High Frequency Trading Is A Scam

http://market-ticker.denninger.net/archives/1259-High-Frequency-Trading-Is-A-Scam.html

by Flemlord • 17 years ago

24 41 17 years ago

market-ticker.denninger.net

Here's a good thread over at New Mogul on the subject. This type of trading is not illegal, and it's actually commonplace among the big players on Wall Street.

http://newmogul.com/item?id=14134

roc3• 17 years ago

Call me jaded, but 'commonplace' and 'not technically illegal' don't strike me as a very compelling defense.

BrentRitterbeck10• 17 years ago

Please don't try to interpret what I meant. What I wrote is exactly what I meant to write. This trading is not illegal. This trading is perfectly acceptable. The only people who seem to have a problem with this are a subset of the people who don't have the resources to do it. Frankly, the arguments I have read against it are mostly penned by ignorant folks who simply come across as jealous.

stuffthatmatter3• 17 years ago

When the average investors leave the market because of this, front running (http://en.wikipedia.org/wiki/Front_running), , and the fact that small number of firms (~400) is involved in 70% of the US trading volume (http://www.ft.com/cms/s/0/a5f03366-6d69-11de-8b19-00144feabd...), will they ever come back?

tptacek6• 17 years ago

The average investor accesses the equity market through mutual funds, which are large institutional investors that can compete with high frequency traders. If stuff like this keeps my uncle-in-law out of daytrading, I see that as a feature, not a bug.

There are markets where the entire order book is transparent, and the bulk of investment dollars don't even go to equities. Hard to see this as the end of the world.

stuffthatmatter3• 17 years ago

True, but stories like this makes them pull out of equity funds and into bond funds.

BrentRitterbeck10• 17 years ago

The average investor is not going to leave the market. I spent time as a retail broker, and the truth is most have no idea what they were doing to begin with. I don't think this is going to persuade them to stop.

roc3• 17 years ago

They're not going to leave because they can't.

Their 401ks, IRAs and the like only work as tax shelters if they invest and (for the most part) they don't even have a choice of which firm they work with.

So long as the firms don't skim more than the tax benefit is worth to the average investor, it's still in the investor's best interest to keep contributing.

stuffthatmatter3• 17 years ago

Those investors (no idea what they were doing to begin with) already got spooked by the 60% drop and pulled out of 401k/into bonds. I mean the average investors who have some knowledge of the market, and have decent capital (20k-200k) but is just trading normally using online trading services.

JSick• 17 years ago

Front running is illegal and is regulated (Rule 92 - also called the "Manning" rule I believe). This should not be keeping average investors away from the markets today.

To refute your second point, there are probably more firms trading today then there ever were before. It's really an economy of scales issues. The large firms have the capital and the resources to: lease fiber lines, buy servers, and hire analysts/developers to build the systems required to be an efficient player in the market players. Many smaller firms simply employ the services offered by these institutions.

To reply to a previous point, the article is very biased and tells a small part of the story. Most of the noise in the media and in blogs today about HFT is very one-sided. The fact is that these HF proprietary trading systems which trade on behalf of the big wall st firms are competing against similar systems offered as "algorithms" to the Institutional investors. To use an example, a mutual fund manager will try to buy 100,000 shares of IBM. That fund manager will go to an investment bank and route his order through a VWAP Algorithm. That Algorithm may be competing in the market against the same investment bank's HFT Black Box trading app. These two "Algos" don't know about each other due to "Chinese Wall" restrictions. I digress.

Bottom line is that these systems which are "gaming" the market are competing against similar systems which aim to prevent such practices. The playing field is much more level than the author leads his audience to believe.

Hope that offers some insightful perspective.

tptacek6• 17 years ago

Rule 92 is NYSE, Manning is FINRA, and both --- if I understand them correctly --- apply mostly to traders trading for themselves against their customers interests. (NB: this is just Google research).

Dilpil• 17 years ago

Keep in mind that 70% of trading volume is not at all the same thing as 70% of all the money in the system.

tptacek6• 17 years ago

Can I just point out --- knowing full well that this is not a meaningful or valid argument or constructive comment on the article --- that Karl Denninger is a huge, notorious Internet crank? He's burned a whole through operating system teams, ISP markets, the security community, at least two major world religions, the SCUBA industry, and now this. He has a bias here, and it's towards controversy he can be self-righteous about.

He may actually be right about this --- he is occasionally right --- but man I wish there was a credible source that backed him up.

ynniv4• 17 years ago

He doesn't seem to extend very far past the facts as presented in the NYTimes article.

joezydeco3• 17 years ago

I do too. I almost feel bad saying I agree with the Yamhead, but the more I read about HST and the wave of financial types claiming this is all perfectly legal just makes me angrier and angrier.

Without donning the tinfoil hat for too long, you gotta wonder if that source code Aleynikov tried to take away from Goldman was a smoking gun. I've never seen the FBI move so fast. When the hat comes off it's probably just one mechanic trying to take the toolbox to another garage.

rwolf• 17 years ago

This sounds like the kind of story Technologists love.

Machines at better are stock market trading, so the humans are being replaced in this industry.

rottencupcakes• 17 years ago

Just so you guys know, there's actually nothing economically inefficient with what these high frequency algorithmic traders are doing.

With the example they gave, the buyer was WILLING to pay up to 26.40. This means, in the buyer's opinion, the stock is worth $26.40 per share. The sellers were willing to sell for anything above 26.10, which was the ask price. As basic economics teaches us, them trading for ANY amount between these two prices is 100% efficient. And, in this case, it doesn't matter who gets the extra money, whether that be the seller, the buyer, or the high frequency trader.

The trader is doing nothing to hurt the liquidity of the market - they are not 'gaming' the system in any way, nothing and nobody is being 'manipulated'. The seller sold for a price that they thought was a fair value, and the buyer bought for a price that they thought was a fair value. The traders are simply looking to make that 30 cent difference. Although it seems like they are contributing nothing, it is still economically efficient.

mbrubeck2• 17 years ago

Except that they're paying money (both to the exchange, for privileged access to the low-latency data, and to their own employees/vendors for their software and hardware) to be the ones who pocket that $0.30/share surplus. That's rent-seeking, and from the point of view of the economy as a whole it is a deadweight loss. The resources used on HFT could have gone toward creating wealth, rather than generating a zero-sum transfer from one market participant to another.

kevinpet• 17 years ago

Thank you. I had been a little "hmm...that seems fishy but I can't put my finger on it", but your analysis gives the missing piece.

tptacek6• 17 years ago

Aren't the HF traders exposing themselves to price risk, creating more opportunities for sellers to sell and buyers to buy, and narrowing the bid-ask spread?

gaius• 17 years ago

I'm not sure how that's zero-sum. There's value in a) liquidity and b) the exchange existing at all. If the exchange didn't get "rent" how could it function?

lrajlich• 17 years ago

If you plop a big limit buy order at $26.40 and the market's at $26.20, you will wind up paying close to $26.40 because you'll eat through all the sell offers and transact inefficiently. It's called slippage.

However, what's preventing you from getting f*ed is that this is a market, so basically you have 10+ HF shops fighting who can be on the other side of that slippage. The fact that it's a competitive market ensures you don't get raped like the guy claims.

bigwill• 17 years ago

I think this characterization of HFT is a bit overblown. The activity he's calling unethical--offering a security at price, getting hit at that price and continuing to raise your price until you stop getting hit--is exactly what market makers have always done. This is basic free market dynamics. You offer at $100, you get hit, you raise your price a little bit, say $100.05, and see if you get hit again. Don't get hit? Ok, drop your price back down a little. The same thing happens in open pit trading, it's just a lot slower.

jongraehl• 17 years ago

John Hempton thinks it's impossible for this to amount to $22billion/yr - http://brontecapital.blogspot.com/2009/07/high-frequency-tra...

He's not a crank.

tptacek6• 17 years ago

From the article:

"If you're wondering how Goldman Sachs and other "big banks and hedge funds" made all their money this last quarter, now you know."

But from this article at Bronte Capital (via New Mogul):

"Anyway if 10 percent of global stock volume provides 220 million dollars revenue per quarter then there is no way that a substantial proportion of Goldman’s trading profit can come from high frequency trading. The numbers do not work."

(http://brontecapital.blogspot.com/2009/07/high-frequency-tra...)

ableal• 17 years ago

The 'price limit' phrase reminded me of the traditional fish selling method called 'lota' in my corner of Europe.

It goes like this: the fishing boats come in, crates of fresh fish are brought to a market area where buyers await. For each crate, the announcer starts with a high price (say 100) and counts rapidly down ("99, 98, 97 ...") until one of the buyers shouts out "Soo" to buy the crate at that price.

Not as amusing as bidding up an auction, but this seems a time-efficient method for finding the buyer's price limit - after all, the fish is not getting any fresher sitting there ...

High Frequency Trading Is A Scam

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