I usually hate TL;DR comments, but if someone provided a short summary of the argument here (and for bonus points, a critique of the argument's strength), I would be very grateful.
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.
The last section makes an interesting point about the type of speculation that HFT does, i.e. it's not long-term (no positions carried overnight) and thus it can't create the types of asset bubbles that we've seen in the past
The rest of the article seems to make some rather dubious strong claims, also. For example: "High frequency traders can only trade profitably when their trades push a stock price towards fair value."
I don't see why there's any particular reason that's true. High-frequency traders can trade profitably whenever their trades are in line with (very) short-term price movements. Ideally everything works together to push prices towards fair value, but you can't assume that as an axiom, since that's the main point being disputed in that section (the one on volatility).
One other aspect of HFT that was not mentioned in the article is that HFTers often seek arbitrage opportunities. For example, the value of many ETFs such as SPY (i.e. an ETF tracking the S&P 500) are derived from the value of underlying securities. If the value of SPY versus the value of the underlying securities becomes out of sync, HFTers may go long one and short the other and then profit when they converge again. In this sense, HFTers only profit if the market returns to fair value. This applies to many ETFs, convertible securities, and options.
Keep in mind that this is appearing in a magazine that is successful because of the success of high frequency trading and that the article is written by the member of a company that bases its profits on the ability to conduct high frequency trading.
My intention wasn't to end the debate, but rather to steer it away from the substance-lessness that characterizes most debates about HFT.
That being said (disclaimer: I am a HFTer), this article is a pretty weak defense of HFT. Like others have pointed out it makes a lot of assertions not based on data/fact. However, I've yet to read a criticism of HFT that doesn't commit the same mistake (and I've read a lot of them).
High frequency trading is not the issue. the issue is an automated system watching for large incoming orders. When this system observes an incoming order, it purchases available supplies at lower cost than the incoming order will pay, then sells the stock to the large buyer.
Is it clever arbitrage? is it a massive denial of service so some people can play middle man? I don't know.
However, Cameron Smith has created an excellent straw man of his opponents. This is an ad hominem argument.
If geeks have one character flaw that holds them back it's the need to understand everything in excruciating detail. In the real world you can't possibly learn enough to engage in informed debates on every topic, however understanding human nature and paying attention to whose interests are served by what ideas will get you a lot of mileage for minimal effort. Maybe the GP isn't a great thought-provoking HN comment, but it's definitely something that should be in the back of our minds.
If pdoughtie were saying "this must be wrong, because ..." then you would have a good point, but that's not quite what's going on.
The article contains a number of assertions, central to its claim but with little evidential support in the article. (For instance: "No serious market observer disputes the claim that volatility would not be higher without the liquidity provided by high frequency traders" -- has the author really looked hard for serious market observers with a different opinion? -- and "High frequency traders can only trade profitably when their trades push a stock price towards fair value"; what exactly is "fair value" supposed to mean, why shouldn't there be short-term bubbles among HF traders just as there are long-term bubbles among slower traders, and who says HF traders can't all happen to trade unprofitably in some particular case?.) It may very well be that those claims are true, but we basically have to trust the author. And that is what we may quite rightly and rationally be less inclined to do, if we know that the author has a vested interest in persuading us.
Certainly he does have a vested interest. Not the end all-be-all, but he does cite the board of governors and hendershott-riodan as evidence it reduces volatility, some indirect evidence in the short selling ban, the history of QQQ as evidence of lowering cost, tightening spreads.
The 'fair value' he's talking about us just the supply-meets-demand of that stock for that particular moment-- that moment could definitely take place in a larger bubble of that security. The mini-bubble within high freq trading he refutes by reasoning only ("another hft would detect this"), so I think a more concrete example would've been more convincing. As with all bubbles the question is how far out of line can the price get, and how quickly will the price be brought back to reality
"While most retail investors probably have little concept of what high frequency trading is or its impacts, active equity traders have seen its pronounced imprint on the markets. High frequency trading is an entirely legitimate strategy of using computer algorithms to execute trading strategies with ultra-low latency. Yet, the explosion in HFT has led to a major structural flaw in equity markets. This flaw is the abuse of uncharged bidding and offering for shares. Level II traders know exactly what this is as they see it day after day in every stock they trade. The book of bids and offers is supposed to be a top-to-bottom list of the prices every player in the market is willing to buy and sell a stock. In this idealized world, there is price transparency as everyone can see who wants to buy and who wants to sell should the participant chose to place a limit order. The price at any given second then is an accurate reflection of the current supply and demand for shares (ignoring the use of dark pools, hidden orders, etc.). Limit orders are meant to be the showing of an explicit intention to buy or sell shares at a predetermined price. Should a trader not want to show his hand, he can execute market orders or use reserve orders. Yet, the book no longer acts in accordance with the idealized world.
Every single listed stock’s order book is filled with false bids and false offers. These limit orders are constantly used to manipulate prices back and forth to the HFT’s advantage. Nearly every higher volume, lower priced stock has a book that is stacked with offers and bids at nearly every penny increment but the vast majority of these quotes are fake. The HFTs submitting the bulk of these orders do not have the objective of being filled on their orders. The purpose is to manipulate the price in some way. This is clearly a deceptive practice occurring in nearly every stock in the current hybrid and fully electronic markets. The high frequency trader has the explicit goal of tricking other traders into believing there is something real there when there is not. Bidding and offering without the intention of actually filling the order is nothing more than a mechanism to mislead other traders. This game, as played by HFTs, is an obscenely inefficient allocation of resources. "
From the Nasdaq note, take a look at Quote vs. Trade:
"Quote vs. trade: The plans then allocate to each SRO a portion of each issue’s income pool for quotes and trades. Quotes and trades in total per security are eligible for approximately 50% each of the symbol’s income allocation subject to the $4.00 cap per eligible trade report.
• Quotes are allocated value based on time and size at the inside market
• Trades are allocated value based on the number of eligible trade reports and reported dollar volume"
Exchanges now earn revenue for not only trade reporting but for quote reporting. And, to attract more quotes, the exchanges are very aggressive in rebating these fees to the subscribers who post the quotes.
"Exchanges devised revenue-sharing and rebate programs that rewarded order-flow providers for tape shredding, and encouraged algorithmic traders to execute strategies involving large numbers of small trades. We provide evidence that data revenue allocation has influenced the trading process
In this paper, we show that the allocation formula has had a significant impact on the trading process. In particular, we demonstrate that average trade size is sensitive to changes in ...
I am somewhat confused by this double-negative: "No serious market observer disputes the claim that volatility would not be higher without the liquidity provided by high frequency traders."
The author seems to be trying to say that high frequency traders reduce volatility. But I parse the claim differently: it seems to me to be saying that volatility could only be lower in the absence of liquidity from high frequency traders.
As to the rest of the argument, it seems to be structured along these lines:
* More efficient markets with lower spreads between buy and sell are good. I think this is a valid claim, but I don't think it follows from the existence of high frequency trading, but rather from more efficient, automated trading systems.
* High frequency trading helps supply market liquidity, and this liquidity is good. I can buy the first part of this, and the second part seems mostly true.
* Old-fashioned purchasers seem to be annoyed that when they make a large purchase, the price for the last share is higher than the price for the first share, because the market has already reacted to the change in supply and demand. He also makes the argument that were this not so, the sellers of shares would in effect be subsidizing purchasers. His case seems solid enough to me.
* But he then makes another claim that seems to contradict it. He suggests that companies with stocks that have low volume turnover are unduly affected by small purchases, and since high frequency trading increases volume, the impact is reduced.
* Finally, it seems he would like to claim that because "our nation's equity markets are far fairer, more efficient, more liquid and have lower transaction costs for investors than ever before", high frequency trading should claim a substantial portion of the credit.
HFT market participants are having the privilege to place and cancel orders up to 30 seconds. For free. No charge. If a big order is coming they can get all available shares and sell it at higher price to the who places the big order. For free.
It actually seems to be more like a quadruple-negative. Let's try to simplify.
"No serious market observer disputes the claim that volatility would not be higher without the liquidity provided by high frequency traders."
"[serious market observers believe] that volatility would not be higher without the liquidity provided by high frequency traders."
"[serious market observers believe] that volatility would [be lower] without the liquidity provided by high frequency traders."
"[serious market observers believe] that volatility would [be lower] without ... high frequency traders."
"[serious market observers believe] that volatility [is higher with] ... high frequency traders."
"[high frequency traders increase volatility]"
This, of course, is exactly the opposite of what the author proceeds to argue in the following paragraphs. My conclusion is that the author managed to create a sentence so overly complicated that even he could not understand what he was saying.
I am a professional trader, and by almost any definition I operate in the "high frequency" space. First, let's establish that Traders is an authority on the real world of financial markets in the same sense that PC World is an authority in the world of technology.
So I've not read the linked article, nor am I going to. But I will say this: HFT does perform a viable, necessary economic function. A well-functioning capital market absolutely requires this kind of activity.
HOWEVER, like most mainstream-media memes, what gets talked about / opined on is almost never relevant to what is actually important and/or controversial: in this case, the question of whether HFT creates a two-tiered playing field where individual (read: non-technically-sophisticated) investors suffer at the hands of the "pros".
Most arguments against HFT basically say that algorithms are purely predatory and only serve to hurt the performance of large investors. This is naive at best and deceptive at worst; for every share I purchase "ahead of" a big order, a seller has been filled at the price he desired. Every transaction has two sides; you can't just pick one and say they got screwed. The other side has to have done as well as the other did poorly (assuming a fictional frictionless world).
The reality is that HFT requires tons of knowledge and a technology budget of seven figures per annum at the barest minimum, and this provides a very real barrier to entry. What should be talked about, but never is: is that ok? Why or why not? What ramifications does it have?
Each time you buy ahead of someone they lose the money you make. It's a zero-sum transaction. Instead of being between a buyer and seller, it's now the buyer, you and the seller. You make enough money over the year to justify the seven-figure technology budget, and all of your profit has to come from the other two parties. (Well, and the money you might get as rebates from the exchange.)
You make the assumption that they would trade. That assumption is only valid because of people like me.
I don't need to justify my activity, nor do I want to go that route--my point is that the fact that participants can realistically expect a fill is not something that happens because of magic.
> You make the assumption that they would trade. That assumption is only valid because of people like me.
You make the same assumption yourself, every time you trade. The entire purpose of high frequency trading is to beat others to good deals -- not to do a better job of discovering good deals.
ok, so i think the original thread here is arguing that "being run over" is just the market doing what it would do anyway, without you playing in the traffic and endangering us all...
If it's completely untrue, then I'd like to hear about how your computerized trades ever "discover" a good deal.
I'm fairly sure this is the answer: They don't -- instead, they're just good at noticing, very quickly, the actions of the market actors who do. Which is just another way of saying that they're about beating others to the deal.
(I'd also guess that they're probably also quite good at handing recreational day-trader's asses to them.)
It's a little less black and white. Suppose I put a guy with a physics PhD in a dark room for a while and he tells me 'with 99% probability, a stock with a price-to-earnings ratio of under 10 will beat the S&P 500 the next year". So whenever a stock's ratio gets below 10, I buy the stock and short the S&P 500 and wait for the bags of money to arrive. In that case, I'm not really relying on noticing the actions of others who have discovered a good deal. Yet, I am keenly interested in beating anyone to the stock when the ratio gets to 9.99. In reality, the market signals are more complicated statistical relationships, they could just as easily arise from someone being very dumb, instead of very smart. Or just the result of random variation that day.
And yet, even for your hypothetical, you use the term "market signals." ;)
If you look at markets through an information-centric lens, it seems possible to draw a clear distinction between actions that introduce external data and those that are pure acts of deduction, no matter how brilliant.
Let me explain what I think the parent is getting at. Say there is a $20/share sell order registered on the exchange. Then another investor submits a $30/share buy order. As I understand it, at this point HFTs jump in, buy out the sell order at $20/share, and then resell the shares to fill the buy order at $30/share, pocketing a $10/share profit.
The question is, why can't the buy and sell orders be matched directly, allowing the buyer to pocket the discount off the price he was willing to pay, instead of the difference going to an HFT with access to the incoming order stream? What possible benefit is provided to the market by skimming off the difference like this?
The behavior I talked about above is one of the objections to HFT as it's currently practiced, and I'd like to know whether it reflects a misunderstanding.
Obviously in this kind of pure arbitrage situation, the world would be a better place If seller A and buyer B are matched up directly. But rarely would this kind of situation come up. There was this nytimes article a while back that describe something similar to the above scenario in context of a 'flash order', and I think everyone thinks this is what HFT is. For a normal retail order this should not happen. But for the flash order described in the nytimes article, the truth is a little more complicated. The buyers and sellers were not immediately matched up in that case. Why? The buyer was trying to hide the fact that they were trying to buy, by using a flash order. The gamble is they could find another pocket of liquidity before sending it to the open market. But in this case the gamble failed-- they would've been better off sending it directly. There are many controversies about flash trading and how it skirts Reg NMS. If you read the flash trading page in wikipedia there's some good info by the BATS people in the Forbes link.
Well, by definition it's true for all trades that would occur without your help. In those cases, you're taking a couple cents and making it more expensive for at least one of the other participants. That would cover, say, any institutional investor who is moving into a position.
In terms of you justifying HFT activity, of course not. There have always been advantaged participants and HFT traders are simply those today. But the article was trying to justify HFT as manna for all participants, which seems unlikely considering how much money the industry is extracting for their liquidity-providing services.
I'm not a professional trader, like yourself, but from what I've gathered over the last several years of HFT coming up in the news is that it is in fact a low-barrier to entry field. All you need is a decent quant, application designer, and some co-located machines as close as you can get them (and other easily acquired amenities.) So I could make a reasonable bet you could open a HFT firm with a couple hundred thousand, plus the talent. (And I've confirmed this with a few hedge fund guys, and they pretty much agreed.)
And I do completely understand the argument for liquidity: more transactions = more accurate price discovery. But I think problem here is that this entire field is black box, meaning property trading algorithms and trading patterns can and are used within the system. This can allow a trading AI to go out into the market place, look for pattens, and to create and cancel millions of orders within the fraction of a second.
I'm sure you know about the former Goldman Sachs programmer who was charged with theft by the FBI. It was totaled at around 32 megabytes of software code. Not very much. But Goldman insisted that if this code got out into the market it would be detrimental to their business and violate their trades secrets confidentiality clause. Not to mention Goldman's largest profit center in their business is their proprietary trading desk, which is heavily into HFT.
My contention is that if we are really interested in a utility that uniformly benefits the market, then let's have an open source platform that provides that, so we can verify that any of these firms aren't "front-running" their trades.
Thats my opinion. I think a lot of the debate over HFT is just filler, it doesn't matter. The guys who are hip to the scene are already making a killing on it now, and it may last a few more years before we begin to regulate.
Sure, you can get the point where you're placing trades for a couple hundred grand... as long as a lot of things fall into place for you. Writing your own apps? Unless you think you can get talent that is willing to roll the dice and possibly be out of a job in a couple months, you're looking at 12 months x the cost of those people... how much is that? $500k? This isn't framework-style assembly of components. If you want to be competitive, the SLOWEST things you can use are linux and C++.
Colocation agreements usually require a minimum commitment of 12-36 months... probably $10k/mo if you have some rudimentary failover and the like.
I'd say anyone who tries with less than 12 months and $500k to truly burn has 0 shot at success. And if you want to really do it right, you're looking at an order of magnitude more.
for every share I purchase "ahead of" a big order, a seller has been filled at the price he desired.
But they would have been filled at the price they desired if they sold directly to the big order, as well. The end effect of the hft systems is just to run up the big order to the max of what they're willing to pay, and take their profit as the difference between that max and the original offer (split up between however many of these things managed to make it over to the feeding frenzy before the real buyer got what they wanted).
40 comments
[ 3.8 ms ] story [ 107 ms ] thread2) 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 don't see why there's any particular reason that's true. High-frequency traders can trade profitably whenever their trades are in line with (very) short-term price movements. Ideally everything works together to push prices towards fair value, but you can't assume that as an axiom, since that's the main point being disputed in that section (the one on volatility).
DH1
I do think it's legitimate to look at sources for articles, especially when there are strong conflicts of interest.
Romans 13:1
That being said (disclaimer: I am a HFTer), this article is a pretty weak defense of HFT. Like others have pointed out it makes a lot of assertions not based on data/fact. However, I've yet to read a criticism of HFT that doesn't commit the same mistake (and I've read a lot of them).
For a defense of HFT that uses hard data I'd direct people here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1501135
Is it clever arbitrage? is it a massive denial of service so some people can play middle man? I don't know.
However, Cameron Smith has created an excellent straw man of his opponents. This is an ad hominem argument.
The article contains a number of assertions, central to its claim but with little evidential support in the article. (For instance: "No serious market observer disputes the claim that volatility would not be higher without the liquidity provided by high frequency traders" -- has the author really looked hard for serious market observers with a different opinion? -- and "High frequency traders can only trade profitably when their trades push a stock price towards fair value"; what exactly is "fair value" supposed to mean, why shouldn't there be short-term bubbles among HF traders just as there are long-term bubbles among slower traders, and who says HF traders can't all happen to trade unprofitably in some particular case?.) It may very well be that those claims are true, but we basically have to trust the author. And that is what we may quite rightly and rationally be less inclined to do, if we know that the author has a vested interest in persuading us.
The 'fair value' he's talking about us just the supply-meets-demand of that stock for that particular moment-- that moment could definitely take place in a larger bubble of that security. The mini-bubble within high freq trading he refutes by reasoning only ("another hft would detect this"), so I think a more concrete example would've been more convincing. As with all bubbles the question is how far out of line can the price get, and how quickly will the price be brought back to reality
http://blog.t3live.com/2010/02/prop...lation-tax.html
"While most retail investors probably have little concept of what high frequency trading is or its impacts, active equity traders have seen its pronounced imprint on the markets. High frequency trading is an entirely legitimate strategy of using computer algorithms to execute trading strategies with ultra-low latency. Yet, the explosion in HFT has led to a major structural flaw in equity markets. This flaw is the abuse of uncharged bidding and offering for shares. Level II traders know exactly what this is as they see it day after day in every stock they trade. The book of bids and offers is supposed to be a top-to-bottom list of the prices every player in the market is willing to buy and sell a stock. In this idealized world, there is price transparency as everyone can see who wants to buy and who wants to sell should the participant chose to place a limit order. The price at any given second then is an accurate reflection of the current supply and demand for shares (ignoring the use of dark pools, hidden orders, etc.). Limit orders are meant to be the showing of an explicit intention to buy or sell shares at a predetermined price. Should a trader not want to show his hand, he can execute market orders or use reserve orders. Yet, the book no longer acts in accordance with the idealized world.
Every single listed stock’s order book is filled with false bids and false offers. These limit orders are constantly used to manipulate prices back and forth to the HFT’s advantage. Nearly every higher volume, lower priced stock has a book that is stacked with offers and bids at nearly every penny increment but the vast majority of these quotes are fake. The HFTs submitting the bulk of these orders do not have the objective of being filled on their orders. The purpose is to manipulate the price in some way. This is clearly a deceptive practice occurring in nearly every stock in the current hybrid and fully electronic markets. The high frequency trader has the explicit goal of tricking other traders into believing there is something real there when there is not. Bidding and offering without the intention of actually filling the order is nothing more than a mechanism to mislead other traders. This game, as played by HFTs, is an obscenely inefficient allocation of resources. "
Directly from the source:
http://www.nasdaqtrader.com/content...ms_revshare.pdf
From the Nasdaq note, take a look at Quote vs. Trade:
"Quote vs. trade: The plans then allocate to each SRO a portion of each issue’s income pool for quotes and trades. Quotes and trades in total per security are eligible for approximately 50% each of the symbol’s income allocation subject to the $4.00 cap per eligible trade report. • Quotes are allocated value based on time and size at the inside market • Trades are allocated value based on the number of eligible trade reports and reported dollar volume"
Exchanges now earn revenue for not only trade reporting but for quote reporting. And, to attract more quotes, the exchanges are very aggressive in rebating these fees to the subscribers who post the quotes.
Also, this research is interesting too: Equity Trading and the Allocation of Market Data Revenue http://wpcarey.asu.edu/fin/upload/C...May-27-2009.pdf
"Exchanges devised revenue-sharing and rebate programs that rewarded order-flow providers for tape shredding, and encouraged algorithmic traders to execute strategies involving large numbers of small trades. We provide evidence that data revenue allocation has influenced the trading process
In this paper, we show that the allocation formula has had a significant impact on the trading process. In particular, we demonstrate that average trade size is sensitive to changes in ...
The author seems to be trying to say that high frequency traders reduce volatility. But I parse the claim differently: it seems to me to be saying that volatility could only be lower in the absence of liquidity from high frequency traders.
As to the rest of the argument, it seems to be structured along these lines:
* More efficient markets with lower spreads between buy and sell are good. I think this is a valid claim, but I don't think it follows from the existence of high frequency trading, but rather from more efficient, automated trading systems.
* High frequency trading helps supply market liquidity, and this liquidity is good. I can buy the first part of this, and the second part seems mostly true.
* Old-fashioned purchasers seem to be annoyed that when they make a large purchase, the price for the last share is higher than the price for the first share, because the market has already reacted to the change in supply and demand. He also makes the argument that were this not so, the sellers of shares would in effect be subsidizing purchasers. His case seems solid enough to me.
* But he then makes another claim that seems to contradict it. He suggests that companies with stocks that have low volume turnover are unduly affected by small purchases, and since high frequency trading increases volume, the impact is reduced.
* Finally, it seems he would like to claim that because "our nation's equity markets are far fairer, more efficient, more liquid and have lower transaction costs for investors than ever before", high frequency trading should claim a substantial portion of the credit.
"No serious market observer disputes the claim that volatility would not be higher without the liquidity provided by high frequency traders."
"[serious market observers believe] that volatility would not be higher without the liquidity provided by high frequency traders."
"[serious market observers believe] that volatility would [be lower] without the liquidity provided by high frequency traders."
"[serious market observers believe] that volatility would [be lower] without ... high frequency traders."
"[serious market observers believe] that volatility [is higher with] ... high frequency traders."
"[high frequency traders increase volatility]"
This, of course, is exactly the opposite of what the author proceeds to argue in the following paragraphs. My conclusion is that the author managed to create a sentence so overly complicated that even he could not understand what he was saying.
So I've not read the linked article, nor am I going to. But I will say this: HFT does perform a viable, necessary economic function. A well-functioning capital market absolutely requires this kind of activity.
HOWEVER, like most mainstream-media memes, what gets talked about / opined on is almost never relevant to what is actually important and/or controversial: in this case, the question of whether HFT creates a two-tiered playing field where individual (read: non-technically-sophisticated) investors suffer at the hands of the "pros".
Most arguments against HFT basically say that algorithms are purely predatory and only serve to hurt the performance of large investors. This is naive at best and deceptive at worst; for every share I purchase "ahead of" a big order, a seller has been filled at the price he desired. Every transaction has two sides; you can't just pick one and say they got screwed. The other side has to have done as well as the other did poorly (assuming a fictional frictionless world).
The reality is that HFT requires tons of knowledge and a technology budget of seven figures per annum at the barest minimum, and this provides a very real barrier to entry. What should be talked about, but never is: is that ok? Why or why not? What ramifications does it have?
I don't need to justify my activity, nor do I want to go that route--my point is that the fact that participants can realistically expect a fill is not something that happens because of magic.
You make the same assumption yourself, every time you trade. The entire purpose of high frequency trading is to beat others to good deals -- not to do a better job of discovering good deals.
(so speed is important to you, just as water is important to a fish; it may not be what you focus on, but that doesn't mean that it's not critical).
There are market participants who make their money on pure latency arbitrage; it is a 100% speed game (because anyone can figure out that 1 - 1 = 0).
The majority of HFT falls into the "you have to be fast enough to not get run over" bucket.
I'm fairly sure this is the answer: They don't -- instead, they're just good at noticing, very quickly, the actions of the market actors who do. Which is just another way of saying that they're about beating others to the deal.
(I'd also guess that they're probably also quite good at handing recreational day-trader's asses to them.)
If you look at markets through an information-centric lens, it seems possible to draw a clear distinction between actions that introduce external data and those that are pure acts of deduction, no matter how brilliant.
The question is, why can't the buy and sell orders be matched directly, allowing the buyer to pocket the discount off the price he was willing to pay, instead of the difference going to an HFT with access to the incoming order stream? What possible benefit is provided to the market by skimming off the difference like this?
The behavior I talked about above is one of the objections to HFT as it's currently practiced, and I'd like to know whether it reflects a misunderstanding.
In terms of you justifying HFT activity, of course not. There have always been advantaged participants and HFT traders are simply those today. But the article was trying to justify HFT as manna for all participants, which seems unlikely considering how much money the industry is extracting for their liquidity-providing services.
Does the fact that Kinkos invests millions in fancy printers make the photocopying business unfair?
And I do completely understand the argument for liquidity: more transactions = more accurate price discovery. But I think problem here is that this entire field is black box, meaning property trading algorithms and trading patterns can and are used within the system. This can allow a trading AI to go out into the market place, look for pattens, and to create and cancel millions of orders within the fraction of a second.
I'm sure you know about the former Goldman Sachs programmer who was charged with theft by the FBI. It was totaled at around 32 megabytes of software code. Not very much. But Goldman insisted that if this code got out into the market it would be detrimental to their business and violate their trades secrets confidentiality clause. Not to mention Goldman's largest profit center in their business is their proprietary trading desk, which is heavily into HFT.
My contention is that if we are really interested in a utility that uniformly benefits the market, then let's have an open source platform that provides that, so we can verify that any of these firms aren't "front-running" their trades.
Thats my opinion. I think a lot of the debate over HFT is just filler, it doesn't matter. The guys who are hip to the scene are already making a killing on it now, and it may last a few more years before we begin to regulate.
Colocation agreements usually require a minimum commitment of 12-36 months... probably $10k/mo if you have some rudimentary failover and the like.
I'd say anyone who tries with less than 12 months and $500k to truly burn has 0 shot at success. And if you want to really do it right, you're looking at an order of magnitude more.
But they would have been filled at the price they desired if they sold directly to the big order, as well. The end effect of the hft systems is just to run up the big order to the max of what they're willing to pay, and take their profit as the difference between that max and the original offer (split up between however many of these things managed to make it over to the feeding frenzy before the real buyer got what they wanted).