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Can someone explain what value HFT actually provides to society at large? Why not add a one cent tax to every trade and wipe out HFT completely?

by mperham 11y ago

wdewind 11y ago
Sure: basically when large institutional investors go to sell shares they sell them in blocks. There are not a ton of people who can afford to buy these entire blocks, though they may want to buy some portion of them. HFTs add value by buying these large blocks, and then breaking them up and selling them in smaller chunks. This is called "market making." This added liquidity makes it far easier for both the institutional investor to sell their shares as well as for the final buyer to purchase them. So the value they provide is increased liquidity to the market. Edit: Whoops, I'm incorrect. This is a description of market making in general, but not how HFTs do it (which have a variety of strategies). But the general premise is that the value provided is still increased liquidity. That being said, not all HFTs employ a market making strategy.
- beagle3 11y ago
  Those who do the block trades are not generally HFTs
  - wdewind 11y ago
    Please correct me, happy to learn.
- oojgaoj 11y ago
  This isn't what HFTs do. One common HFT trick is exactly the opposite of what you wrote: they'll attempt to identify probable sellers of large blocks who are disguising their actions by using smaller blocks (they can identify this by measuring latency orders arrive at different exchanges), and then using knowledge of the order books at different exchanges to buy the large block at 10.00 from the seller who was already committed to sell and then sell it at 10.02 to the buyer who was already committed to buying. They can do this because the institutional seller is using the NBBO based on the SIP, and they're watching 200micros ahead using direct feeds.
  - wdewind 11y ago
    Please correct me, happy to learn. Edit: Ah you added an explanation, thanks.
inthewoods 11y ago
The argument that HFTs would likely make is that they improve the efficiency of the marketplace, making for smaller spreads and for more liquidity, making it easier for all trades. The counter to both is that HFTs tend to disappear when market stress occurs, thus they fail to provide liquidity when the market needs it the most. I have no dog in the fight - HFTs do seem to have helped lower the cost of trading (along with the internet in general). Whether or not we consider what the article describes as "frontrunning" - I'm not sure. Surely all these firms have bought access to the same Nasdaq direct feed, and have co-located their boxes as close to the Nasdaq servers as possible. I'm guessing the buy side and the sell side are both doing this at this point - either directly or through 3rd parties. My point is that yes, the advantage exists - but is probably getting reduced by the day. Is the retail trader going on SIP getting prayed upon? Probably, but retail traders also make up a small portion of total trades. That's not to say it isn't a problem - but they aren't the major market participants. Mutual funds are probably the biggest losers here - and they are, in turn, owned by individual investors. So there's an argument there that they are hurting individual investors that way. To me the real question the idea that these firms are essentially riskless. I'd agree that has been the case in the past - I've seen reports of HFT firms having something like 300+ winning days. But what happens when the entire market is made of competing bots - will the efficiency the competition essentially take away any advantage that any one player might have, thus making their profit disappear?
- kasey_junk 11y ago
  The use of the term front-running in this article is completely inaccurate and is unfortunately becoming standard in reporting around HFT. No HFT sees your order before it trades as a result of a latency advantage, and therefore cannot "front run" it (not to mention the fact that even if they did, they do not have a fiduciary duty to you so they can't front run you by definition). Saying you have N number of winning days is largely immaterial as that usually means "trading profit" ie it does not account for the price of doing business and would not be considered profit in other businesses. Also, there are lots of easy to devise schemes for making a little money often, but most of them lose a lot of money occasionally. Finally, HFT profits have already disappeared (at least in the market making space which is where these venue arbitrage volume numbers come from). It is a low margin race to the bottom that is now being propped up via legislation (the sub penny rule in equities).
vasilipupkin 11y ago
unless you have evidence that a particular activity is harmful in specific ways, the question is irrelevant in a reasonably free society
beagle3 11y ago
I do not believe that HFTs actually provide value to society at large (and I am familiar with all the arguments and counter arguments). However, why do you think that "no value to society at large" is a good enough reason to tax or wipe out an industry? Taken ad absurdum, Most people on this earth do not provide any value to society at large, and never will - maybe we should wipe most of humanity? There are thousands of examples of middlemen and industries that provide values to themselves only. What's your criteria for being a "wipe out" candidate?
- wdewind 11y ago
  > There are thousands of examples of middlemen and industries that provide values to themselves only. Care to name a few? These are great startup opportunities.
  - vasilipupkin 11y ago
    car dealers, real estate agents
    - drdeca 11y ago
      Don't those provide the service of helping to distribute goods? That seems like saying that grocery stores don't provide any value because they just buy the food and then sell it to you? Or, alternatively, like saying FEDEX doesn't provide any value because they just bring things from one place to another (buying it from one place for $0 (plus an agreement) and then selling it to you for $[0+x] (and also the fulfilment of the agreement) , or alternatively, buying it from you for an agreement and $[0-x], and selling it somewhere else for $0 and the fulfilment of the agreement)?
      - vasilipupkin 11y ago
        well, you could buy cars online from manufacturers. That's why every state has laws prohibiting this. If car dealers added a lot of value, you wouldn't need laws that stop people from competing with them
toth 11y ago
For as long as there have been financial markets, there have been people playing the role of market makers, HFTs are just the latest incarnation (although HFTs are not exclusively market makers, it does tend to be the largest chunk of their volumes). Market makers are people that take no long term view on price movements, just try to provide liquidity in the short run, collecting the spread and trying not to to accumulate positions that are too large either way. Without market makers, prices would be much more volatile (they would just move a round lot because of short term fluctuations of supply and demand with no long term predictive power). Basically you can think that market makers charge you a small (very small in case of HFTs) fee in exchange for the risk they run for holding inventory for a little bit and in the process reduce volatility. Before HFTs, market makers were people that had seats at exchanges, which had much more of an information advantage over normal market participants and who certainly charged much larger fees and ripped off people more. The current system, with HFTs playing that role, is by any measure better for both retail and institutional investors. (disclaimer, am an HFT trader)
- oojgaoj 11y ago
  There's an important fact to remember though: HFTs aren't really making markets. HFTs make markets when markets least need liquidity, and they consume liquidity by fleeing the markets when it is most valuable. As such, an HFT provides service when it is least valuable, and he doesn't just stop providing the service, he actively consumes the resources when they're most needed by society. edit: downvote me if you like, but what I'm saying is absolutely true. HFTs consume liquidity as vol increases.
  - toth 11y ago
    This is an often repeated claim, but things do not become true by repetition. First of all, HFTs have certainly taken over market making functions in today's markets, almost entirely in equities, to a lesser extent in some other asset classes. Yes, it is true that some HFTs will stop trading during extreme volatility events (but they are not consuming volatility either, merely not providing it any more). But the same was true of human market makers of the past (there is a famous story of NASDAQ brokers simply stopping to answer their phones during crashes in the '80s, even though they were required to always make markets by regulation) - so who are you comparing them too? The flip side is that HFTs (as any market maker) make more money when the volatility is high, so they have strong incentives to get back in there providing liquidity.
lordnacho 11y ago
To answer your question, HFTs provide liquidity: you can show up at the market, trade with them, and be on your way without doing what they do in illiquid markets, which is to waste time and money on finding someone who wants to trade. A question for you: why should HFTs be held to the standard that they "provide to society at large"? There's hardly any business that in and of itself (ie not taxes and jobs, which HFT also does) that helps everyone in society. You go to a restaurant, who benefits? Society? I doubt it. You take a cab, who benefits? You go to a hair salon, a supermarket, a gas station, a used car shop, a clothes store, who benefits? Save for the fact that the presence of the shop gives everyone a free option to acquire the goods/service they sell (just like HFT), nobody benefits apart from the customer.

Can someone explain what value HFT actually provides to society at large? Why not add a one cent tax to every trade and wipe out HFT completely?

by mperham 11y ago

Can someone explain what value HFT actually provides to society at large? Why not add a one cent tax to every trade and wipe out HFT completely?

wdewind 11y ago

Sure: basically when large institutional investors go to sell shares they sell them in blocks. There are not a ton of people who can afford to buy these entire blocks, though they may want to buy some portion of them. HFTs add value by buying these large blocks, and then breaking them up and selling them in smaller chunks. This is called "market making." This added liquidity makes it far easier for both the institutional investor to sell their shares as well as for the final buyer to purchase them. So the value they provide is increased liquidity to the market. Edit: Whoops, I'm incorrect. This is a description of market making in general, but not how HFTs do it (which have a variety of strategies). But the general premise is that the value provided is still increased liquidity. That being said, not all HFTs employ a market making strategy.

beagle3 11y ago
Those who do the block trades are not generally HFTs
- wdewind 11y ago
  Please correct me, happy to learn.
oojgaoj 11y ago
This isn't what HFTs do. One common HFT trick is exactly the opposite of what you wrote: they'll attempt to identify probable sellers of large blocks who are disguising their actions by using smaller blocks (they can identify this by measuring latency orders arrive at different exchanges), and then using knowledge of the order books at different exchanges to buy the large block at 10.00 from the seller who was already committed to sell and then sell it at 10.02 to the buyer who was already committed to buying. They can do this because the institutional seller is using the NBBO based on the SIP, and they're watching 200micros ahead using direct feeds.
- wdewind 11y ago
  Please correct me, happy to learn. Edit: Ah you added an explanation, thanks.

inthewoods 11y ago

The argument that HFTs would likely make is that they improve the efficiency of the marketplace, making for smaller spreads and for more liquidity, making it easier for all trades. The counter to both is that HFTs tend to disappear when market stress occurs, thus they fail to provide liquidity when the market needs it the most. I have no dog in the fight - HFTs do seem to have helped lower the cost of trading (along with the internet in general). Whether or not we consider what the article describes as "frontrunning" - I'm not sure. Surely all these firms have bought access to the same Nasdaq direct feed, and have co-located their boxes as close to the Nasdaq servers as possible. I'm guessing the buy side and the sell side are both doing this at this point - either directly or through 3rd parties. My point is that yes, the advantage exists - but is probably getting reduced by the day. Is the retail trader going on SIP getting prayed upon? Probably, but retail traders also make up a small portion of total trades. That's not to say it isn't a problem - but they aren't the major market participants. Mutual funds are probably the biggest losers here - and they are, in turn, owned by individual investors. So there's an argument there that they are hurting individual investors that way. To me the real question the idea that these firms are essentially riskless. I'd agree that has been the case in the past - I've seen reports of HFT firms having something like 300+ winning days. But what happens when the entire market is made of competing bots - will the efficiency the competition essentially take away any advantage that any one player might have, thus making their profit disappear?

kasey_junk 11y ago
The use of the term front-running in this article is completely inaccurate and is unfortunately becoming standard in reporting around HFT. No HFT sees your order before it trades as a result of a latency advantage, and therefore cannot "front run" it (not to mention the fact that even if they did, they do not have a fiduciary duty to you so they can't front run you by definition). Saying you have N number of winning days is largely immaterial as that usually means "trading profit" ie it does not account for the price of doing business and would not be considered profit in other businesses. Also, there are lots of easy to devise schemes for making a little money often, but most of them lose a lot of money occasionally. Finally, HFT profits have already disappeared (at least in the market making space which is where these venue arbitrage volume numbers come from). It is a low margin race to the bottom that is now being propped up via legislation (the sub penny rule in equities).

vasilipupkin 11y ago

unless you have evidence that a particular activity is harmful in specific ways, the question is irrelevant in a reasonably free society

beagle3 11y ago

I do not believe that HFTs actually provide value to society at large (and I am familiar with all the arguments and counter arguments). However, why do you think that "no value to society at large" is a good enough reason to tax or wipe out an industry? Taken ad absurdum, Most people on this earth do not provide any value to society at large, and never will - maybe we should wipe most of humanity? There are thousands of examples of middlemen and industries that provide values to themselves only. What's your criteria for being a "wipe out" candidate?

wdewind 11y ago
> There are thousands of examples of middlemen and industries that provide values to themselves only. Care to name a few? These are great startup opportunities.
- vasilipupkin 11y ago
  car dealers, real estate agents
  - drdeca 11y ago
    Don't those provide the service of helping to distribute goods? That seems like saying that grocery stores don't provide any value because they just buy the food and then sell it to you? Or, alternatively, like saying FEDEX doesn't provide any value because they just bring things from one place to another (buying it from one place for $0 (plus an agreement) and then selling it to you for $[0+x] (and also the fulfilment of the agreement) , or alternatively, buying it from you for an agreement and $[0-x], and selling it somewhere else for $0 and the fulfilment of the agreement)?
    - vasilipupkin 11y ago
      well, you could buy cars online from manufacturers. That's why every state has laws prohibiting this. If car dealers added a lot of value, you wouldn't need laws that stop people from competing with them

toth 11y ago

For as long as there have been financial markets, there have been people playing the role of market makers, HFTs are just the latest incarnation (although HFTs are not exclusively market makers, it does tend to be the largest chunk of their volumes). Market makers are people that take no long term view on price movements, just try to provide liquidity in the short run, collecting the spread and trying not to to accumulate positions that are too large either way. Without market makers, prices would be much more volatile (they would just move a round lot because of short term fluctuations of supply and demand with no long term predictive power). Basically you can think that market makers charge you a small (very small in case of HFTs) fee in exchange for the risk they run for holding inventory for a little bit and in the process reduce volatility. Before HFTs, market makers were people that had seats at exchanges, which had much more of an information advantage over normal market participants and who certainly charged much larger fees and ripped off people more. The current system, with HFTs playing that role, is by any measure better for both retail and institutional investors. (disclaimer, am an HFT trader)

oojgaoj 11y ago
There's an important fact to remember though: HFTs aren't really making markets. HFTs make markets when markets least need liquidity, and they consume liquidity by fleeing the markets when it is most valuable. As such, an HFT provides service when it is least valuable, and he doesn't just stop providing the service, he actively consumes the resources when they're most needed by society. edit: downvote me if you like, but what I'm saying is absolutely true. HFTs consume liquidity as vol increases.
- toth 11y ago
  This is an often repeated claim, but things do not become true by repetition. First of all, HFTs have certainly taken over market making functions in today's markets, almost entirely in equities, to a lesser extent in some other asset classes. Yes, it is true that some HFTs will stop trading during extreme volatility events (but they are not consuming volatility either, merely not providing it any more). But the same was true of human market makers of the past (there is a famous story of NASDAQ brokers simply stopping to answer their phones during crashes in the '80s, even though they were required to always make markets by regulation) - so who are you comparing them too? The flip side is that HFTs (as any market maker) make more money when the volatility is high, so they have strong incentives to get back in there providing liquidity.

lordnacho 11y ago

To answer your question, HFTs provide liquidity: you can show up at the market, trade with them, and be on your way without doing what they do in illiquid markets, which is to waste time and money on finding someone who wants to trade. A question for you: why should HFTs be held to the standard that they "provide to society at large"? There's hardly any business that in and of itself (ie not taxes and jobs, which HFT also does) that helps everyone in society. You go to a restaurant, who benefits? Society? I doubt it. You take a cab, who benefits? You go to a hair salon, a supermarket, a gas station, a used car shop, a clothes store, who benefits? Save for the fact that the presence of the shop gives everyone a free option to acquire the goods/service they sell (just like HFT), nobody benefits apart from the customer.