As a mostly lay person, for me it's vilified because my understanding of it is that HFT has a significant advantage over my own personal trading, and that through this advantage HFTs are able to make "more" profits than would be possible without HFT. My brain tells me that some of these profits are likely at my own trades' expense, and that while markets and economies rise and fall, my own profits are negatively impacted by HFT.
That may not be accurate, but that's why I personally feel uncomfortable with HFT.
You don't do the kind of trading HFTs do. No matter whether trading is done with hand signals or in FPGAs, you were never going to be making markets.
Meanwhile, cost of trading for normal people like us has gone through the floor. And we're only really looking at the last 15 years when we think about trading costs, but even steeper reductions precede that, and it was all brought about by replacing human market makers --- who are crooked as a barrel of fishhooks --- with automated systems.
Respectfully --- I don't know you, and this isn't a personal comment --- but my guess is that you distrust HFT because you've been told to distrust it. If you do even the most superficial cui bono analysis, you'll see the people most interested in making you believe that are themselves major financial institutions, all of them far larger than the HFTs.
It wasn't HFTs that brought down the economy in '07-'08. It was their adversaries.
The only disagreement I have with Thomas here is the last line. Securitization groups at the large banks and HFTs aren't adversaries -- they don't interact in any meaningful fashion. Large banks, taken as a whole, have some groups which are in competition with HFTs but have other groups which are their happy customers. (If you're a large bank, and you're taking liquidity, you are either astoundingly bad at your job or you actually desire to be buying what HFTs are selling.)
The industry standard for buying/selling mortgage-backed securities or collateralized debt obligations isn't HFT. It isn't even automated. It is one sweating jock yelling at another sweating jock over a recorded telephone call. You can see this dramatized in The Big Short, where to unwind the shorts that the "good guys" have made they have to get their own not-quite-sweating not-quite-jock played-by-Brad-Pitt to do the phone calls on their behalf.
Yes. No. Maybe. There's a massive push towards exchange trading the more liquid products: traders are expensive, and if you can get a robot to do basic inventory management and market making for you (even with a human in the loop), that's savings for a desk manager looking to cut costs in a highly straightened FI environment.
The highly distressed and/or exotic stuff that people are talking about in the Big Short are still slung by salespeople, with the connivance/approval of traders.
In the pre-HFT era there were manual day traders doing spreading, arbitrage and short-term speculation based on the order book. A famous example would be the SOES bandits of the 90s. They would pick-off slow NASDAQ market makers and offer the shares back out on nascent ECNs like Island to make a few ticks.
Some of them worked for firms as professionals, but many traded on retail platforms similar to what you'd see from Interactive Brokers or TT these days. Still you are right that the average investor never traded in this fashion. At worst, the people HFT put out of work were trading as a profitable hobby similar to playing poker online.
I do not believe DRW is colluding with Virtu to keep spreads wide. In fact, all available evidence overwhelmingly suggests that the opposite is happening.
But human market makers colluded routinely, and in some cases famously.
Do you think when Don Wilson (founder of DRW) was making markets in the pits at the CME in the 80s that he was colluding with anyone is more what I was asking. Does he deserve to be labeled "crooked as a barrel of fishhooks?"
On that case I think I agree with the Matt Levine take that "Back in September I was pretty sympathetic to DRW and after reading the CFTC's complaint. I'll double down on that.†" I guess we'll see what happens.
My only point was that some people think all HFT is bad, and here we have a complaint that actually the situation is reversed and it was actually all human market making that was bad. I don't think either statement is completely true, and I was trying to highlight the contradiction because the human market makers and the HFTs are, in a lot of cases, the same people.
Alright, it's hard for me to explain how sometimes all means all and sometimes it doesn't. But tptacek's comment didn't literally say that every last floor trader was crooked, just that was generally true. And it's easy to see how it could be true. A wink here, etc. The difficulty for anyone to see the size of the order book.
I think it's harder to describe how HFT is bad. Most of the efforts in this thread are, we'll say, only loosely connected to reality.
The best you can say about sweaty men shouting is that if not corrupt, still inefficient. (To say nothing of spreads in eighths.) I think that's a claim that really is true for literally every trader.
I don't think people on the floor were necessarily all crooked or doing something illegal, but that market structure doesn't invite fierce competition. You'd see the same people every day and go to drinks with them. There was a real camaraderie between people on the floor, even if they were ostensibly competitors. Think of any community. Most people would probably work a little harder to have a nicer car than their neighbor, but they wouldn't want to see the neighbor's family starve to death in the process. By undercutting your rivals in the pits, you were literally taking away their mortgage payment, and you had to do it to their face. A lot of the locals in the pits were independent, so it was personal, not just business.
You also could see who was on the other side of your trade. Savvy floor traders would use that information to their advantage. If a sharp broker traded with you, you could hedge more aggressively or speculate in the same direction. Most electronic markets are anonymous these days so there's less information leakage.
HFT is generally considered good for retail traders because spreads tend to be lower. You trade both more cheaply and more quickly.
However, it's generally not good for large institutions (which are more than just 'big evil hedge funds') because markets react very quickly to movements caused by this big firms. If they decide that something is priced wrong, they won't be able to make many trades taking advantage of that.
It limits the ability of value investors who do fundamentals research to profit. Arguably those investors are the ones who actually ensure efficient allocation of capital (the supposed purpose of the market). There's kind of a paradox of efficient markets - the more efficient the market is, the less value can be gained selling information to it.
It does no such thing. Market makers prefer not to interact with people that have a directional view as they may move the market. If a market maker gets caught with inventory and the price is moving they will lose money. Market makers tend to be less involved in price formation then other types of investors.
> It does no such thing. Market makers prefer not to interact with people that have a directional view as they may move the market. If a market maker gets caught with inventory and the price is moving they will lose money.
Are you claiming this doesn't impact the profitability of those people with directional views?
It depends on what you mean by impact. A market makers role is to provide market participants the instantaneous ability to buy or sell a security. They compensated a small amount for providing this service. If someone is using very poor execution techniques the price could worsen, however most large asset managers and brokers that serve them have quite advanced execution technology. The actual impact of modern market making on final execution price is typically positive relative to not having it due to competition and ultimately a tighter spread.
Vanguard invests almost purely passively, and does not generally take directional views. I agree HFT benefits Vanguard but that doesn't contradict my point at all.
Let's not get into a semantic argument. The point is that Vanguard doesn't do fundamentals research or participate in capital allocation (in a meaningful sense; Vanguard does allocate capital but in proportion to existing allocation); they just invest passively and hope to earn the return of the overall market.
Its not semantics. You simply don't know much about the asset management business. Vanguard has numerous actively managed offerings. For example Windsor (http://performance.morningstar.com/fund/performance-return.a...). But there are others like the Admiral funds.
A clarification on my other sister post: options allow one to lock in a price for cheap even at large volumes. For example expiring options can be bought for nickels in premium, with each one locking in price for 100 shares.
Expiring options are pretty thinly traded, no? If you're trying to sell 100000 shares, you may have a hard time scrounging up 1000 puts at 3:30 Friday.
Rather than seeing HFTs as competing against you, a more accurate model is to see various firms competing against each other to service your needs at the lowest possible cost. These firms used to be staffed with expensive and slow humans, but by automating they are able to deliver a service to you at a much lower cost than was previously possible.
The story of automation in the financial markets is similar to the story of automation in many other businesses.
How does that really help me if I'm buying/selling a specific stock (vs. being in a larger fund, etc...)? My, again very lay, understanding is that the HFT is likely to push my buy price up slightly and make money in the middle of me a non-HFT seller, and push down the price slightly on the sale side, again making money as a very fast middleman.
1) It reduces the bid/ask spread. There isn't just one price for a stock, there are two. The price at which you can buy and the price at which you can sell. The price at which you can sell is lower. So when you buy a share of stock you are immediately down a little bit. This amount is called the spread. By automating firms can reduce this spread which does the opposite of what your intuition told you. It will bring buy prices down slightly and sell prices up slightly.
2) It helps make sure that prices are as accurate and up to date as possible. When you go to buy a share of $GOOG you probably aren't really sure if it should cost 775.40 or 775.45 or 775.50. You just figure it's a good company and likely to go up in the future. But because there are all these firms working really hard and acting really fast you can be pretty confident that whatever price you buy at at any given time contains the total available knowledge currently available in the world about Google's future potential.
Unless you are exceeding the liquidity on a single exchange HFT will never affect you.
Here how it works... Imagine you want to BUY 10000 MSFT...
You send your order to exchange A, it does a partial fill for 1000 orders, and sends the remainder to exchanges b,c,d. An HFT firm sees your order to exchange A knows its not going to fill and sends its own orders to buy the liquidity on B,C,D and then sends sell orders at a higher price to B,C,D, your order fails to fill and you have to issue a new order at a higher price.
Since retailers will very likely never exceed the liquidity on a single exchange they'll never have any issue with HFT and will just experience increased liquidity and faster fills.
However, if you're a large dinosaur still sending huge orders now you'll need a group of suckers who want to trade only with you, enter IEX, and 'consumer' protection from HFT on their exchanges who now has a large pool of suckers to trade with.
"You send your order to exchange A, it does a partial fill for 1000 orders, and sends the remainder to exchanges b,c,d. An HFT firm sees your order to exchange A knows its not going to fill and sends its own orders to buy the liquidity on B,C,D and then sends sell orders at a higher price to B,C,D, your order fails to fill and you have to issue a new order at a higher price."
Maybe, but that seems like a pretty risky strategy. A simpler and far less risky strategy that would look very similar (admittedly only if you're looking exclusively at orders on the book and not fills) would be for HFT market makers to cancel or reprice their existing resting orders on exchanges B, C, D in response to getting or seeing a large fill on A.
In the strategy described by the parent, in addition to having to cross the spread, the HFT firm would also be at the back of the line at the next price level (unless maybe they already have an order there? but no guarantee that it's the right size, or maybe they have multiple small orders and cancel whatever is in excess of the position..).
So I'm genuinely curious: is what the parent describes something that is really that commonly done? This is one of the things that made me highly skeptical of Flash Boys. It seemed to me they observed a phenomenon, came up with a single explanation for it and never even considered any other possibilities that didn't fit the chosen narrative.
I believe the repricing behavior you describe is far more common now than the more aggressive strategy. Several years ago, before the exchanges got rid of "flash" orders, a variation of the more aggressive strategy was common, but under limited circumstances. The way it worked was that after a limit order was partially filled on exchange A, it would show the remaining size at the limit price very briefly before routing it to the other exchanges (this was the "flash"). If the limit price was a few ticks through the other exchanges best prices, the HFT's would take those prices out and offer at the order's limit price. Less risky because they knew the order would be automatically executed at that price as long as there was an offer there.
I kind of agree with your underlying premise, but when I invest in a mutual fund / ETF, isn't that a giant investor that might be affected by HFT? And if that was costing the fund money, wouldn't that affect me (without me seeing it directly)?
Assuming that hft forms didn't drive other prices down. In particular the costs to trade (in the form of the spread, fees & execution costs) hadn't been decimated by hft firms.
What you are missing is that in the old days, your buy/sell order was probably handled by a human market maker instead of an HFT's algo, who would push up/down the price much more than 'slightly', hence making you pay more in trading costs. The biggest opponents of HFTs are the major financial institutions who used to provide those market making roles.
If you think HFT is going to push up the buy price, set your limit a penny lower and wait a second for the "slow" traders to handle it. (If that's how you think markets work.)
That may not be accurate, but that's why I personally feel uncomfortable with HFT.