It's an excellent example of the middleman that only extracts money from a system, that adds no value to the system.
They insert themselves into the transactions where they can siphon off very small amounts of money over a very large number of transactions. Nobody benefits but them from what they're doing, no one walks away with something in their hands or brains by their actions.
The counter argument is that they do provide a benefit, by providing liquidity and/or making price discovery more efficient.
Whether it's "good" liquidity or not, and whether the discovered prices actually reflect true value or not, is a discussion that seems to fairly rapidly head down an acrimonious rathole.
Look at a market without market-makers. Housing is a good one. Houses sell only when there are "slow" traders willing to buy and sell. Have you ever bought or sold a house? Would you like the financial markets to be more like real estate?
The alternative to HFT is not the real estate market.
The alternative to HFT is how the markets operated for decades prior to HFT companies vacuuming money out of the system--that is, quite well, and with adequate liquidity, and with lots of money still being made.
The markets in the decades before HFT were crooked like a bucket of fish hooks! They were NOTORIOUSLY corrupt. Everyone was scamming everyone else. The entire market was a giant grift. Are you really sticking up for 1980s trading? Or have you just not done much research about how it worked?
Really? And now, with HFT, they're no longer crooked? If I remember right, in the 2000s we've seen a ton of crooked market scandals (fraudulently rated securities, LIBOR, etc etc). I don't see this relationship you're positing between HFTs and a non-corrupt trading market at all.
For your argument to make sense, all forms of corruption would need to have a single cause, and all interventions to reduce corruption would need to impact all forms of corruption. That's nonsensical and not a point I'm willing to engage further with.
I think we've pushed this thread far enough to the right margin of the page.
I don't think it's acrimonious to say that no, that liquidity is not beneficial to society as a whole.
I struggle to see how any sector other than the financial sector would suffer if all trades happened once a second, or even once a minute. No process in the human world is going to change the value of a company quicker than that.
So what's the RIGHT amount of tax we should be paying to commercial market-makers for the privilege of trading?
The residential real estate market is gigantic, a demonstrably functional piece of the US economy. Maybe the stock markets should work more like the real estate market. Forget about liquidity. Who needs it? Instead, we'll just pay seven percent of every transaction to an "agent".
Good question! I don't have an answer to that. I do know that the markets survived just fine before the HFT companies came along, and now that they're here, I don't see society as a whole any better off for their presence.
Maybe, without just saying "they provide liquidity" and leaving it at that, you can explain how the post-HFT world is better for anyone but the HFT companies?
Why don't I just let Vanguard, the most trusted firm in all of retail investing, explain that for me? Go look up with their Chief Investment Officer said about the impact HFT has on Vanguard's mutual funds.
Your reply reminds me of that saying, "Who do you believe, me or your lying eyes?"
If you can't explain it in pretty simple language why HFT-level liquidity is beneficial to society as a whole--to the people working in shops, managing restaurants, dealing in real estate, and on and on--then I'm inclined to think you're just trying to bluster about it.
That's a very self-righteous way of saying "I am not willing to perform a few Google searches and do a bit of reading".
Here, another hint: you can use the search box on the bottom of this page to find comments from me quoting Vanguard.
Either way, since you've accused me now of simply making things up to win arguments, I think I can let you off the hook. There's not much point in us discussing things further.
I won't speak for him, but I think I can sum up a position that he would agree with very simply:
HFT has made trading cheaper for the vast majority of market participants. It has done this at the expense of the previous regime that was less efficient and more squalid.
Further, don't take my (or his) word for it. Listen to Vanguard which has a sterling reputation for caring for the interests of their clients who tend to be long term, small scale, investors and large pension/retirement funds.
I tend to agree that the value of a company doesn't actually change substantially from one second to the next. But to focus on that is to ignore the value of having liquidity available. For an example of what can happen when there isn't enough liquidity, take a look at the graph of RSP on the morning of August 24th.
If traders, be they high-frequency or otherwise, can't make money by making liquidity available, they won't do it. Less liquidity means wider spreads, which means higher costs especially for smaller transactions (i.e. individual investors).
You could reasonably argue that HFT has caused expenses to increase for large investors who need to buy or sell large volumes of shares. But to the extent that is true, it is like saying that large investors used to get on average an unreasonably good deal at the expense of their counter parties. As in any free market, an especially good price for one party is by definition an especially bad price for the other party.
Be very clear what you mean when you say this. Because the vast majority of the time when people talk about HFT, the only way the "insert themselves" into transactions is by acting as the counter party to one side of the transaction.
In this context they add a lot of value to the system, they smooth the demand curves in time and take on some of the risks of warehousing supply.
The big claim with HFT is they "add liquidity", but there's evidence that shows the opposite. Indeed it seems like HFT's only add liquidity when it's already plentiful, but reduces liquidity when it's really needed.
I'm not sure who is making that claim, but I think what they are implying is that HFT "provides liquidity cheaper than the previous system of pit traders" or even "fragmentation of exchanges has dramatically brought down exchange fees at the cost of added complexity for liquidity providers (and possibly liquidity consumers). Only HFT systems could have cheaply dealt with this new complexity".
In any case, I'd sum it up as "it is cheaper to trade now after the rise of HFT than at any other time, at least some of that is because they can market make more efficiently than a dude in a vest". Vanguard for one agrees with me (http://www.cnbc.com/2014/04/25/vanguard-chief-defends-high-f...).
What many critics have claimed is that this has come at the cost of an increase in volatility, especially in the form of flash crashes and it is unclear as of yet if that is better/worse than the traditional liquidity crunches we saw under the previous regime and still see in markets not dominated by HFT.
The Fed was specifically talking about this in the context of treasury bond (and futures) volatility and a skeptic might wonder which is more likely to have caused volatility in the treasury markets, HFT or unprecedented fed monetary policy.
None of which is germane to the question of what the OP meant when he said that HFT insert themselves into transactions.
When people point out that HFT's seem basically like a giant high speed frontrunning operation, as the OP did, the usual counter is that it's all fine and dandy, because they provide liquidity. Indeed right above your reply, is someone replying saying exactly that. Therefore the question of HFT's providing liquidity, or not, is very germane to the question, and if you're willing to be skeptical about what the Fed is saying regarding HFT's, then surely you would be similarly skeptical about what CNBC or Vanguard is saying, or would that go against your confirmation bias?
Most critics of HFT rely on three major arguments:
1) It is a front running operation.
2) It has no "social benefit".
3) It increases volatility or structural instability.
Items 2 & 3 are not germane to the question of "it is a front running operation".
My response to item 1 is simply, no it's not. If you state it is, then either you have an unclear understanding of how market mechanics work, or a specific natural opposition to HFT systems. When the OP said that HFT "insert themselves into transactions", I really wanted him to clarify if he meant "insert" in the sense that he thinks they can change a standing order based on new orders before they execute, or the more general sense of "inserting themselves" that any middleman does in any commercial transaction. That is, as an expert in sourcing/warehousing/etc items that have varied demand curves.
Your response (and the fed's part in it) seemed to muddle the responses to items 2 and 3. My answer (and the common one) to item 2 is that it provides liquidity cheaper than the prior regime. That is largely not debated, though it is an open question of whether you could provide the same liquidity even cheaper within some other environment (batch auctions etc).
The question of whether HFT contributes to high volatility vs acts as a response to it is much more nuanced and I suspect unanswered/unanswerable, but the problem with the Fed specifically speaking to it, is that the Feds own actions are at the heart of the question as well. A given bank or investment fund service is unlikely to have the systematic impact of the Fed.
Finally, notice that the Fed did not speak to whether HFT lowers the cost of trading (ie item 2) they only spoke to the volatility question. So using the Feds statements as a counter to the argument that HFT lowers the cost of trading does not work.
My interpretation of his "insert" comment, was that of 1). My response to that was to preempt the common refrain of HFT defenders who universally trot out the "liquidity" defense.
As for the criticisms focusing on volatility vs liquidity, to me they are linked, because in those instances of flash crashes that are the target of the recent criticisms, the issue has been that volatity increases due to HFT algorithms withdrawing from the market (i.e. reducing liquidity).
Also, there are other criticisms of HFT's beyond those three, including the "coincidence" that HFT firms seem to be responsible for most of the major order spoofing. Regulators have been VERY slow and uneven about enforcing HFT spoofing, but are finally catching on, albeit with slaps on the wrist (excluding Citadel being banned in China).
Is that an argument against HFT though? That the regulators aren't doing a good job was true in the previous regime.
I'm some what receptive to the argument that HFT makes the laws harder to enforce, given that the laws rely on "intent" which is murky with algos, but how do we square that in the face of any innovation?
Also the waste of talent argument is a red herring. People who say that assume the alternative is no financial system in their heads. It takes many fewer people to run many HFT firms than to run one JPM prop trading floor which is the actual alternative.
I'd say "highly alarmist" based on what I've read from them over the years. They're pushing people to use their product, so it makes sense for them to publish alarmist stuff which segues into their product offerings.
I used to respect them -- they do (or perhaps did) visualize events of interest in the markets in a useful way.
Their recent crusading against HFT however has moved outside the bounds of logic, as evidenced by this "definition" of HFT, which is just silly (as others here have pointed out).
Nanex sells market data and tools for analyzing market data.
Historically (I haven't looked in a long time) their market data was inappropriate for HFT usages as it was not at the fidelity required for those applications, but it was very cheap in comparison to other market data providers.
This led to a natural segmentation of their market such that most of their clients are people who are a) interested in market structure but b) not interested in high fidelity market structure information and who aren't interested enough to spend more on other options. That frequently is large block traders (hedge funds) who have a natural opposition to HFT market makers.
Whether that is the only factor in their strident anti-HFT position or if they have other personal moral reasons for it as well, they also publish a highly biased blog railing against HFT, but that is not their business.
In the industry, I never encountered them in the context of "highly respected financial research firm" and only in the context of "dirt cheap market data archive".
I still dont get what the issue is with any of this... For a trade there has to be two counterparties with firm instructions on the ELOB to be lifted or filled at a certain level. If you dont want to transact at that price dont have an order in the market...
HFT, when it is done at milliseconds of latency between exchanges to trick an order into executing at a 'fair price' because the order was sent to one exchange and HFT 'arbitragers', decide to manipulate the price at other exchanges due to latency for the same stock buy/sell.
It is arbitrage free, riskkless arbitrage that adds no value to a market, as it creates none but destroys it. Arbitrage adds value to a market by offering something cheaper; HFT removes the cheaper for the more expensive.
> Be clear what you are saying. They are "manipulating the price at other exchanges" by changing the prices they themselves set on their own inventory.
Which will be sold instantly, as they have 'discovered' the price on the other exchanges were lower than where the initial order went to, bought that, and then instantly, give or take a few milliseconds, resell.
It is not price discovery, it is price manipulation. HFTs have no inventory, they are perfectly lean, they throw hot potatoes across different exchanges.
Not that this is not interesting technology. It is, but it is also manipulative.
I exclude prop trading from the above, obviously, because it is different, and does hold inventory.
The HFT debate is bound to be misunderstood... It rose to prominence last year with the book by Michael Lewis "Flash boys". A discussion between two exchange operators Bats and the new IEX: https://www.youtube.com/watch?v=RcpmHyPD_PY
This issue is not about frequency per se at all. Its about who has access to what information at what price. For instance one thing that happened was that data providers (e.g. Reuters) sold information to a group of traders, before it was available to the public.
The question is not at all whether software should be used to trade (we're not going back to pen & paper / pit trading). Rather the question is how software should be used in financial markets. HFT is not evil, it's a difficult problem to be solved.
I think your viewpoint is fair. The aspects with hft that strike me as unfair are generally the result of bad exchange practices, such as lack of transparency in customer segmentation on their platforms. If it was all out in the open with price tags on display, I think the problems would fade away. Instead, the exchanges are running their businesses with about as much integrity as a bucket shop.
Can you identify a particular way in which an actual US exchange implements "customer segmentation on their platform" in a way which is tradable? This is not me trolling, this is a sincere question. If that actually exists I want to make a level in a trading simulation where the playing programmer would have to abuse that.
I think he is lumping dark pools in with exchanges. Technically there are only 11 registered US equity exchanges and any displayed quote has to be accessible to all market participants under nondiscriminatory terms.
Dark pools OTOH tend to have all sorts of gimmicks with respect to whose orders are allowed to match against other orders and under what circumstances. E.g. if I connect to a bank-run dark pool, I may be able to opt out of matching against principal flow from any of the bank's prop desks. The matching rules should be described in a dark pool's "form ATS" which some dark pools publish (and some don't).
One of the things that gets some of the anti-HFT types going is that it's possible to subscribe to direct exchange data feeds.
All exchanges are obliged to contribute to the SIP, which offers a market-wide view of quotes (prices) and historical trades. However, because the SIP must aggregate data feeds from all exchanges and then republish this information, it's possible to "predict the future" if you subscribe to the direct exchanges feeds (which are more-or-less what they send to the SIP) and avoid the added latency of a hop via the SIP's aggregator and redistribution.
These direct exchange feeds are expensive, and getting more so (ie. NYSE UltraBook is $11,000/month for the data, plus port fees, plus connectivity). The argument is that this segments the customers such that unfair advantage is available to those who can afford to subscribe to the direct feeds.
More recently (last two? years) it's been possible to get a microwave transmission of the data, rather than fiber, which is both lower-latency and more expensive again.
Direct feeds are available to all market participants. Expensive really sounds like an excuse. It costs what it costs, it's not clear why it should cost any less than it does.
Not a US exchange, but much more straight forward example is Eurex.
They have 2 different electronic connections based on your latency/throughput requirements. One is more expensive than the other (http://www.eurexchange.com/exchange-en/technology/connecting...). If I remember correctly, the HFT version also requires more onerous legal hurdles as well.
Personally, I view this as a good thing. Why wouldn't we want segmentation in exchange technology?
They're saying that low latency / lack of fundamentals (versus 'market events') marks HFT.
Unfortunately, at the end of the day, even if you are only about 'fundamentals' (whatever that means) you're obviously going to want to trade FIRST on those fundamentals .. right? Cause whoever does is going to win the day. Ok, so low latency is necessary for normal electronic trading.
Ok, now market events versus fundamentals. Seriously? At what point are 'market events' not fundamentals? The definition is all arbitrary. If there is a change in some correlating index, isn't that a 'market event'? But isn't it also rather fundamental (say, that correlating index is interest rates futures)? At what point does that change in the correlating index no long qualify as a 'fundamental event'? When Nanex says it doesn't?
Nanex simply wants to have its cake and doesn't want to be marked as "HFT". All electronic trading, at its heart, is going to be HFT at some point. The only way to keep that from happening is just come up with really arbitrary definitions marking the line you can't cross. Likely those definitions will be used to help whoever is paying Hillary Clinton/Bush/Trump/etc the most money.
Let's not bother with these shenanigans just put a transactional tax on everything and be done with it. Let's stop spending all our time and our brain power creating software to do trading and start getting back to actually researching /innovating / building things.
> you're obviously going to want to trade FIRST on those fundamentals .. right? Cause whoever does is going to win the day
If you're only trading long term, then sub-second differences are essentially irrelevant.
I think there's a perfectly reasonable point here. Fundamentals as "trading against the future profit of the company". HFT as "trading against the system".
The tax is instantly rebated since 1981 (thanks, Reagan-era politicians!), so no money around this tax ever changes hands. It seems like it could be an interesting place to start looking as a model for a federal-level tax on financial trading.
Yeah, but I'm not naive enough to think this will get passed soon. The problem with the US is that its manufacturing base has been so hollowed out it has become reliant on its treasury bonds + QE money printing fed (backed by its military) and financial hegemony (think Goldman Sachs) that results from it. The ftt got passed in the EU because Germany (which runs the EU, mostly) actually still makes things. They don't need the world to transact their bonds in order to stay liquid.
I was curious about this conjecture that the US doesn't make things, while Germany does. So I dug up [0], a table of "Manufacturing, value added (current US$)", and here are the top five countries for 2013:
1: China $2.9bn, 2: United States $1.9bn, 3: Japan $904m, 4: Germany $745m, 5: Korea $368m
Manufacturing in Germany may contribute a higher percentage of GDP, but it does not appear to have a larger (in dollars, according to this data) manufacturing base than the US in absolute terms.
To the extent transactional taxes retard market-making and drive spreads back towards where they were in the 1980s, those taxes do in fact harm retail investors.
Sweden tried it and had to go back on this due to liquidity drying up. By the way, we already have transaction taxes in the US. That's how we fund the SEC and CFTC. Every sale of stock is charged an SEC fee. The issue is, if you set these fees too high, then you will in fact harm investors by reducing liquidity.
Unless you're trading way more frequently than you need to be, the spread is hardly a big deal. If you are trading frequently, than the spread is an opportunity to make money. As someone who trades a lot, I like fat spreads.
My advice to any retail investor though is just dollar cost average into an index fund as a function of your age and forget about it. If you are going to try to 'beat the market' (and worry bout things like transaction taxes and spreads) you will lose.
When people talk about retail traders in this conversation, they are either totally clueless or working in the industry and just don't want to be taxed.
Anyone who says a retail trader should be trading enough to worry about spreads is not your friend.
High frequency traders front run the dumb money, err, pensions. Getting rid of HFT via a transaction tax will not hurt them. Also, pensions shouldn't be trading so much that these things will hurt them. As for mutual funds, again, you're better off with an index fund and just not looking at it until you retire.
How anyone outside the industry can argue against a transaction tax is beyond me. You have no idea how much the market has been rigged to suck as much money as possible out of you. Wall Street does not generate wealth. Everything they make is a tax on those that do.
If that's true, why doesn't Vanguard agree with you? They've said publicly more than once that they are benefiting from HFT activity.
I'm a little concerned that we're not talking about the same thing, by the way. Should retail traders care about modern spreads? No. Modern spreads are tiny. But before electronic trading pushed out the crooked human market makers, they were not.
They have 3.5 trillion in client funds invested. They'd be insane to say the market is rigged.
edit to add: Thinking more about it, likely their more profitable accounts (ie, not their index funds) would be destroyed by a transaction tax and so they don't want to see it implemented. The salad days of just doing a simple honest index fund with 3% annual turnover are long over for Vanguard.
But people who trade against fundamentals aren't trading directly against future profits, they are just betting on long term price movements. HFT traders are betting on (very) short term price movements.
According to the theory that stock prices are a martingale (which is well established), there is no qualitative difference between long and short run price movements. In particular, there is no reversion to the mean in stock prices [0].
[0] Of course, there are going to be literally hundreds of papers exhibiting some reversion to the mean effect. But this effect is always tiny.
yeah, in fact any long term movement is mathematically a sum of short term movements :) so if your goal is to predict a long term movement, there is really no contradiction between using both long term and short term predictions to trade
Yes, but being a martingale implies something stronger, which is that both short and long term traders are betting on the fundamentals to exactly the same extent.
"In particular, there is no reversion to the mean... there are going to be literally hundreds of papers exhibiting some reversion to the mean effect."
Okay.
I also think you don't know what a martingale is. It is impossible to make any expected value betting on martingale movements, by definition. If you believe traders are purely "betting on price movements" of martingales then profit is impossible. So either prices aren't martingales or trading is not purely a process of betting on the movements of market-clearing prices. Actually, both assumptions are false.
If you knew anything about academia, or if you even bothered to carefully read my post instead of nitpicking, you would understand that just because something is in general true, doesn't mean that there won't be hundreds of papers showing how this thing fails to be true in special cases, or to a very small extent.
Regarding martingales, a martingale is defined relative to an information set (you know what a martingale is so you already knew that, right?). Saying that there is no reversion to the mean implies being a martingale with respect to the weakest possible information set (the history of prices). Traders, whether high frequency or others, may have extra information outside this information set.
In short, stop nitpicking and revise your understanding of what a martingale is.
the problem with transaction taxes is, if they are high, they reduce trading and liquidity. When you go to buy and sell stocks, or futures or govt bonds, what do you think is the process that keeps the difference between bid ( buy ) price and ask ( sell price ) relatively narrow ? it's the frequent trading process that does it
Does anyone know if regulations on minimum terms for holding period for stock ever been used/considered in modern markets? (eg. day/week/month?) I realize that it'd effect liquidity in a similar way to transactional taxes (portion of portfolio tied up in term at any given point) but could it also reduce volatility and ensure trading against long term value rather than short term artifacts?
no, it would increase volatility. People think that volatility increases with trading. In fact, volatility can be very high without trading. Because the prices at which people can trade will fluctuate even more if you make it harder to trade
I understand we can speculate that volatility could increase due to lower trading volumes, but the lower volumes aren't the only factor to take into account in this scenario.
right, well, think of it this way. Trading process is the process of price discovery. Most recent traded price is the current price for the asset, assuming it's trading frequently. An infrequently traded asset creates more uncertainty about what is its actual current market price. And volatility is a function of uncertainty.
This defines market making as HFT, and while many HFTs make markets not all market makers are HFT. You can, using absolutely no knowledge of an underlying stock and the mathematical skills of a bright ten year old, make markets manually.
In 2015, if you do it in a highly-traded U.S. equity, you probably will not have a great risk-adjusted return because your bright ten year old is in all ways worse at this task than a computer is, but it is very doable.
To the extent that HFT is more meaningful than Big Data ("trading that I don't like and data I think is valuable, respectively!"), it had to include some element of Very Frequent, Very Fast. How fast? Like "the speed of light is literally a logistical challenge fast." If you see an order in Chicago and make an order in Tokyo a second later, no matter what your rationale is, you are not doing HFT. That's just T. Got a model of the mind of your counterparty? Oh, welcome to T. Observed a correlation in an ETF and its underlying stocks and using it to trade with 1,000 times a minute? Wow, such impressive T!
I don't disagree with you here, but, on the other hand, parasitic trading [1] is a concept that's existed in market microstructure books for ages, since before HFT. It is not clear to me why this happens, but the concepts of parasitic trading and high-frequency trading seem to be mixed up quite often, even though they are strictly speaking orthogonal to each other. It should still be possible to argue against parasitic trading that also happens to be high-frequency.
So are there systems out there making trades designed to confuse and make HFT systems do the wrong things? Could you make some move then others? Can you run game theory stuff to constantly move the market in certain ways?
Is this really the most efficient way to allocate resources...?
Yes. For instance: all the recent drama about "layering" and "spoofing" fraud is about small (and surprisingly dumb) pieces of code that exist to trick electronic trading systems into trading against their owners interests.
As for efficiency: it is sure as shit more efficient than when stocks were quoted in eighths, and market makers had a collusive agreement to not to quote odd eighths so they could pocket extra money.
Yes, absolutely there are many HFT systems trying to game other HFT systems. Some of them are using perfectly legal means and others are doing things that are less clearly legal.
> Is this really the most efficient way to allocate resources...?
A - Yes as far as we can tell. All the other options haven't worked nearly as well.
B - Be very careful when assuming that the markets are about "allocating resources". That is a by-product of the markets. Their main purpose is about risk management.
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[ 2.9 ms ] story [ 180 ms ] thread...but it doesn't really go on to explain that. It's just a fairly dry bullet pointed definition of different types of High Frequency Trading.
It's a shame it doesn't explain, because high frequency trading is evil, and a really depressing waste of talent.
They insert themselves into the transactions where they can siphon off very small amounts of money over a very large number of transactions. Nobody benefits but them from what they're doing, no one walks away with something in their hands or brains by their actions.
It's legal, but it isn't right or a good thing.
Whether it's "good" liquidity or not, and whether the discovered prices actually reflect true value or not, is a discussion that seems to fairly rapidly head down an acrimonious rathole.
Thus, by definition the liquidity already has to exist (market participants wanting to buy and sell) for HFT's to profit.
The alternative to HFT is how the markets operated for decades prior to HFT companies vacuuming money out of the system--that is, quite well, and with adequate liquidity, and with lots of money still being made.
You implied that, without HFT companies, we'd be right back there, though I see now that you didn't explicitly say exactly that.
I think we've pushed this thread far enough to the right margin of the page.
I reject that premise. HFT algos are majoritarily run in markets with deep liquidity.
I struggle to see how any sector other than the financial sector would suffer if all trades happened once a second, or even once a minute. No process in the human world is going to change the value of a company quicker than that.
Liquidity keeps spreads narrow. Wide spreads are a tax paid by retail investors to a cabal of sell-side firms.
The residential real estate market is gigantic, a demonstrably functional piece of the US economy. Maybe the stock markets should work more like the real estate market. Forget about liquidity. Who needs it? Instead, we'll just pay seven percent of every transaction to an "agent".
Maybe, without just saying "they provide liquidity" and leaving it at that, you can explain how the post-HFT world is better for anyone but the HFT companies?
If you can't explain it in pretty simple language why HFT-level liquidity is beneficial to society as a whole--to the people working in shops, managing restaurants, dealing in real estate, and on and on--then I'm inclined to think you're just trying to bluster about it.
Here, another hint: you can use the search box on the bottom of this page to find comments from me quoting Vanguard.
Either way, since you've accused me now of simply making things up to win arguments, I think I can let you off the hook. There's not much point in us discussing things further.
I also don't think, if it's that simple and obviously good for society as a whole, that it should be that hard to simply explain your position.
HFT has made trading cheaper for the vast majority of market participants. It has done this at the expense of the previous regime that was less efficient and more squalid.
Further, don't take my (or his) word for it. Listen to Vanguard which has a sterling reputation for caring for the interests of their clients who tend to be long term, small scale, investors and large pension/retirement funds.
http://www.cnbc.com/2014/04/25/vanguard-chief-defends-high-f...
For a more detailed description of the mechanics and motivation behind market making, I recommend "A High Frequency Trader's Apology": https://www.chrisstucchio.com/blog/2012/hft_apology.html
If traders, be they high-frequency or otherwise, can't make money by making liquidity available, they won't do it. Less liquidity means wider spreads, which means higher costs especially for smaller transactions (i.e. individual investors).
You could reasonably argue that HFT has caused expenses to increase for large investors who need to buy or sell large volumes of shares. But to the extent that is true, it is like saying that large investors used to get on average an unreasonably good deal at the expense of their counter parties. As in any free market, an especially good price for one party is by definition an especially bad price for the other party.
Be very clear what you mean when you say this. Because the vast majority of the time when people talk about HFT, the only way the "insert themselves" into transactions is by acting as the counter party to one side of the transaction.
In this context they add a lot of value to the system, they smooth the demand curves in time and take on some of the risks of warehousing supply.
The Fed has said as much recently.
I'm not sure who is making that claim, but I think what they are implying is that HFT "provides liquidity cheaper than the previous system of pit traders" or even "fragmentation of exchanges has dramatically brought down exchange fees at the cost of added complexity for liquidity providers (and possibly liquidity consumers). Only HFT systems could have cheaply dealt with this new complexity".
In any case, I'd sum it up as "it is cheaper to trade now after the rise of HFT than at any other time, at least some of that is because they can market make more efficiently than a dude in a vest". Vanguard for one agrees with me (http://www.cnbc.com/2014/04/25/vanguard-chief-defends-high-f...).
What many critics have claimed is that this has come at the cost of an increase in volatility, especially in the form of flash crashes and it is unclear as of yet if that is better/worse than the traditional liquidity crunches we saw under the previous regime and still see in markets not dominated by HFT.
The Fed was specifically talking about this in the context of treasury bond (and futures) volatility and a skeptic might wonder which is more likely to have caused volatility in the treasury markets, HFT or unprecedented fed monetary policy.
None of which is germane to the question of what the OP meant when he said that HFT insert themselves into transactions.
1) It is a front running operation.
2) It has no "social benefit".
3) It increases volatility or structural instability.
Items 2 & 3 are not germane to the question of "it is a front running operation".
My response to item 1 is simply, no it's not. If you state it is, then either you have an unclear understanding of how market mechanics work, or a specific natural opposition to HFT systems. When the OP said that HFT "insert themselves into transactions", I really wanted him to clarify if he meant "insert" in the sense that he thinks they can change a standing order based on new orders before they execute, or the more general sense of "inserting themselves" that any middleman does in any commercial transaction. That is, as an expert in sourcing/warehousing/etc items that have varied demand curves.
Your response (and the fed's part in it) seemed to muddle the responses to items 2 and 3. My answer (and the common one) to item 2 is that it provides liquidity cheaper than the prior regime. That is largely not debated, though it is an open question of whether you could provide the same liquidity even cheaper within some other environment (batch auctions etc).
The question of whether HFT contributes to high volatility vs acts as a response to it is much more nuanced and I suspect unanswered/unanswerable, but the problem with the Fed specifically speaking to it, is that the Feds own actions are at the heart of the question as well. A given bank or investment fund service is unlikely to have the systematic impact of the Fed.
Finally, notice that the Fed did not speak to whether HFT lowers the cost of trading (ie item 2) they only spoke to the volatility question. So using the Feds statements as a counter to the argument that HFT lowers the cost of trading does not work.
As for the criticisms focusing on volatility vs liquidity, to me they are linked, because in those instances of flash crashes that are the target of the recent criticisms, the issue has been that volatity increases due to HFT algorithms withdrawing from the market (i.e. reducing liquidity).
Also, there are other criticisms of HFT's beyond those three, including the "coincidence" that HFT firms seem to be responsible for most of the major order spoofing. Regulators have been VERY slow and uneven about enforcing HFT spoofing, but are finally catching on, albeit with slaps on the wrist (excluding Citadel being banned in China).
I'm some what receptive to the argument that HFT makes the laws harder to enforce, given that the laws rely on "intent" which is murky with algos, but how do we square that in the face of any innovation?
I'd say "highly alarmist" based on what I've read from them over the years. They're pushing people to use their product, so it makes sense for them to publish alarmist stuff which segues into their product offerings.
Their recent crusading against HFT however has moved outside the bounds of logic, as evidenced by this "definition" of HFT, which is just silly (as others here have pointed out).
Historically (I haven't looked in a long time) their market data was inappropriate for HFT usages as it was not at the fidelity required for those applications, but it was very cheap in comparison to other market data providers.
This led to a natural segmentation of their market such that most of their clients are people who are a) interested in market structure but b) not interested in high fidelity market structure information and who aren't interested enough to spend more on other options. That frequently is large block traders (hedge funds) who have a natural opposition to HFT market makers.
Whether that is the only factor in their strident anti-HFT position or if they have other personal moral reasons for it as well, they also publish a highly biased blog railing against HFT, but that is not their business.
In the industry, I never encountered them in the context of "highly respected financial research firm" and only in the context of "dirt cheap market data archive".
HFT, when it is done at milliseconds of latency between exchanges to trick an order into executing at a 'fair price' because the order was sent to one exchange and HFT 'arbitragers', decide to manipulate the price at other exchanges due to latency for the same stock buy/sell.
It is arbitrage free, riskkless arbitrage that adds no value to a market, as it creates none but destroys it. Arbitrage adds value to a market by offering something cheaper; HFT removes the cheaper for the more expensive.
Be clear what you are saying. They are "manipulating the price at other exchanges" by changing the prices they themselves set on their own inventory.
It is not arbitrage, it is price discovery and it is not without risk.
Which will be sold instantly, as they have 'discovered' the price on the other exchanges were lower than where the initial order went to, bought that, and then instantly, give or take a few milliseconds, resell.
It is not price discovery, it is price manipulation. HFTs have no inventory, they are perfectly lean, they throw hot potatoes across different exchanges.
Not that this is not interesting technology. It is, but it is also manipulative.
I exclude prop trading from the above, obviously, because it is different, and does hold inventory.
This issue is not about frequency per se at all. Its about who has access to what information at what price. For instance one thing that happened was that data providers (e.g. Reuters) sold information to a group of traders, before it was available to the public.
The question is not at all whether software should be used to trade (we're not going back to pen & paper / pit trading). Rather the question is how software should be used in financial markets. HFT is not evil, it's a difficult problem to be solved.
Dark pools OTOH tend to have all sorts of gimmicks with respect to whose orders are allowed to match against other orders and under what circumstances. E.g. if I connect to a bank-run dark pool, I may be able to opt out of matching against principal flow from any of the bank's prop desks. The matching rules should be described in a dark pool's "form ATS" which some dark pools publish (and some don't).
All exchanges are obliged to contribute to the SIP, which offers a market-wide view of quotes (prices) and historical trades. However, because the SIP must aggregate data feeds from all exchanges and then republish this information, it's possible to "predict the future" if you subscribe to the direct exchanges feeds (which are more-or-less what they send to the SIP) and avoid the added latency of a hop via the SIP's aggregator and redistribution.
These direct exchange feeds are expensive, and getting more so (ie. NYSE UltraBook is $11,000/month for the data, plus port fees, plus connectivity). The argument is that this segments the customers such that unfair advantage is available to those who can afford to subscribe to the direct feeds.
More recently (last two? years) it's been possible to get a microwave transmission of the data, rather than fiber, which is both lower-latency and more expensive again.
They have 2 different electronic connections based on your latency/throughput requirements. One is more expensive than the other (http://www.eurexchange.com/exchange-en/technology/connecting...). If I remember correctly, the HFT version also requires more onerous legal hurdles as well.
Personally, I view this as a good thing. Why wouldn't we want segmentation in exchange technology?
Unfortunately, at the end of the day, even if you are only about 'fundamentals' (whatever that means) you're obviously going to want to trade FIRST on those fundamentals .. right? Cause whoever does is going to win the day. Ok, so low latency is necessary for normal electronic trading.
Ok, now market events versus fundamentals. Seriously? At what point are 'market events' not fundamentals? The definition is all arbitrary. If there is a change in some correlating index, isn't that a 'market event'? But isn't it also rather fundamental (say, that correlating index is interest rates futures)? At what point does that change in the correlating index no long qualify as a 'fundamental event'? When Nanex says it doesn't?
Nanex simply wants to have its cake and doesn't want to be marked as "HFT". All electronic trading, at its heart, is going to be HFT at some point. The only way to keep that from happening is just come up with really arbitrary definitions marking the line you can't cross. Likely those definitions will be used to help whoever is paying Hillary Clinton/Bush/Trump/etc the most money.
Let's not bother with these shenanigans just put a transactional tax on everything and be done with it. Let's stop spending all our time and our brain power creating software to do trading and start getting back to actually researching /innovating / building things.
If you're only trading long term, then sub-second differences are essentially irrelevant.
I think there's a perfectly reasonable point here. Fundamentals as "trading against the future profit of the company". HFT as "trading against the system".
http://www.thenation.com/article/why-cuomo-leaving-wall-stre...
The tax is instantly rebated since 1981 (thanks, Reagan-era politicians!), so no money around this tax ever changes hands. It seems like it could be an interesting place to start looking as a model for a federal-level tax on financial trading.
1: China $2.9bn, 2: United States $1.9bn, 3: Japan $904m, 4: Germany $745m, 5: Korea $368m
Manufacturing in Germany may contribute a higher percentage of GDP, but it does not appear to have a larger (in dollars, according to this data) manufacturing base than the US in absolute terms.
[0]: http://data.worldbank.org/indicator/NV.IND.MANF.CD?order=wba...
With its population 4x higher, the US only produces 2.5x more stuff.
That's a huge difference.
A large component of US output is agricultural or natural resources which are not included in that number (nor is software for that matter).
My advice to any retail investor though is just dollar cost average into an index fund as a function of your age and forget about it. If you are going to try to 'beat the market' (and worry bout things like transaction taxes and spreads) you will lose.
When people talk about retail traders in this conversation, they are either totally clueless or working in the industry and just don't want to be taxed.
Anyone who says a retail trader should be trading enough to worry about spreads is not your friend.
So no, that argument very much does not carry.
How anyone outside the industry can argue against a transaction tax is beyond me. You have no idea how much the market has been rigged to suck as much money as possible out of you. Wall Street does not generate wealth. Everything they make is a tax on those that do.
I'm a little concerned that we're not talking about the same thing, by the way. Should retail traders care about modern spreads? No. Modern spreads are tiny. But before electronic trading pushed out the crooked human market makers, they were not.
edit to add: Thinking more about it, likely their more profitable accounts (ie, not their index funds) would be destroyed by a transaction tax and so they don't want to see it implemented. The salad days of just doing a simple honest index fund with 3% annual turnover are long over for Vanguard.
According to the theory that stock prices are a martingale (which is well established), there is no qualitative difference between long and short run price movements. In particular, there is no reversion to the mean in stock prices [0].
[0] Of course, there are going to be literally hundreds of papers exhibiting some reversion to the mean effect. But this effect is always tiny.
Okay.
I also think you don't know what a martingale is. It is impossible to make any expected value betting on martingale movements, by definition. If you believe traders are purely "betting on price movements" of martingales then profit is impossible. So either prices aren't martingales or trading is not purely a process of betting on the movements of market-clearing prices. Actually, both assumptions are false.
Regarding martingales, a martingale is defined relative to an information set (you know what a martingale is so you already knew that, right?). Saying that there is no reversion to the mean implies being a martingale with respect to the weakest possible information set (the history of prices). Traders, whether high frequency or others, may have extra information outside this information set.
In short, stop nitpicking and revise your understanding of what a martingale is.
In 2015, if you do it in a highly-traded U.S. equity, you probably will not have a great risk-adjusted return because your bright ten year old is in all ways worse at this task than a computer is, but it is very doable.
To the extent that HFT is more meaningful than Big Data ("trading that I don't like and data I think is valuable, respectively!"), it had to include some element of Very Frequent, Very Fast. How fast? Like "the speed of light is literally a logistical challenge fast." If you see an order in Chicago and make an order in Tokyo a second later, no matter what your rationale is, you are not doing HFT. That's just T. Got a model of the mind of your counterparty? Oh, welcome to T. Observed a correlation in an ETF and its underlying stocks and using it to trade with 1,000 times a minute? Wow, such impressive T!
[1] https://books.google.ca/books?id=Rd9hDRR1Yx4C&pg=PA195
Is this really the most efficient way to allocate resources...?
As for efficiency: it is sure as shit more efficient than when stocks were quoted in eighths, and market makers had a collusive agreement to not to quote odd eighths so they could pocket extra money.
> Is this really the most efficient way to allocate resources...?
A - Yes as far as we can tell. All the other options haven't worked nearly as well.
B - Be very careful when assuming that the markets are about "allocating resources". That is a by-product of the markets. Their main purpose is about risk management.