HFT people will argue that they provide more liquidity in
the market - it's easier to sell your stocks because HF
traders increase the overall volume, etc.
A problem with their argument, (one of many) is that HFTs are not regulated market makers.
HFTs provide liquidity when the market's good, but you always have plenty of liquidity when the market's good. You only really need liquidity during a price crash, which is precisely the moment all the HFTs head for the exits, and the exchange seizes up.
HFTs are essentially a tax on stock transactions, and if you actually wanted that, why not have a legislative tax, rather than giving 5% to whatever stock trader has the shortest fiber optic cable to the exchange?
Charlie Munger, vice chairman of Berkshire Hathaway, argues that high-frequency trading is "legalized front-running".
I think it is very stupid to allow a system to evolve where half the trading
is a bunch of short-term people trying to get information one-millionth of a
nano-second ahead of somebody else. It’s legalized front-running; I think
it’s basically evil and it should never have been able to reach the size
that it did ... why should all of us pay a little group of people to
engage in legalized front-running of our orders?
Charlie, as a guy who regularly buys and sells large volumes of stock, is just talking his book. It would be great for him if he could make large transactions without the stock price responding quickly to this new information. But it would be bad for everyone he transacted with.
To make this concrete:
Say Charlie & Warren wake up one day and decide Company X is undervalued and that they want to by 5% of it. They start buying stock. In the old pre HFT days it would take a while for the market to notice all this new demand so they could get a lower price. But now HFTs are really good at noticing this so the price rises faster.
But wait you say! This is the "front-running" that Charlie is complaining about and that's bad! He's getting screwed!
But what if you were one of the people selling to Charlie. Before HFTs made the price faster you were the one getting screwed! There was all this new demand and you didn't know about it yet so you weren't getting as good of a price as you otherwise could have.
HFTs aren't front running. They just move the stock to it's true price faster than the humans doing the job before could.
HFT front-running isn't about faster price discovery. It's about getting quote data in advance of the consolidated feed and executing trades a few microseconds ahead of the order flow.
If I'm buying, the HFT buys ahead of me and resells it to me at a higher price. If I'm selling, the HFT shorts ahead of me and buys from me at a lower price.
This isn't about liquidity or efficient markets, it's about gaming the system through preferential access to data and executions. It results in higher prices for buyers and lower prices for sellers.
It's simply not possible to "short ahead of you". If I place an order via ETrade an HFT doesn't know about it until it hits their FIX/ITCH/OUCH feed (i.e., after it's already on the order book and possibly after it executed).
They cannot jump ahead of you except by offering a better price.
chris, you're right in the context of HFT stuff, but of course different matching engines have different rules.
There was a big trade for a while where people had different account types. the CBOT matching engine, for example, had customer orders prioritized over marketmaker or firm, so customers actually COULD jump the line.
Some companies had customer accounts specifically so they could insert orders in higher priority in the queue (the tradeoff is that customers pay for CXLs, but you can just do the math to see when you should be using which account)
to @panarky of the comment, its not on the order of microseconds -- the stuff people used to rip on were flash orders, which are exactly 30 milliseconds.
So @panarky has a bit of a point about knowing the order in advance, but its still damn hard to profit from it. The narrative of just front running trades by having order information in front is just not feasible because of the bid-ask spread (the flash orders are to try to help maintain some semblance of BBO consistency across exchanges)
So as yummyfajitas says, it's not possible to sell ahead (saying "short ahead" in that way exposes you as not really knowing the trade, btw) or buy ahead in a way that necessarily affects price.
"But what if you were one of the people selling to Charlie. Before HFTs made the price faster you were the one getting screwed!"
The sellers sell at their ask price (or at my bid), it's their decision to sell. If you offer to sell something to me at $10, I haven't "screwed" you just because someone else was willing to pay $11.
It absolutely is front running. Moving the price of a stock to your advantage because you know my intentions is exactly what front running is.
Front running is when a broker trades in front of his client. The broker has a fiduciary duty to act in his client's best interests. If I trade ahead of you because I can guess your actions, that's just me kicking your ass.
Incidentally, if it's acceptable for Charlie Munger to sell in such a way that others will suffer the price impact of his trade, why is it not acceptable for HFTs to do the same thing? In both cases, it's just one trader playing short term games against other traders in order to make money.
You can have the price react quickly without needing to invest in microsecond response times by having auctions every 5 seconds or so as suggested by Larry Harris.
Anyone connected to Direct Edge can send an order flagged as HideNotSlide. Everyone is playing on an even field with respect to that order type.
HideNotSlide does not cause an order to "jump to the top of the order cue[sic]." It preserves your order entry time at a price that is contra the NBBO if there is not an order at Direct Edge at the NBBO (if there is an order at Direct Edge at the NBBO the incoming HideNotSlide order is filled).
I doubt "HFT" would be dramatically limited by a transaction tax. I believe that it would lower trading volume by some amount and widen the bid/ask by some amount. The number of "HFT" firms and their trading habits would look mostly the same though.
You don't have to be a member of the exchange to trade there. You can connect through many outlets, some of whom offer a FIX (Financial Information eXchange) API. You can submit HideNotSlide orders through FIX and perhaps through your brokers' GUIs.
The point is that no special license or membership is required, although you may have to do some work to implement this type of order.
> The large investment banks actually have a code they can append to their orders so they can jump to the top of the order cue.
Source? I believe you but I'd like to be able to quote an authority if I'm telling someone else about this. I've gotten into this HFT debate with colleagues, and I'm pretty sure none of us knew about this nifty trick.
HFTs are not any more a tax on stock transactions than previous market makers. In many settings they actually do lower transaction costs. Just ask other market participants such as L/S hedge funds, systematic traders, mutual funds etc. In particular, HFTs drove many of the old school manual market makers out of business, or at the very least reduced their margins significantly.
The non-populist argument these days seems to be less about fast, electronic market making and more about whether there should be a fixed, minimum trading time, e.g. by discretizing trading into intervals of a certain length.
Any stock trade where the buy vs. sell of a stock is under 3 months is not investment.. In under a day, even more so. It will not be felt by the company in question in any meaningful way, and is simply a newer form of gambling. By taxing any income made from trades where ownership is less than a month at 100% we can create a more honest trading environment, where sane investment becomes a norm.
The fact is that would never happen. I'm all for investment.. hell, I'm all for gambling, sex, drugs and rock and roll for that matter. I don't think most things should be illegal... but labeling the stock trade and wall street as investment companies is ludicrous.
It's not an investment, but it doesn't have to be an investment to be useful!
Instead of making money by choosing stocks, market makers make money by providing a concrete service to the market: they make it easier to buy and sell for people who are investing. They are more like the merchants or shipping companies of finance, rather than speculators. And there is nothing wrong with this!
In fact, calling it gambling is just wrong: most market makers actually take on very little risk! While their actions are not felt by the company directly, they are felt by people who own the stock and people who either want to buy or sell it. And knowing that it's easy to buy or sell a stock makes people more likely to participate in the markets, which is definitely a good thing.
Also, it's very important to note that even non-trivial investment strategies do not involve buying and holding on to large blobs of stock for months. Instead, you likely want to micro-manage your portfolio following some sort of mathematical model every day to minimize risk and exposure. Again, there is nothing wrong with this! But it does involve quite a bit of buying and selling stock, and the liquidity created by market makers really helps.
Viewing the stock market as solely a means to invest for long periods of time is really missing most of the picture. Your suggestion would actually increase most people's risk, leading to more gambling rather than less--or just significantly less investment over all!
It's not investment, but it may be legitimate market making. If the only people in the market are investors, it is significantly harder for me to liquidate my stock when I need to and significantly harder for me to buy stock when I want to.
Not really. If there aren't investors willing to buy your stock within a few minutes, there won't be any HFTs willing to buy either. HFTs just bridge that gap in time, for a fee.
You said 3 months. Bridging gaps in time is useful and worth a fee, even at amounts of time significantly shorter than 3 months. I made no claim about all HFT being this, I complained about the metric you were using.
For a sensible and mature owner-manager partnership to flourish, investor holding periods need to be aligned with business planning horizons. Many significant projects need between 6 months and 5 years to come to maturity, and holding periods should reflect this pattern (according to the needs and nature of the business).
I would argue that investors with a 3 month holding period are actually exerting a pretty corrosive influence on businesses: emphasising a focus on the next quarter's results at all costs.
A company isn't affected by who holds the stock. If I decide that I don't want to hold a stock in a company building a bridge across a river, and sell it to Jack, why does that change the company's desire to finish the bridge?
Is there evidence that's actually what's happening? I hear a lot of complaints on the internet about a quarterly results focus, but I've never heard of shareholders actually telling a company to change tack.
Over the past two or three decades it has become increasingly common for large and institutional investors to regularly hold meetings with the senior leadership (and investor relations) teams of the companies with which they have (or are looking to have) significant holdings.
After all, the investor needs to understand the business strategy, the operating conditions, and the particular risks and opportunities available to that business. The company and (particularly) it's management have an interest in increasing demand for the stock, so they normally oblige.
The conversation is not one-way. Stock options mean that the personal financial interests of the senior leadership team are normally well-aligned with that of the investors, so all the parties to these discussions have a mutual interest in the performance of the stock.
Investors have a mandate to maximise return and minimise risk. They have a limited ability to predict the future; an ability which drops precipitously the longer into the future they look. Investing client funds based on unreliable long-term predictions would be an irresponsible dereliction of duty on the part of the fund manager. In addition, measuring the performance of fund managers is also notoriously difficult, so there is a very human need to get as much feedback on performance as possible as quickly as possible. All of these factors combine to exert incredible pressure on the institutional investor to focus on gains in price over shorter time-spans (months rather than years).
This interest and short-term focus will naturally come across in discussions between the investor (=owner) and the senior management in the company. It takes an unusually self-aware, self-confident and self-assured management team to recognize (let alone resist) this inexorable pressure.
There are anecdotal evidence of this regularly happening, but usually those are fair decisions: both strategies discussed are generally sound, if radically opposed. One is generally a cash-out option and is favored by influential raiders who want the cash flow to invest elsewhere; the other is a growth option that might be more about serving management’s ambition that the stakeholders' interest. But those debate are public, rare and not entirely nefast.
What I have seen far more often is smart decisions delayed to please the investors, or costly decisions taken, at all stages: before or during Series A, B or further, before or during an IPO, etc. The most common ones are related to HR: contractors costing double and won't be here when what the set up breaks rather than employees to set-up a strategic asset because, otherwise, accounting practices would show increasing long-term duties to said employees. More generally, many companies suffer from a lack of investment because of the short-term focus — this I can describe in details in repeated cases, for the dozen of more companies that I’ve worked with. The single exception was when investors used the product themselves and behaved more like end-users.
You can be a de facto market maker without any government regulation. Economically, a market maker is someone who moves the bid and ask closer, so that more people are willing to do transactions. They do this by deducing the true price, and they might do this through fundamental or technical analysis.
Providing liquidity in all situations might be useful, but it is an added bonus. If you don't do this, you are still a market maker.
By getting in before you on the seller. HFT arbitrages the price differential by means of moving faster than you can. Rather than buying Wigets-R-Us at $100/share, the HFT slips in with a, say, $99.99 offer to the seller, and offers you $100.01. Rinse, wash, repeat a few million times a day, and those two cents add up. And it's cost you (and the seller) a penny a share each.
The numbers are made up here, but that's the principle.
A limit order only specifies your price. Nothing keeps the HFT from getting between you and another long-term trader in that case. Which can have a few effects.
One is that the seller loses on additional value. The other is that the HFT has bought from a seller who would have sold to you, but sees a higher buy price and sells to that instead, so you miss your trade.
For low-volume traders these aren't huge issues, but for institutionals or others looking to make or exit a large position the costs can mount. Again: HFT wouldn't be undertaken if there wasn't value to be extracted in doing it, and that value is coming directly from other buyers and sellers, just as when you introduce a middleman to any other transaction.
HFTs certainly are making money. But they're making money by making the market. And they're making a lot less money than they used to which you can see because spreads have shrunk dramatically. This is because computers can do this job much faster and cheaper than the humans who did it before could.
It's the same kind of automation we've seen in many other industries.
Broker-dealer internalization, queue jumping, flash trading. Regulators are years behind the traders on methods.
Trading center proximity is a big one. The Internet travels at the speed of light (actually, somewhat less than that). Which is finite and within the bounds of algorithmic trading. The HFTs get pricing data before the general public, even if it's just a few thousandths of a second (5000 km is about 0.01 light seconds, 500km is 0.001 ls).
With HFT operating at the 250 microsecond level, 75 km is significant.
You have no idea how to actually write an informational comment rather than hinting at some received wisdom and greater general understanding without actually revealing any of it, wrapped in condescension which actually lands far of the mark and fails to address the points raised here, do you?
"Rather than buying Wigets-R-Us at $100/share, the HFT slips in with a, say, $99.99 offer to the seller, and offers you $100.01."
So, 2 possibilities, you don't say, but you are sending a limit order to buy at $100 or a market (or marketable limit, or fill-and-kill) order to buy at $100. Apparently, you seem to be suggesting that there is a seller in the market, presumably offering at $100. Now, you seem to be suggesting that the HFT sees your order before it hits the matching engine (nonsense) and also that they can somehow re-negotiate with the seller and get him to lower his limit sell to 99.99 (I'm not sure how, do they send goons around to kneecap him if he doesn't? All in the 20 milliseconds your order is on the way to the market?).
" and offers you $100.01"
...but let's assume that somehow the magic omnipotent packet-sniffing HFT knows your order is enroute to the exchange, can force market participants to lower their offers, now you're claiming that it can force you to buy at $100.01. Why didn't you send a limit buy at $100, if that's the price you wanted, you saw, and were prepared to pay?
>wrapped in condescension
If you want to write entire paragraphs about something you know nothing about, you're not really adding to the conversation are you? So you'll open yourself up to a little condescension.
Thanks, that's better than your first pass, though I'm still not buying the story. My social engineering effort worked though.
I'll freely admit I find this confusing. And that's with having studied this shit in school and worked in the financial industry (in trading no less).
There are a number of methods of getting inside or around the order book, most of which involve breaking rules. But the regulators aren't even playing catch-up, they're so far behind.
HFT is very time sensitive, operating at or within the 250 microsecond window -- that's the time a light beam takes to travel 75 km. So one way of jumping in on the order is being, say, a few thousand km closer to the exchange than some other trader.
As to limit orders (and you really haven't explained how the order book avoids this), by beating others to the trade on both sides of the order, the HFT can get in and spin the equity, taking a cut, or stealing your trade (you look to buy at $100, seller is at $99.99, HFT buys at $99.99 but finds a buyer at $100.01).
The point is that by inserting themselves between other traders, by virtue of speed, HFTs skim a proft. It's small (and was enabled largely by decimalization), but can be made up for in volume.
The saving grace is that the HFTs are up against one another (at least until they start colluding), so they're weaving complexity traps against one another that wear down the advantage. Though there's the risk of more flash crashes and other disasters resulting from processes they barely understand themselves.
You're still not getting it. You send your messages on a private link to the exchange. Then the exchange processes them (either puts an order in the order book) or matches a trade, and only then publishes that this has happened on the public market feed. At which point other participants can react.
This:
"So one way of jumping in on the order is being, say, a few thousand km closer to the exchange than some other trader."
...is silly. No one gets to jump in front of anyone. Being closer to the exchange allows you to react quicker to a public event, but not a private one (which you can't see). In fact, even if you could somehow see someone else's TCP packets departing, from point A to the exchange, and you were in co-location next to the exchange at point B, you'd still have to get the information in their packet from point A to point B, run decision logic on it, then dispatch your own orders to the exchange (point B to the exchange). Faster than their already in-flight packet could arrive. It would still be impossible. What you're talking about is a common public misconception, that somehow the HFT bogeyman sees your order before it arrives.
Relevant quote:
"He became convinced exchanges were providing such an edge after he says he was offered one himself when he ran a high-speed trading firm—a way to place orders that can be filled ahead of others placed earlier. The key: a kind of order called "Hide Not Slide."
Whether it is legal is highly questionable but it appears that exchanges indeed offer this feature to sophisticated traders.
Bodek is a failed trader, and one who apparently can't read exchange API manuals (here's BATS explaining it for him: https://www.batstrading.com/resources/features/bats_exchange...). Now he's trying to make money from sensationalism and poorly written books.
That aside, Hide not Slide orders are an interesting case. They exist only in US equity markets, and they're a great study in unintended consequences. US equities are quite fragmented (the same security can be traded on several different exchanges), so well intentioned US regulators introduced something called the NBBO (National Best Bid Offer), ostensibly to "protect investors" from getting a worse price on one exchange. What this meant is that different exchanges trading in the same product could never be "locked" - you could never have one exchange showing say 101 on the bid when another has 101 on the ask (because in theory then they are crossed and should trade). Pretend the tick size is 1 for following discussion...
This leads to a situation where every equity exchange in the US may be trading 100/102 (with an empty tick in the middle), but as long as one remaining exchange is trading 100/101, you aren't allowed to insert a bid at 101 on the other exchanges (since the interpretation of the rule is that this would be unfair on the resting 101 offer). But HFTs are all very keen to be the first to fill that 100/102 gap in the spread - to be the first on that new queue is an advantage since you get filled first. And obviously that one holdout exchange will soon get filled and the price will tick up. But the other exchanges legally can't accept a bid at 101 yet.
So exchanges started to either reject orders or "slide" them - you submit that 101 Buy and they slide it down to a 100 Buy. Which leads to this:
10 SUBMIT BUY@101
20 IF RESPONSE = "SLIDE TO 100" THEN DELETE, GOTO 10
All of a sudden the exchanges are being flooded with messages, as algos are pinging the exchange constantly wanting to put that 101 bid in. Which leads us to 'Hide not slide' - the exchanges promise to sit on your order until the NBBO ticks up and put it in the queue then. The problem is that these order types, while documented and available to all who are connected to the exchange directly, aren't usually going to be available to someone who is trading through an intermediary - a broker or some retail trading platform. So that's the story of how a well intentioned bit of regulation ended up disadvantaging US investors.
US equity markets are full of weird quirks like this, the NBBO needs to be done away with.
So ... the exchange processing the trade -- where's it getting its liquidity from? If it can't satisfy the trade internally, it's getting buy/sell orders from elsewhere, correct?
Or flip this around: instead of telling me how HFTs can't arbitrage their trades, tell me what's actually happening. Because HFT's like deepwater oil drilling: it's an awfully expensive hobby to be doing if there's no profit in it. Where's the profit? And who's that coming from? Because in the world of the financial market, it is a zero-sum game, where one set of traders extracting value means another set isn't getting it. It's not as if they're building widgets for a value-added proposition.
I've seen the HFT trade price-seeking patterns -- bandsaw and crop circle visualizations from NANEX (this is now a few years old, so ancient history, but):
The point is that by being able to generate thousands or millions of buy/sell orders, across a band of price points, the HFT is getting in on any movement faster than any slower trader.
You're also not addressing straight out fraud where book is open, which is what I understand queue jumping to be. It's one thing if everyone's playing by the rules. Something tells me that's not the case. Oh yeah. That's my former officemate doing time at Club Fed for insider trading.
In the simplest case, an order book is generated from all outstanding buy and sell limit orders, assuming none have crossed (if they have, the matching engine will immediately transact those orders). The price is discretized, so there is a minimum tick size, and each price has a FIFO queue of orders.
HFT provides liquidity to all other traders, including other HFT. They are paid in either the bid-ask spread (in the case that HFT is passive) or arbitrating bid-ask spreads between different exchanges, e.g. they aggress and take out an offer on exchange A which is below the bid on exchange B, providing liquidity to the standing offer on exchange A immediately instead of letting the prices disjoin.
The answer to the last two lines are the same -- there is no meaningful difference between a buy and a sell. The net effect is more liquidity than without any short term market making, for both market and limit orders (IMO market orders should simply not exist, but that's a small aside).
>Now, you seem to be suggesting that the HFT sees your order before it hits the matching engine
HFTs pay brokers for order flow so they get orders before they hit the exchange and decide to trade on them from their own book (at NBBO) or pass them on to the exchange. Besides jumping the order book at the exchange they get advance information on orders about to hit the market.
True enough, I was discussing direct market access. If you're going through a third party, it's up to you to vet them and make sure they are trustworthy. I agree almost word-for-word with Optiver's submission on payment for order flow:
http://en.wikipedia.org/wiki/Market_maker
HFTs provide liquidity when the market's good, but you always have plenty of liquidity when the market's good. You only really need liquidity during a price crash, which is precisely the moment all the HFTs head for the exits, and the exchange seizes up.
HFTs are essentially a tax on stock transactions, and if you actually wanted that, why not have a legislative tax, rather than giving 5% to whatever stock trader has the shortest fiber optic cable to the exchange?