I think it's pretty fair to call HFT strategies that rely on low-latency connections in order to gain a competitive advantage front-running.
It's definitely front-running in the commonly-understood sense of the word, and sometimes it's specifically front-running in the sense you're talking about: a large company puts in orders for large buys on several exchanges, e.g., and a low-latency HFT sees one of them before it hits the other markets, and puts those buys in first.
edit: This theoretically _will_ happen without any malicious actors, btw: HFT uses machine learning and its inputs include recent trades. Recent trades include large buys from said bank, which previous history indicates the price will go up. HFT puts the buy in. That's front-running.
> I think it's pretty fair to call HFT strategies that rely on low-latency connections in order to gain a competitive advantage front-running.
I'm not sure what you mean by "fair", but no, (again), it's not front-running.
> It's definitely front-running in the commonly-understood sense of the word
No, it's not. At what point do we get to come up with arbitrary definitions simply because many people misunderstand them? Would you like "front-running" to become as meaningless a term as "literally" is for emphasis?
> a large company puts in orders for large buys on several exchanges, e.g., and a low-latency HFT sees one of them before it hits the other markets, and puts those buys in first.
This is not how latency arbitrage works. Exchanges have a fiduciary duty to you as your trading intermediary. They may sell your order flow to other parties, such as HFT firms, but they are still liable for how that information is used. High frequency traders are not capable of seeing your order before it arrives at an exchange. While they will have order flow visibility and buy/sell positions at multiple exchanges, they also must abide by a NBBO price, which means they cannot cross the spread. You cannot bid above the best offer and skip ahead of existing orders in the book.
They are free to alter their prices in reaction to orders in different exchanges, but this is designed to improve accuracy, not target any single particular trade. This also does not constitute front-running, in either the real definition or the imaginary one where they can magically skip ahead of you.
> This theoretically _will_ happen without any malicious actors, btw: HFT uses machine learning and its inputs include recent trades. Recent trades include large buys from said bank, which previous history indicates the price will go up. HFT puts the buy in. That's front-running.
I don't understand what you're getting at here. This is not front-running.
This thread is becoming kafkaesque...do you have a problem with basic information asymmetry in the market?
I am not sure how Franz Kafka would define it, but the NASDAQ[1] defines front-running as:
> Entering into an equity trade, options or futures contracts with advance knowledge of a block transaction that will influence the price of the underlying security to capitalize on the trade[...]
Can you explain how the practice I described does not fit this definition? Or provide a definition that better suits your position?
> Entering into an equity trade, options or futures contracts with advance knowledge of a block transaction that will influence the price of the underlying security to capitalize on the trade. This practice is expressly forbidden by the SEC. Traders are not allowed to act on nonpublic information to trade ahead of customers lacking that knowledge.
The key terms here are “advance” and “nonpublic.” “Advance knowledge” and “nonpublic information” refer to information that other market participants could not have had without breaking a confidentiality agreement or a fiduciary duty. It does not refer to information which is merely difficult to find nor does it refer to information which is public but unevenly distributed. HFT firms cannot see your orders before the exchange receives them and executes them. They are further not obligated to a confidential or fiduciary duty with respect to your interactions with the exchange once the orders are executed, and the order flow is technically “public” once broadcasted by the exchange.
HFT firms are very fast, but they are fundamentally operating by the same processes as other market participants. They purchase order flow, use colocation and write extremely low latency bespoke trading software, but they are not intrinsically doing something that bypasses the normal operating procedure of the markets.
Information asymmetry is not illegal if you’ve “earned” it, in the same way that you can “insider trade” if you come upon “secret” information without breaking a confidentiality agreement or fiduciary duty. There are legitimate arguments that can be made against HFT, but starting off with “front-running” is absolutely not one of them. You need to levy an argument that the same processes of information asymmetry break down in ways that are bad for overall market efficiency and price discovery at high speed, not that HFT firms are doing something other than “information asymmetry, fast.” And this is a hard argument to make in full view of the liquidity offered to the market by automated market making algorithms, i.e. HFT.
Your argument is that latency-based front-running isn't front-running because the front-runners "earned it" via whatever system they built to front-run the trades.
> HFT firms are very fast, but they are fundamentally operating by the same processes
This is the key part I disagree with. A lot of firms set up shop right next to exchanges and built fiber optic connections between them, so that it's impossible for anyone without such a setup to trade on the same information.
I don't see how you could interpret that as "good" for anyone other than the HFT firms who do it best. It's pretty clearly this:
> Your argument is that latency-based front-running isn't front-running because the front-runners "earned it" via whatever system they built to front-run the trades.
It’s not front-running.
> This is the key part I disagree with.
You’re not just disagreeing, you’re incorrect by definition. I explained why in my last comment. It’s not front-running to gain an advantage through capital expenditure. Capital expenditure (like colocation) is not fundamentally an advantage other market participants don’t have. It doesn’t matter if you think it is, it’s not. Insider trading is an example of an advantage that is fundamentally unavailable to other market participants. If we accept your argument, we might as well say that spending more money than competitors to build a better performing fund is unfair.
> I don't see how you could interpret that as "good" for anyone other than the HFT firms who do it best. It's pretty clearly this:
>bad for overall market efficiency
No, it’s very clearly not, for anyone who has worked in finance or who is familiar with how market making works. High frequency traders improve net liquidity in the market. Would you prefer the pit days of preferential treatment by manual market makers, or much slower (and thus less accurate) price discovery?
I don’t know what else to tell you at this point. You have done exactly the thing I was talking about in my original comment. I’ve explained to you that high frequency trading does not satisfy any legal definition of front-running. You’re free to make up an arbitrary definition of front-running, but it’s not the correct definition. Do you need me to cite research showing why high frequency trading improves liquidity and explaining why it can’t step in front of other retail traders’ orders?
> Capital expenditure (like colocation) is not fundamentally an advantage other market participants don’t have.
Except that it is. Market participants cannot all be right next to exchanges, for physical impossibility reasons.
> High frequency traders improve net liquidity in the market.
I agree that there are forms of high-frequency trading that improve market liquidity
> Would you prefer the pit days of preferential treatment by manual market makers...
This is a straw man
> legal definition of front-running
I'm not a lawyer, and don't know what courts have decided about this issue. I'm guessing they've sided with you. But there are plenty of situations where judges make decisions I disagree with, and I'm guessing there are probably some practical issues with making this kind of front-running illegal anyway. Have any other exchanges opened with rules that address this?
Anyway, I certainly don't think all HFT are evil or anything like that, but what you call "latency arbitrage" is clearly front-running and bad for the market: it's basically a "distance from the exchange" tax that doesn't provide any value. I don't know how that should be fixed though, or whether it's possible.
Also, I would love some links on ways in which HFTs are good for the market :)
If I fly a plane over various Walmart and competitor stores, and buy and sell stock based on which parking lots are the busiest, is that front running because it's impossible for anyone without the money to rent a plane to have access to the same information?
Let's take take a textbook example of HFT with orders larger than single exchange can satisfy therefore overflowing to other exchanges and examine timeline. 1. Investor places order at exchange A --> 2. order is known to both exchange A and HFT --> 3. HFT places reactive order in exchange B --> 4. exchange B receives "overflown" order from exchange A.
The time between exchange A receiving original order (point 2.) and exchange B receiving remains of that order (point 4.) is extremely small, but larger than zero. The argument here is that until exchange B acknowledges reception of the original order in its ledger, that information is not public at exchange B and acting upon that order in exchange B until exchange B acknowledges said order is acting on non-public information, therefore front-running.
> <...> the order flow is technically “public” once broadcasted by the exchange.
The core argument I see in this debate is whether we consider exchange network as one large source of public information with multiple access points and accept non-immediate distribution of information through the network as unavoidable technical detail.
At that point the HFT is guessing and hoping the second order will actually arrive at exchange B. That's the risk the HFT takes.
There is no automatic overflow function that will transfer (the rest of) an order between two exchanges. At best either the original investor can decide to split up his order, or someone else can decide to buy at B and sell at A. But still the HFT will be hoping that actually happens.
It's definitely front-running in the commonly-understood sense of the word, and sometimes it's specifically front-running in the sense you're talking about: a large company puts in orders for large buys on several exchanges, e.g., and a low-latency HFT sees one of them before it hits the other markets, and puts those buys in first.
edit: This theoretically _will_ happen without any malicious actors, btw: HFT uses machine learning and its inputs include recent trades. Recent trades include large buys from said bank, which previous history indicates the price will go up. HFT puts the buy in. That's front-running.