the industry, nobody calls it an "algobot". It sounds ridiculous and doesn't really express much.

I'm guessing someone was winding up the reporter, as from reading the article it seems obvious the person is in over their head.

Reminds me of the (possibly apocryphal) story of how a bunch of teenagers made fun of a 20/20 reporter by describing a made up word "mosh pit", and then it caught on.

yummyfajitas7• 12 years ago

I don't get it. The article first criticizes HFT for making markets rather than speculating, incorrectly asserting that it's somehow a tax on traders (hint: don't cross the spread if you don't want to pay the "tax"). Then it reveals that HFT does speculate - they pay people to do market research and trade on that basis, which is somehow also evil.

Damned if they do, damned if they don't I guess.

The authors reasoning in going from HFT engaging in speculation to a financial transaction tax is unclear. He wants to prevent speculation and information gathering? Or prevent people from speculating quickly?

ronaldx2• 12 years ago

The author's point is clear - that HFT adds no value to society ("socially worthless").

I don't believe that he wants to prevent anything, but he suggests that trades should be taxed to create some value to society from this. He is suggesting their value (at the moment) is exclusively to the benefit of making rich people - who can pay for access early information and technology - richer.

gaius5• 12 years ago

It's not clear what journalism of this quality does to create some value for society. Just sayin'.

rtpg2• 12 years ago

There is a subset of HFT (Arbitrage) that does have a value to society, because it allows you to trade between markets without fearing that you're somehow losing out (Because the arbritage players would have swept that up).

vasilipupkin5• 12 years ago

Traders are already taxed. They make money from their trades and pay income taxes on this trading. If, however, you tax the trading itself, there will be less of it, significantly less and, most likely, the total taxes collected will decrease

pron3• 12 years ago

Damned if they do, damned if they don't I guess.

Why can't the two be bad in their own way? It's like the mob switching from extortion to burglary, and saying, what, you didn't want us threatening people so we're not – now we're just stealing; what more do you want from us? I guess it's damned if we do, damned if we don't...

yummyfajitas7• 12 years ago

I missed the part of the article that claimed all speculation is bad.

I did not, however, miss the part of the article that explained why charging for early access to information is socially useful (it pays for the information to be gathered). But I guess if a human uses that info it's ok, while if a machine uses that info it's evil. Or something.

wcummings2• 12 years ago

How is market makers aggressively competing for positions bad?

muyuu• 12 years ago

It's plain simple trading luddism and it's been going on for decades. There was massive resistance to the computerisation and networking of the stock markets, which only succumbed via foreign competition.

Lots of people who lived on being in a racket where passing orders and pushing buttons was extremely valuable saw their livelihoods endangered. Now the same happens to people who make a living on trivial short-term market decisions. Computers do it better and quicker.

jellicle• 12 years ago

Yeah, any time people object to theft, it's "trading luddism".

bbosh• 12 years ago

The primary function of the stock market is to exchange ownership (shares) in a company. It's odd that we seem to have forgotten that. What value is there in a computer owning a stock for 10 milliseconds?

drunkpotato• 12 years ago

I've read elsewhere on here that the value of high-frequency trading is that it reduces transaction costs and increases liquidity in the market. I.e. it makes it easier for the humans to buy and sell at the prices they wish to buy and sell at.

Assuming that's true, the question then becomes what are the costs and externalities of HFT and, in balance, are we willing to make those trade-offs? I haven't seen anything addressing those issues yet, but I haven't been looking either.

HFT experts want to weigh in, pro/con/otherwise?

yscale• 12 years ago

HFTs tend to add liquidity when it's least valuable, and they tend to consume liquidity when it's most vital.

For example, an analysis of the 2010 flash crash shows it was worsened by HFTs fleeing their positions once volatility increased, which is the exact time that liquidity and market-making are most valuable.

If there is any social benefit to HFT it is utterly trivial.

yummyfajitas7• 12 years ago

Since most of the people commenting here don't seem to even understand HFT, I'll just leave this here (a tutorial I wrote a while back):

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

http://www.chrisstucchio.com/blog/2012/hft_apology2.html

http://www.chrisstucchio.com/blog/2012/hft_whats_broken.html

gaius5• 12 years ago

Sure, but now it's on you to say how long a stock should be owned for, and why that is.

I mean, you could ban HFT and say that you can trade no more than once a second, or a minute, or whatever. Then people would get upset because computers could trade exactly on that second...

AnthonyMouse2• 12 years ago

Then people would get upset because computers could trade exactly on that second...

I would think the way to do it would be to hold every trade open for five seconds during which time either party can cancel it.

smoyer• 12 years ago

That computer is artificially raising the price of the stock for someone who would buy it ... so they marginally either buy less stock, or pay more for each share.

I'm not going to argue that HFT and hedge-funds are necessarily bad (though I don't buy the liquidity argument for stocks that have reasonable volumes), but I don't see how it's helping to fund the company behind the stock at all (or make it attractive to future investors).

graphene• 12 years ago

In the same way as the bid price is increased by HFT actors (which I think is what you're referring to), the ask price is decreased as well, and your hypothetical buyer would benefit from that.

These are two sides of the same coin, namely HFT decreasing the bid-ask spread, making trading (and thus capital allocation) more efficient across the board.

itchyouch• 12 years ago

Actually, it's arguable that among the primary functions of the markets in addition to exchanging ownership is price discovery.

cmb99• 12 years ago

"Price discovery." What a sweetly tight little piece of propaganda. Hnngh.

harryh2• 12 years ago

The primary function of a market is to set prices to facilitate that ownership. The computer is providing value by setting a more accurate price faster.

tikhonj• 12 years ago

A few immediate thoughts:

Transaction volume is ultimately not the important metric--revenue is. And, following [1], it seems that the total revenue for HFT was probably around $2Billion in 2013--for a whole industry, that's not very much! Measuring transaction volume is akin to comparing shipping between Amazon and Walmart ignoring the fact that Amazon ships directly to consumers while Walmart mostly ships to large Walmart stores.

"...increasing liquidity is the last refuge of bullshitters" is not an argument--it's an assertion. That was not really supported. Liquidity is a good thing; the article claims that HFT does not help much because most of the actual benefits happened before its advance. Of course, considering how limited HFT revenue is compared to other forms of trading, it's likely that the benefits are just smaller in proportion.

So I don't see, from the article, that HFT is necessarily socially useless. Rather, I see that it is likely useful in a moderately small way spread out over a lot of people (most people in the markets). The benefit is not obvious or concrete, but that doesn't mean it doesn't exist.

Similarly, the article complains about how bots just quote each other prices without necessarily making a trade. I don't see how this is a bad thing. All it means is that their quotes are at a much higher resolution than manual quotes, that's all. This seems like it would generally be a good thing.

Now, I'm not saying that HFT is not without its own risk or issues--they're just not the issues brought up in the article. Or, in fact, in most popular articles: popular reporters want to turn HFT into a moral issue and paint HFT firms as evil manipulators, when they really aren't. The actual risks of HFT are more structural and technical, which, I suppose, is not great for a broad audience or lots of pageviews!

It's also not immediately clear that HFT should be banned or how to deal with it. Many proposals I've heard would reduce liquidity beyond affecting just HFT, raising real costs for consumers. Ultimately, this is why there has not been much regulation in the space!

[1] http://247wallst.com/investing/2013/03/24/high-frequency-tra...

michaelt2• 12 years ago

See, here's the thing I don't understand about liquidity: If it's so valuable for trades to execute in microseconds instead of seconds, and the stock exchanges recognize this value and provide co-location etc to enable it, why are so many stock exchanges closed for half to two thirds of the day? [1]

Surely the 15+ hour shut downs are a much bigger limit to liquidity than a few microseconds here and there?

There's obviously no technical reason - I don't see Amazon or Google closing down their websites from 4pm to 9:30am. And if it's about the release of news, that only really needs a window of an hour or so.

[1] https://en.wikipedia.org/wiki/List_of_stock_exchange_opening...

sillysaurus22• 12 years ago

I worked in the industry for a little while.

At this point, some companies depend on having that daily downtime. Their whole development is based around the fact that they will have guaranteed downtime. It's built right into their software stack.

Trying to fiddle with this expected downtime would throw (parts of) the industry into turmoil.

It's just a historical quirk, but it's probably here to stay.

SavvyGuard• 12 years ago

I found a similar question on Quora [1], with an answer by an ex-quant. It seems to boil down to tradition and bureaucratic inefficiencies by the involved parties. So I agree, this makes the whole liquidity argument seem weak.

[1] http://www.quora.com/In-the-24-hour-world-why-do-the-New-Yor...

gaius5• 12 years ago

the stock exchanges recognize this value and provide co-location etc to enable it

Not true. The exchanges charge hefty fees to colo in their datacentre. What you do with it is completely up to you. It's just more revenue as far as the exchange is concerned.

why are so many stock exchanges closed for half to two thirds of the day

In practice, this doesn't matter. When NYC closes, trading moves to Tokyo, then onto London, then back to NYC. Anything you want to trade, you can do so 24 hrs a day if you really want to.

rwissmann• 12 years ago

Liquidity during trading hours is important because an open market with little liquidity makes it difficult to to sell and buy assets in significant quantities. Even reasonably sized transaction start having massive effects on price. Short-term price stability gets lost and what you ultimately have is a significant increase in transactions costs.

Ultimately, liquidity during trading hours is a different question from what hours the exchange is open for trading in the first place.

yummyfajitas7• 12 years ago

Trades executing in microseconds is about beating the other HFT. It's useless for consumers.

Price competition (one HFT bidding 10.01 instead of 10.00) and depth of book (the ability to buy 10,000 shares in one shot) is what helps traders.

TheCondor• 12 years ago

Multiple reasons... History being one. They clear the books after market too, it's a big part of catching the crooks and frauds. Almost certainly makes auditing easier.

Is executing trades quickly bad? Or is flipping an equity quickly bad? I cam see no good that comes from buying and selling in milliseconds; the tax should inversely exponential to the hold time or something.

brandynwhite• 12 years ago

Can't agree more (focusing on microsec vs nights/weekends). It's not an excuse to say they need to train/test their algos, they have entirely separate machines for that. For any other tech company live rollouts are a fact of life. I'd suspect the reason is historical and based on a single person's practical workday, if you extend it to 24/7 then naturally you'd have to have several shifts. Same reason why they are closed on holidays, to give people a break. So I'd suspect it's to benefit the people involved and not the machines which I'm certain can be adapted.

a_c_s• 12 years ago

Excellent point! Being able to trade on information revealed overnight would have much greater value than being able to trade at an even smaller sub-second interval.

Since the marginal value of additional liquidity decreases rapidly, I've often wondered if having a fixed resolution (say, one trade per minute) would actually be beneficial.

Nobody can realistically trade a stock based on sub-minute changes in information anyway, and having a fixed resolution would eliminate the advantage some players have by having more servers/etc. After all, if we are chasing liquidity, allowing some players in the market to have an advantage restricts the number of players able to participate which lowers liquidity.

pron3• 12 years ago

popular reporters want to turn HFT into a moral issue and paint HFT firms as evil manipulators, when they really aren't.

First, almost every issue is a moral issue, especially one dealing with the value of a certain endeavor (isn't that what ethics is about? Trying to find the value of things?).

Second, claiming that HFTs aren't evil is as much of an assertion as calling them bullshitters. Most "popular reporters" as you call them (I assume pejoratively) at least support their claim. They say that HFT has little social value, and then claim that putting so much effort into something of little social value is at least morally questionable.

It is claiming that this is not a moral issue that is the more powerful moral assertion here, and quite suspect, at that. Whatever economic risks HFT may entail, its mere existence is first and foremost a problem of ethics.

fennecfoxen• 12 years ago

Much of HFT does have little social value. We could eliminate much of the worst of it by allowing subpenny trading, so trading firms could compete on price instead of on latency.

Maybe you think "sub-pennies? that's just a different kind of insanity." But remember that we're talking per share pricing. So imagine every transaction of every share ever being wrong by an average of half a penny. Imagine you could compete for the money represented by that error, and you could win it, just by having the fastest computers which put in the orders first. Behold: Wall Street as you know it.

wpietri3• 12 years ago

I agree that we could and should treat it as a moral issue, and that avoiding those questions is often a sign that something immoral is going on.

But we can also look at it as a system design question: if we're trying to build an efficient, robust marketplace, what activity do we permit and forbid? What do we encourage and discourage?

Having worked for market-makers, I get the value of liquidity. It's not at all clear that HFT firms actually provide liquidity [1], but even if they did, we'd want to ask, "What is the cost of different sorts of liquidity provided, and which ones do we choose to maximize the value of the market to participants and society as a whole?" So far I haven't seen any evidence that HFT activity isn't purely parasitic. In which case it's reasonable to ask whether we should still reward it.

[1] The most profitable ones apparently remove liquidity from the market: http://faculty.chicagobooth.edu/john.cochrane/teaching/35150...

panarky• 12 years ago

It's not about speed for the sake of speed. That speed allows insider trading and frontrunning.

Insider trading means[0]:

  buying or selling a security, in breach of a fiduciary duty or other
  relationship of trust and confidence, while in possession of material,
  nonpublic information about the security.

How do HFT traders get "material nonpublic information"?

  The Wall Street Journal reports that HFT funds buy early access to data
  from third-party distributors—everything from corporate earnings to
  the Philadelphia Fed's manufacturing survey.

If an analyst at the Philly Fed tells me the results of the manufacturing survey two days in advance of its release, and if I profit from that information and give a kickback to the analyst, that would be clearly illegal.

But if the Philly Fed gives the information to Reuters ten minutes early so they can write a story, and if Reuters sells electronic access to HFT traders two seconds before the public can trade on it, how is that different?

And don't get me started about using HFT for frontrunning client orders[1, 2].

[0] https://www.sec.gov/answers/insider.htm

[1] http://blogs.barrons.com/stockstowatchtoday/2013/05/03/charl...

[2] http://www.nanex.net/aqck2/4442.html

foobarqux• 12 years ago

Early access to research reports is not insider information and is not in general illegal.

First, presumably the report was generated from public information so it is not non-public. Second who are the parties involved in a breach of "fiduciary duty or other relationship of trust or confidence"?

wpietri3• 12 years ago

"...increasing liquidity is the last refuge of bullshitters" is not an argument--it's an assertion.

I believe it's technically an observation, a claim that in the writer's experience, bullshitters fall back on that argument. It's true that he didn't explicitly give evidence for that, but expecting writers to justify every single statement in a short piece that is one of many they write on a topic is another refuge of bullshitters. He's right, though. Bullshitters use that claim because it's a vague, hard-to-verify positive claim that can be made about almost any market activity.

He does support the implied assertion that the claim is bullshit in this case. The only reason we care about liquidity is that you want people the market serves to be able to execute productive trades more quickly and cheaply. If it hasn't gotten cheaper, that's good evidence that HFT trading is not socially useful.

You interestingly also provide evidence that the claim is bullshit. In the article you link, it mentions that the most profitable HFTs aren't liquidity-generating; they are liquidity-taking. That is, they aren't coming into the market with open orders that sit their waiting for other people to take them. They are coming in with orders that match existing offers, removing liquidity from the market. That's from an academic study linked in your article: http://faculty.chicagobooth.edu/john.cochrane/teaching/35150...

dllthomas• 12 years ago

"The only reason we care about liquidity is that you want people the market serves to be able to execute productive trades more quickly and cheaply. If it hasn't gotten cheaper, that's good evidence that HFT trading is not socially useful."

That serves as some evidence that it is not socially useful. It completely ignores "more quickly", and for the strongest argument you should also show that nothing else has happened in that time period that would have increased costs and slowed transactions but for HFT.

"the most profitable HFTs aren't liquidity-generating; they are liquidity-taking"

Sure, the easiest way to be among the most profitable HFTs is to cheat, and the way you act on early information is active orders. That doesn't mean they are the most prevalent - I was not able to find actual statistics on the number of each class (aggressive, mixed, passive) represented in the market, but the sample count for trades of aggressive firms was less half of that for the other two.

Edited to add: Actually at a slightly closer glance, it looks like they were looking only at firms that didn't lose money, which seems pretty worthless. "Active strategies have more divergent outcomes" seems a better explanation of the data then "active strategies make more money" - particularly if the reason for the lower sample count is more "active" firms lost money.

None if this is to say that I think there's nothing worth fixing in our financial system, I just want to be sure we're using the evidence we have appropriately.

tutufan• 12 years ago

On the contrary, the idea that HFT increases liquidity is pretty much obvious if you think about it. It's the assertion of the opposite that needs extraordinary proof, and since the author doesn't provide anything at all, he sounds like a bullshitter to me.

chrischen• 12 years ago

But they're profiting off making the 2 second early access to data more liquid, at best.

_random_• 12 years ago

I don't mind one of the few industries where developers can get relatively good money without being a founder (here in UK).

dschiptsov• 12 years ago

"High-Speed" is redundant.)

With a very few exceptions, modern trading is a form of cheating, based on mass-media powered deceptions (we have full-time satellite channel - TLC, which promotes premium (read: overpriced) and/or "chap-but-healthy" fast-food chains) and "optimizations" such as purchasing a "30% meat stuff" at a penny price and adding lots of spices and synthetic sauces, etc.)

Why should it be different in finance? Especially in speculative trading.)

throwwit• 12 years ago

Are there any protections in place for if an investor is hovering a cursor over a buy button that the stock doesn't get pumped up?

mjstahl• 12 years ago

I don't know how I personally feel about HFT. I don't have a high enough view of the system as a whole to make a determination if HFT is or will be a problem.

But the mention (http://www.cnbc.com/id/100809395) of Reuters selling data to customers 2 seconds before the conference calls (which occurr 5 minutes before the public receives the data) unsettles me a bit. Two seconds isn't a long time except when you consider that HFT operates in milli, micro, or maybe even nano seconds.

I am not sure whether I would go as far as to consider it insider trading, but I do think the conference call and the data meant for HFT should all be released at the same time as the public data.

maxerickson• 12 years ago

But that isn't public data, it is private research.

That a university is doing the work muddies the water, but pretend that a private institute is selling access to its research, what benefit is there in telling it how to sell the data?

stuaxo• 12 years ago

In other news gravity works on apples and spicy food can be enjoyable.

Tycho2• 12 years ago

No new insights in this article.

What I've been thinking about recently though is that the problems HFT companies work on may have unexpected benefits in other fields. For instance they are working on things like machine learning, transmission speed, long range networking, mathematical modelling, and software. If we were to ban HFT we would lose the potential upside of all this. In the words of NN Taleb, this sort of 'stochastic tinkering' is primarily how scientific progress is made.

zacinbusiness• 12 years ago

I've never really understood the stock market. Is this basically how it works?

A person can make or sell things, but that person is limited in the scope of their business by their available capital. Thus, they can increase their capital by either securing a business loan or by making their company "public." Securing a business loan is risky, because they will still have to pay back the loan regardless of whether or not their company makes any money. Going public carries additional risks, but at least they aren't on the hook if the business fails - and there's an added benefit of the potential for enormous gains in capital which can further increase their business potential.

So, the person "goes public" which is extremely complex and time consuming, but let's say they are able to convince 100 people that they should each buy a "share" of the company. This means that the more money that the company earns in profit, that a little bit of that profit is "owned" by each person who owns a share. Right? (I am legitimately asking here, because as I said I really don't understand much of the way it works.)

So, now we have stock exchanges. These are places that people can buy, sell, or trade stocks of different companies for cash or other assets? I own one share of Company A and that share is worth $51 right now. Later in the day, however, we see that company A has earned a little bit more money than we thought it was going to, and so now my stock is worth $53. And I originally purchased the stock for $47, so I can potentially sell that stock for a $6 profit, or I can hang on to it and hope that it goes a little higher.

However, humans can only act so quickly, and day-traders and short-sellers act on stocks in the span of minutes or hours. So if I purchase 10,000 shares of Company B at 10:00 for $5 each, and then sell those same 10,000 shares back at 10:04 for $5.02 each, then I have made a small profit. And large firms do this hundreds of times each day, with dozens of companies, and likely tens of thousands of stocks. Right?

So, HFT does the same thing. Except, instead of making a purchase-sell decision every few minutes, they do it every few microseconds. And the returns per transaction are something like... .0000034 per share (this is a guess), but over tens of thousands of shares, and millions of times a day. Right?

This, however, is where my understanding breaks down completely.

HFT obviously benefits a company that can wield it. If my hedge fund can hire the programmers, run the servers, and buy the licenses to the data then I stand to make huge profits for a minimal investment when my HFT "algobots (lol)" do their thing. But I don't understand how this benefits the rest of the market?

I'm guessing that most of these HFT bots are not being run by small-time investors, and in fact that the trades made by small-time investors will be heavily influenced by the HFT trades that are made in-between the time the guy using E-Trades can point on the "Buy!" button and the time he can click on it.

And as a consumer who does not participate in the stock market (in that I do not have an investment portfolio, I realize that the stock market influences me regardless of whether or not I put money into it), I really don't get how HFT helps me.

What it looks like to me, is that players who have the most money, and who have the best technology will have a benefit over players who lack those resources. And so while there's no evidence (that I'm aware of) that these HFT-using companies are committing any malfeasance, it looks like the natural side-effect is that the market becomes more one-sided.

I would liken this to a professional athlete using steroids (let's pretend that steroids aren't illegal). Steroid use may stem from the player simply wanting to maximize their ability to use their body, and so they enhance their muscles and work hard to be able to control them. This player isn't actively trying to cheat, he is simply using technology to overcome a natural hurdle (let's also assume that this same player has, through hard work, literally pushed their body to the limit of what it can naturally achieve). However, a similar player who has also pushed their body to the limit is either unable or unwilling to use steroids, and thus they are unable to compete against the other due to the slight technical advantage.

Is this a true analogy?

shabble• 12 years ago

I'm not entirely clear on the exact process either, but I think your initial summary has it mostly correct. There are additional complexities in Share Dividends (you receive a fraction of the companies profits proportional to your number of shares owned, which incentivises not-selling, to a point)

The basic issue that HFT (and markets in general) seek to solve is liquidity - the ability to buy & sell when you want, rather than having to wait while a deal is worked out. Consider the differences in process when buying/selling a commodity such as gold, vs buying a particular house.

There's a good overview of the mechanics & benefits of [HF]T in the 'A High Frequency Trader's Apology'[0] series, written by HN member yummyfajitas.

[0] http://www.chrisstucchio.com/blog/2012/hft_apology.html

Lazare3• 12 years ago

That's an excellent series of posts. Thanks for the link!

Lazare3• 12 years ago

Kinda. A few points to help clarify things:

All funds that go into the business will either be debt or equity. Debt gets a guaranteed rate of return, and needs to be paid back. It gets first claim if you go under, but gets no "bonus" if you do well. Equity is an ownership stake; last in line if you go under, but with a claim on all future profits if you do well. The most obvious type of equity stake is your own, but you might say to a friend hey, go halves with me on buying a new lathe, and I'll split the profits from the furniture I make 50/50. That's another example of an equity stake, as old as the hills.

All a stock market is, is your friend saying "look, I've got the note saying I have a right to 50% of the profits of Zac's furniture business, but I'm broke right now; anyone wanna give me $50 for it?". And because in practice this sort of thing is fraught with risk, this is incredibly regulated, but that's all a stock market is; people trading the right to some uncertain future profits. (Well...kinda. There's also the question of control. Some shares give you a say in how a company is run; some don't. That's rarely a factor though.)

Notionally, incidentally, the value of a company's stock is the discounted sum of all future cash flows. If you owe 100% of Amazon, obviously you have the right to 100% of all future profit they make. If you owe 0.0001% of Amazon, you have the right to 0.0001% of all future profit they make. That's the core driver of stock prices; the market's ever-changing estimation of a companies future.

As for HFT...no, you won't make huge profits. The entire HFT industry, globally, makes chicken feed, but they make for VERY entertaining news stories, so you read about them a ton.

Anyhow, as to "why HFT is good", the answer is basically that we all benefit when markets work better, and one way markets can work better is if they are deep and liquid. In simple terms, that means that if you want to buy or sell something, there's always someone there offering to take the other side of the trade for more-or-less the market rate. Conversely, housing is a very shallow, very illiquid market. If you want to sell your $400k house, it might takes weeks or months, and you may find yourself happily paying significant fees to the broker, and maybe even selling it at a discount, just to get the damn thing to sell. If you want to sell your share of Apple stock, it will take microseconds, and you'll get very close to the market rate (ie, low commission/low spread). And while HFT doesn't have a huge impact, to the extent it has an impact, it is to make the market deeper, more liquid, and more efficient. HFT benefits the HFT traders, but it also, and this is really, really, important to grasp benefits every person who trades with the HFT traders. The losers are the "low frequency traders" who would have bought your Apple share from you a little slower and for a little less money, but lost out.

But again, this effect is minimal. The drive for HFT is the race for pennies in an increasingly efficient and competitive market. Small time investors, honestly, aren't the victims here. (Unless they're doing the day-trading, "I can pick stocks because I read a book on trend analysis" thing, in which case...they're absolutely screwed, but no more so now than before HFT. The stock market is not a game.)

And no, I wouldn't say the market is becoming "more one-sided"; that presupposes there being two sides. There aren't; there are seven billion sides. HFT does not profit at the expense of pension funds or entrepreneurs; it profits at the expense of everyone else who wanted to profit from them.

And I think the sports analogy is especially inapt. We want markets to work as efficiently as possible. We want sports to provide a spectacle. These things are not similar.

jchendy• 12 years ago

If you owe 0.0001% of Amazon, you have the right to 0.0001% of all future profit they make.

That totally makes sense for stocks that pay dividends, but how do you claim your 0.0001% of profits for stocks that don't?

moron4hire• 12 years ago

HFT is more likely about front-loading their own customers' orders than it is about reacting efficiently to price changes.

stormqloud• 12 years ago

Anybody that has looking into things like the voodoo of "doji candlestick strategy" etc realizes that the entire market is full of people reading tea leaves.

99% of the portfolio managers, investment professionals have no more luck in picking stock then HFT or these other strategies.

It's basically gambling in one form or another. The ony way to get ahead in that world is to cheat.

HFT by itself isnt; a problem. When juiced with regular insider information, front running your own clients etc it's a massively profitable biz.

The biggest crowd that hates HFT is the stock pickers, day traders (any left?) and others that work int he investment biz.

They have had a nice scam going for the last hundred years and you are ruining their party.

Haw can they go have cocktails at 4 pm every day when computer programmers are working hard all night long?

The other group of course are the luddites. Afraid of any advance in technology. Other favorite causes, "Kids and violent video games". "The 100 mile diet" "environmental anything".

vasilipupkin5• 12 years ago

Here is the problem that I have with this whole "socially useful" line of reasoning: Do we have philosopher kings or benevolent rules who are able to accurately designate social usefullness and ban or allow things on the basis of it? Is facebook or snapchat socially useful? Are hamburgers socially useful? what about french fries? Whether or not HFT is socially useful is irrelevant. Since there is no harm to a long term investor from someone trading 50 millisecond early, etc. , HFT should be left alone to do what it wants to do.

eplumlee• 12 years ago

A case could be made that HFT is beneficial to society. The author is incapable of demonstrating exactly how HFT is "bad" beyond just claiming it's "bad". I submit that the speed at which a market can respond to changing conditions is a measure of it's health.

I believe many people would be surprised to learn that they're already engaging in HFT, by way of their pensions at the least. Mom and pop traders have already experienced significant disadvantages with regard to day-trading. Long-term trading is usually best for them.

joshsegall• 12 years ago

It's not about banning or allowing, it's about counting the true costs and benefits of the trade, not the immediate effects. And you don't need philosopher kings to do this, just basic math and science. This particular article may not make a good case for the harm of HFT, but that doesn't mean there isn't any. And yes, there are serious researchers that are pointing out hidden costs for things like facebook, hamburgers, and french fries. Those things may have demonstrable value, but that doesn't mean the value outweighs the cost or that they are correctly priced. For example, some studies put the true price of a hamburger at around $30 based on the burden put on healthcare and the environment, which are ultimately paid by other people. With perfect information, those costs should be factored into the trade, but they aren't. So, while HFT might have some small benefit to market liquidity as claimed by other comments, I can easily believe there are hidden costs that would outweigh such small benefits. I don't have any evidence to provide in this specific case, but I would support research to investigate whether we are overcounting the benefits or undercounting the costs.

vasilipupkin5• 12 years ago

Right, by this logic literally anything might have a hidden cost that exceeds the demonstrable benefit. The onus is on the ones crying wolf to present concrete evidence. Otherwise, we will end up living in Soviet Union or Nazi Germany ( yes yes I know, Godwin's law)

dclowd9901• 12 years ago

So you were around a few years ago right? When money for mortgages was easy and people were getting houses left and right, damned if they could afford them. The questionable mortgage-backed securities seemed great on paper. People were buying new houses, the market was humming along. Banks, builders, and anyone else involved was making money hand over fist. What could be wrong with MBS then?

In hindsight, the stupidity of bundling crappy loans for speculation was embarrassing, of course, and anyone not benefitting from the game saw the bubble.

If something looks good on paper, but feels wrong , it means we're missing something. In the case of HFT, it's (quite literally) a breath away from insider trading. Insider trading regulations give the impression that the market isn't rigged. If people lose confidence that they can't trust the market, it will fail. The only way markets work is if they're fair and all the players are playing legally.

harryh2• 12 years ago

So HFT is wring not for any particular reason, but just because it feels wrong?

Isn't that circular reasoning?

scotty79• 12 years ago

I'm pretty sure—or at least I hope—that Red Auerbach was kidding when he told a gym full of kids to cheat to get ahead.

He didn't tell them to cheat. He told them that to gain competitive advantage you cheat. Games are mostly random so you can get ahead without getting competitive advantage. And you don't even need to get ahead to have almost all benefits of playing the game or even some other benefits that you can't get when you have an advantage.

I think that attitude towards cheaters is pretty much an american (maybe british?) cultural thing. Lot's of people were successfully taught to be honest, and if they can't be honest to defend the ideal of honesty by teaching honesty and never admitting their dishonesty. People who are honest about their dishonesty meet exasperation and disbelieve.

If a company sold hedge funds an early look at their earnings, it'd be insider trading. But when a third-party like Business Wire sells hedge funds an early, albeit split-second, look at corporate earnings, it's perfectly legal. It's nuts.

Nuts is the fact that insider trading is illegal. It's unenforceable idea of how to make intrinsically unfair game appear sort of fair. It comes from the fact that shares are not as attractive as they need to be on their own. Possessing part of some company and getting dividends when the company decides to pay them is not incentive enough to shell out your cash and give it to the company that needs the cash to develop.

Since people love to participate in lotteries (before taxes it was the way money was gathered for expensive projects, people were just voluntarily were giving their money away in hopes of winning the big prize) they attached sort of casino to the idea of shares. The game is mostly: guess future ratio of supply and demand for pieces of paper. But people don't like to play in the casinos that are known to rig the games and despite the fact that price is random as it depends on so many different pieces of information some information can have some predictable influence. So casino (exchange and companies) pinky swear to prevent anyone from acting on the knowledge that gamers didn't have chance to familiarize themselves with. It works. I makes the game look fair. Of course insider still trading exists because you can't tell it apart from luck if you can't trace where the information leaked. And you can do that only rarely.

farginay• 12 years ago

He starts with an anecdote about cheating and then lays out HFT an implies it is cheating without saying how. If he had to defend his assertion that it is cheating he wouldn't have an article.

omilu• 12 years ago

maybe i didn't read the piece accurately enough, but i don't get why it's cheating. It's about ingenuity and the ability to allocate money to where you think the market will move. It's been this way since the beginning. We do the samething with our 401k.

Houshalter• 12 years ago

The problem is someone is always going to get important information and act on it first in a market. A tax wouldn't stop that, it would just make small transactions more expensive (for both parties.) I don't know if this is a real problem or how to fix it but this article is entirely useless.

arikrak• 12 years ago

HST doesn't sound that useful, but the article didn't really say much or show that they're cheaters.

radikalus• 12 years ago

The clueless preaching to the more clueless?

Early data access has been around for a decade and generally has NOTHING to do with HFT. Events desks typically have very different architecture than other groups in HFT, and, well, are a very very small cog.

philrapo• 12 years ago

Distributed exchange architecture is an interesting alternative:

https://ripple.com/blog/ripples-distributed-exchange-and-the...

When there's no central location towards which orders need to race to get time stamped, the whole low latency arms race seems unnecessary.

There's also no central place to co-locate servers.

Some of the existing traditional (centralized) exchanges are making 20-30%+ of their revenues from co-location and data fees. So they have little incentive to change. They cater to HFT because it's a big driver of their bottom line...

kasey_junk2• 12 years ago

I assume folks who advocate for a transaction tax don't actually want less transactions, rather they want more "real" transactions and a less artificially volatile market place.

Unfortunately, a transaction tax would create the exact opposite of that situation. The hypothesis that if there were a transaction tax there would be less transactions is incorrect. What would happen is that transaction quantities would get bigger in order to overcome the new added cost. These larger transactions would magnify the risk at play in the market place. This in turn would raise the reward for being able to pull out of quotes faster and/or to misrepresent the riskiness of your trading strategy.

So a transaction tax would actually incentivize more "false" liquidity and work to the betterment of companies that are more risky.

What HFT systems actually do, is allow firms to "pay" for priority of an order at a price level, by investing in network infrastructure/algorithms. If you want remove that advantage the easiest way would be a system where you transparently pay for priority of an order. The system with the least likely negative side impacts of this would be making arbitrary price level sizes. That is, instead of quoting down only the penny level, let people quote arbitrary (or some fixed but very small) decimals of a penny. That way if you really want to pay up for priority, you can just increment your order slightly and actually pay for the privilege.

minimax• 12 years ago

We actually have a system similar to what you describe in your last paragraph with the three "inverted" US equity exchanges where liquidity providers pay a fee and liquidity takers receive a rebate. It means that shares posted to the inverted exchanges are cheaper (net of fees) to aggressors than shares posted to other exchanges, so liquidity takers with a smart order router will look first to the inverted exchanges before the other exchanges.

ChristianMarks• 12 years ago

An example of privileged, well-connected parties systematically winning asymmetric zero-sum games against the not so well connected.

I'll believe that HFT adds liquidity to the market when the typical retirement horizon is 15 milliseconds. HFT proponents seem not to (or pretend not to) understand diminishing returns where "adding liquidity to the market" is concerned.

PythonicAlpha• 12 years ago

The stock exchange has just become the ultimate casino today. Yesterday, stock exchange helped to build companies, to have some security against bad crops and so on ... but that has changed. More and more money is just made by gambling and the more money is made, the more money is again put into the big gambling machine. It is legal, but just gambling and we all have to pay the price, because the gamblers carry the wealth of the Earth away -- and the others are left empty.

kyleblarson• 12 years ago

Key quote: "Now, what they do is strictly legal".

This article felt like it was written by a college freshman who just took their first class on "social justice".

michaelochurch• 12 years ago

Actually, HFT is socially useful in the same way that Cold War research, even though most of it never went anywhere, is.

It bids up the price of talent, and that's an inherent social good because it means there is a chance for smart people to get into decision-making positions (which, otherwise, go to entitled, and mostly untalented, incumbents and their shitty offspring). Google and Amazon would not be paying $140k per year for mid-career software engineers, were it not for the hedge funds paying $200k.

VC-istan is terrible, with founders lucky to get 10% and earliest employees getting 0.1-1%, but if Wall Street wasn't absorbing most of the top talent (and it is) those numbers would be closer to 1% and 0.001-0.05%. Instead of very few people getting rich in the tech lottery, it'd be almost no one, because the founders and early engineers would have zero leverage.

The HN crowd likes to assume that talented people will, as if it were a law of nature, have options to rise economically and socially. It's not so. If it weren't for socially useless talent vampires like HFT and online ad targeting, talent would have even less leverage against the good-ol'-boy networks and widespread stagnation would ensue.

(High levels of funding, probably originating from governments at first, for basic research would achieve the same effect in a socially useful way, but I wouldn't hold my breath.)

smoorman1024• 12 years ago

Interesting way too take the conversation but valid.

High-Speed Trading Isn't About Efficiency—It's About Cheating

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