In the case of HFT the number of actions has grown only because there was alpha sitting on the table, but it wasn't worthwhile for human market makers to chase it.
Think about a strategy which generates $100/day trading OTSS (Obscure Thinly Traded Symbol), a security with a $0.25 bid/ask spread. No human will waste their time on this strategy, so $100/day of alpha is left sitting on the table. HFT allows a computer to chase after this $100, $50 on some other stock, etc. This is simply a case of 3 programmers + computers doing work which was unprofitable for humans to do.
Similarly, twitter didn't exist before the internet because no human would be willing to earn $0.0003/day hand-delivering short messages to anyone who cared to listen, being paid to verify that "yes, this message really came from Mallika Sherawat".
Once the market becomes saturated, the bid/ask on OTSS will shrink to $0.10 and the algorithm will only generate $40/day. We are already approaching that point in HFT.
As for margins, they may grow if demand increases. I was really speaking about a situation of increased competition with all else held equal.
The major issue is HFT can create wild market swings with little to no basis in reality. It's actually possible for them to suck up all the outstanding bids over a few seconds using small amounts of capital and while a human might desire to sell if a stock goes up by 2% the seconds or minutes it takes US to make that choice is eons for the algorithms. The net result of this is actually less liquidity as someone buying or selling can't place large orders on the market or the algorithms with eat them alive. Also, they are often setup to simply stop all actions if the market deviates to far from the norm which pushes things even further out of whack.
I think you are arguing something different than I. I am open to being wrong, but I think I am making a different point.
You are saying that by having a zero latency trading capability, financial markets are the sign of progress and it is an inevitability that, not only is desirable, but preferred.
That's fine, but not what I am am taking issue with is fully automated system of extremely high volume, low margin, trades that are conducted by bots and have no human interaction other than those that are profiting from them.
I admit I am not savvy enough in this area to argue about whether or not HFT provides more equilibrium to the price of a stock, but I don't see that as a wholly convincing argument as to why HFT is important and adds value.
I am skeptical of that claim, mostly due to my ignorance, so please educate me on the following: The claim that HFT rarely goes wrong such that "ordinary investors" are harmed; who then is the non-ordinary investor who is benefiting from the HFT, and what value are they providing in the markets, other than profiting from HFT.
It appears to be making the claim that HFT is a meta market that the ordinary investor shouldn't even be concerned with except in cases of extreme rarity where a flaw causes them some financial harm/risk.
Again, if this is true - what true concrete value to the world does this meta system provide? I simply cannot see it, and again, I claim awareness of my ignorance, so please explain like I am five.
My understanding is that HFTs function in a complete race to the bottom, with the only profitable activity being to trade faster and with slightly faster information than the next HFT. There is no secret sauce to keep them from eating each other as the costs to create a new HFT are not all that high vs. the profit opportunity of shaving a few percent off the commissions of the dominant trading system. Faster links and faster trades between exchanges mean they carry less risk when carrying out arbitrage (while also lowering the amount of arbitrage available).
The fact they made crazy profits initially is more of an artifact that they were competing against humans rather than other automated systems. In a few years we may see them reach the point of diminishing returns where all exchanges share a common pool of liquidity that adapts in a few millis to new information.
You believe HFT is bad because it makes swing trading and day trading unprofitable?!? Fun fact: they aren't unprofitable, since the algorithmic traders you criticize are swing trading and day trading. It sounds like your complaint is simply that machines do a better job than you.
Concering micro-arbitrage, if you don't notice 1/4 second price inconsistencies, you also won't notice if computers resolve them in 1ms rather than a fast fingered human resolving them in 1/4 sec. The money is being extracted regardless, the only difference between now and the past is that a geek with a computer beats the fast fingered frat boy. That's bad if you were the human trader, but who else is harmed?
Front running is illegal and has been for a long time. I'm also not sure how you think HFT traders do it - do you think HFT firms have trojans which alert them when your mouse is hovering over the "place order" button at etrade?
I'm really curious how you believe HFT will "eat away at your margins" if you make long term value investments. If you believe apple will go up 20%, do you really care about the $0.01 spread? Even if you care, how can the HFT guys make money off you if you place an ALO order? Could you explain the mechanics?
Right. HFT relies on finding arbitrage opportunities, which are limited and temporary. Unless you're building AI that will adjust to other players' strategies in real-time, you're behind the game.
On the contrary, equities markets need the liquidity HFTs provide to function well. Before HFTs there were human market makers who played a similar role in equities markets, but charged far more to do it. HFT is a story of efficient technology bringing prices down a lot and shrinking the profitability of an existing industry.
I’m sympathetic to the view that a lot of resources have been poured into making trades happen in 1 nanosecond when 100 or 1000 nanoseconds would probably be fine for all practical purposes. The issue is that people keep finding that letting the fastest system get the trade actually does work better than alternative approaches.
Thats not what I am saying either or at least not what I meant to say.
What I was trying to say was that humans simply can't do HFT and that the advantage of that is only possible if you have millisecond updates. If you remove that then you remove the advantages of HFT and humans would be able to compete.
Whether that is good or bad for the market is another discussion.
One of the biggest justifications for HFT that I see is that it increases liquidity. However, did major markets ever really have a huge problem with lack of liquidity, 20 or 30 years ago before HFT?
I can't help but wonder if this level of liquidity is only really useful to HFT, if it is something that HFT is both the primary provider and beneficiary of, and if they're sort of using their existence to justify their existence, so to speak.
Chris uses mom and pop trader examples to explain the concepts here, but the fact is that Algo trading now accounts for much of the volume on major exchanges, and HFT is probably a decent portion of that.
I'd love to see Chris or any other HFT trader's take on that. He sort of does near the end, but would be interesting to see a more in depth discussion:
>Although the latency competition provides little to no value to the end consumers, all HFTs must play the game. If they don’t, a faster HFT will beat them to market and their order flow will be reduced.
This is a very real social cost of HFT - many very smart people spend a lot of time and effort reducing the latency of trading systems. I’m no fool, but when I worked as an HFT I often felt like one. The field contains a lot of very smart people, and the world would probably be better off if the stock market had a little more latency and those smart people were building products for the world. For example, after leaving HFT I built a useful consumer product.
But with current market mechanics, the global optimum where trading is marginally slower and smart people build useful products is impossible to reach. The latency arms race has us stuck in a suboptimal Nash Equilibrium which is similar in character to signalling competitions (e.g., the education bubble).
I guess I'll pose my question about HFT directly: what value do you add to the economy by being in the HFT business?
Surely the markets must at some point be "liquid enough". i.e. that the companies that are supposed to actually benefit from liquid markets no longer do see any additional benefit from increased speed. If trades could only be made once per day, then traders would be very, very hesitant to invest in a new company IPO, because if there was new information or a problem, they couldn't sell it for 24 hours, at which point the price could have plummeted. Companies would have a bona fide problem raising new capital.
But does that problem really still exist if trades could only be executed once per second? per quarter-second? Billions are now being made that justify shaving a few milliseconds off of a signal -- how do you justify that in terms of benefit to the companies?
I think its on the people who don't want HFT to be regulated out of existence to convince the rest of us that it actually has value for someone other than themselves and isn't basically legalized gambling.
0. Just to be fair I think any discrete time auction would reduce HFT. No matters less if it will be 100ms or 15 minutes. Just a parameter that you can optimize based on your market.
1. Not all startups are equal, but quite a few will create some lasting value.
2. Unsure if most of this career alternatives will ever give that sort of gains. The question is where the gains come from? Inefficiencies in trading strategies of your retirement fund? Maybe those inefficiencies are always present if humans type orders? Maybe we should design stock market with human first approach, not HFT exploitable?
Depends on the time window. It's not that hard to gain a few fractions of a second in front of large trades, but it's much harder to have enough time for a human to react, thus the need for HFT to exploit such trades.
While ultimately I do agree with you, especially about humans trying to beat HFT in the short term, I don't think HFT and algorithmic trading are _currently_ the panacea you are making them out to be.
The argument is essentially:
1) High-frequency traders (HFTs) increase liquidity. For the benefit of those who don't know what that means: there are actually a finite amount of shares of each company, and you cannot buy shares unless someone is willing to sell theirs to you, and you cannot sell shares unless someone is willing to buy them from you. You can imagine that you might not be able to sell your shares the instant you want them to if humans are in the loop on the buyer side (i.e., if a human has to review your selling price and decide whether or not to buy), and vice-versa. In contrast, if somebody has programmed a computer to automatically execute trades if certain conditions are met, you can buy and sell shares very quickly. This is what HFTs do.
2) HFTs provide transparent price discovery. This means that the computer programs the HFTs have set up will quickly and unambiguously tell you at what price they are willing to buy and sell shares. Contrast this with a hypothetical process in which you had to haggle with human representatives of each shareholder or potential buyer in order to figure out the price. It's similar to consumer vs. enterprise software sales (sticker price vs. "well, how much can you afford?"). In theory, transparent price discovery promotes fairness (everyone sees the same price) and encourages trading due to decreased latency and hassle.
3) Lots of repetition of 1 and 2. Also an assertion that HFT decreases volatility (average dPrice/dt), while most commentary on the matter assumes that it would increase volatility, due to algorithms that are either busted ( e.g., http://arstechnica.com/business/news/2010/01/how-a-stray-mou...) or interacting with one another in a bad way. It is disconcerting to me that the author cites empirical evidence without a hint of intuition or insight to help the reader generalize it; however, it is difficult to dismiss the evidence off-hand without looking at it more closely and/or being more expert than I in the matter.
Points 1 and 2 are by far the most common and obvious arguments for HFT, and the analysis in TFA is not bad, but not exemplary either. The rest of the article is basically redundant and comes off a little defensive. I found this article interesting ( http://www.zerohedge.com/article/whoa-glitch-hft ), though its tone is also less-than-objective.
I see your point about the risk, but is there really that much activity in most stocks that getting to the top of the sell pile would be a large enough issue? As I understand some order types were more or less designed to give HFT an edge.
Although I suppose the profits to be made by any strategy dry up pretty quickly as more shops discover it, so it does make sense to me that this doesn't appear to be done any more. I mean, isn't that what worked a few months ago doesn't work any more is the only thing most people posting about HFT can agree about? :D
I have no experience in electronic trading and my knowledge of it mostly comes from HN posts and - as you guessed correctly - Flash Boys, so please forgive my ignorance
Nowhere do I mention a guy actively wanting to sell 2 million at 209 (the market maker was willing to, but didn't necessarily desire to) nor do I mention a guy (an actual human being, not HFT) who was in fact able to buy it for 210 because neither of those happened.
Furthermore there is no such thing as an HFT market maker (at least that I'm aware of) because the definition of a market maker is someone who has to provide liquidity continuously. The HFTs all go offline when things get dicey ergo they're not market makers.
What I described is how it SEEMS to a lay-person and how it SEEMS like HFTs are jumping the line.
A human being can't want to buy or sell stocks much faster than the blink of an eye, which is about 80ms. So everything that happens faster than that, or the click of a key (which might be 100 or 200ms) is going to SEEM like some serious bullshit. Technically it might not be but the entire world isn't going to get educated about HFT to make "smart" decisions.
There is a lot of bot-driven trading going on. To the degree it starts approaching HFT-levels of speed I'm not sure. I don't know what sort of algorithmic trading arms race is going on in that space since the order books are still thin enough for a small number of well-moneyed people to impact the price in a non-trivial manner.
Being pedantic, 4000 trades a day isn't HFT. This is stil algo trading, of which HFT is a subset.
I consider HFT to be any strategy where speed itself is the what gives the edge. Colocation is usually a prerequisite, though not sufficient. It's a shame HFT gets all the attention, when it's really a tiny portion of trading activity. Algo-trading in general is 70%+ of market activity in the US.
Also limiting trades isn't really adequate risk management. The tech exists to very accurately model your exposures. This is something I see underdeveloped a lot, and what separates the top trading firms from the rest.
Still I commend you creating a model, working out how to test and execute it automatically and actually trading your own money.
I really think more hackers should be actively managing their money, (in general, not like in the article). We have these amazing liquid markets, all time low spreads/commissions, products like ETFs/derivatives to accurately and cheaply execute a given strategy, and a huge increase in tech to model risk, but personal personal investing is the same as the 60s.
You are acting like algorithmic/hft/market making terms are clearly defined.
It turns out that the vast majority of HFT are algorithmic market makers. Why is that? Because if they can trade more they are more profitable (if they are good at market making). This means that they can make less on each trade driving down the bid/ask spread which is good for everyone. Further, if they can reduce their risk by trading fast, then they don't have to price that risk into the spread once again making the price better for everyone.
You can't separate hft from algorithmic market making because it is a central driving premise of the industry.
So HFT is not absurd because it lowered transaction costs for retail investors. What mechanism did it achieve this by?
I call it absurd because computer algorithms trading stocks at the microsecond level seems completely divorced from the theoretical basis of “investing.” I don’t understand how it makes sense on a theoretical level. Reducing transaction costs doesn’t seem to explain that.
Think about a strategy which generates $100/day trading OTSS (Obscure Thinly Traded Symbol), a security with a $0.25 bid/ask spread. No human will waste their time on this strategy, so $100/day of alpha is left sitting on the table. HFT allows a computer to chase after this $100, $50 on some other stock, etc. This is simply a case of 3 programmers + computers doing work which was unprofitable for humans to do.
Similarly, twitter didn't exist before the internet because no human would be willing to earn $0.0003/day hand-delivering short messages to anyone who cared to listen, being paid to verify that "yes, this message really came from Mallika Sherawat".
Once the market becomes saturated, the bid/ask on OTSS will shrink to $0.10 and the algorithm will only generate $40/day. We are already approaching that point in HFT.
As for margins, they may grow if demand increases. I was really speaking about a situation of increased competition with all else held equal.
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