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Why Do High-Frequency Traders Cancel So Many Orders?

206 points by yummyfajitas 11y ago

elecengin 11y ago
This article brings up something that HF traders have been bemoaning for a long time: the fragmented US market structure. In US equities, you need to monitor almost a dozen exchanges to be competitive. The popular book "Flash Boys" gave the impression that HF traders loved this market structure and used it to extract more money out of the market. In the majority of cases, this is wrong. In fact, the fragmented market results in huge costs (4 datacenters worth of infrastructure, low latency connectivity, etc) In reality, most market makers would vastly prefer to simplify this away. This is one of the reasons many traders have moved to alternative markets that have fewer trading venues (for example, many futures and options trade primarily on a single venue)
- bko 11y ago
  Bare in mind that the system used to be centralized and, as mentioned in the article, was much costlier [0]. The fragmentation has downsides and no one likes redundancies, but it is a direct response to the older, less competitive system. The fact that a decentralized system is better is exhibited in the lower price and the participation in the smaller exchanges. [0] http://www.bloombergview.com/articles/2014-03-31/michael-lewis-doesn-t-like-high-frequency-traders http://www.bloombergview.com/articles/2014-03-31/michael-lew...
  - elecengin 11y ago
    Completely agree - in the single exchange markets you see a lot of monopolistic behavior with the operators. In this current, though, we have three major operators with 2-3 exchanges each - many with single digit percentages of market share. I suspect that the savings in execution cost due to competition are vastly overwhelmed by the increased cost of infrastructure for most market participants (excluding the largest firms).
- CyberDildonics 11y ago
  Fragmented exchanges are better for everyone except for high frequency traders. Then they actually have to do low latency arbitration to make money instead of full on front running like they do now. Arbitration between physical locations is something that can't be helped. The other things ways that high frequency traders make money can be helped by better systems, but there are no incentives to make those systems when exchanges make so much of their money from high frequency traders themselves.
  - elecengin 11y ago
    > Fragmented exchanges are better for everyone except for high frequency traders. Then they actually have to do low latency arbitration to make money instead of full on front running like they do now. This is a very strong statement with little support. I agree that some competition among exchange operators is important, but how do you justify exchanges like CHX, with approximately 1% market share? I am not sure how to respond to your comment regarding front running without more detail. Many sources have already debunked the Michael-Lewis-style argument regarding front running. Where do you see front running? (Using the proper definition of trading ahead of a customer order based on knowledge of that order)
    - CyberDildonics 11y ago
      > how do you justify exchanges like CHX, with approximately 1% market share? What needs to be justified? It is competition and decentralization.
  - Rimpinths 11y ago
    Some HFT strategies depend on fragmented exchanges. Look up "latency arbitrage" for examples.
    - CyberDildonics 11y ago
      Yes that is one way they make money but not the only way and not even the most effective way since they are splitting their profits with anyone that can compete with them and there is only so much to be made. The fact that there are multiple issues with high frequency trading is one of the reasons it ends up being so polarizing. It ends up being an ambiguous term that sometimes means something that is a natural result of decentralization, and sometime means techniques that would be grating to most people's common sense of what should be legal.
- kevin_thibedeau 11y ago
  The HFT guys love the fragmentation. If not they wouldn't be building out private microwave links between Chicago and NY to "beat the market".
  - minimax 11y ago
    The NY/Chicago arb trade is futures vs equities. In other words it's two separate products with highly correlated prices. On one side are the futures contracts and on the other side are the underlying stocks (and ETFs). As long as the two separate products exist, you'll always have fast arbitrageurs. This is true whether the matching engines are 1000 miles apart or in the same rack.
  - joosters 11y ago
    I'm sure they'd rather not be paying for microwave links, but they have to because everyone else is doing it. End result: everyone wastes lots of money to get no additional benefit.
  - harmegido 11y ago
    That makes no sense. Here let me rephrase it: "Americans love commuting. If not, they wouldn't be spending millions of hours in their cars each year to get to work!
MisterMashable 11y ago
Legalized quote stuffing.
NickHaflinger 11y ago
Because they're gaming the market. How it works: place a large order, wait for others to make a bid, then cancel the order and sell your own at a mark-up.
deleted 11y ago
[deleted]
- jstanley 11y ago
  Read the article.
chollida1 11y ago
I think to understand most HFT market makers you have to understand how the markets pay. Most work on a maker taker model. Which means the trader who initiates the trade pays a small fee and the trader who is the passive side, the one who had their order in the market already, gets paid a small fee. as a side note there are inverted markets but lets leave those aside for now. This means to get paid you want to be at the top of the book, which means you are the first order to get filled when someone crosses the spread to get their order filled. the way priority is determined is first by price and second by time. So you have a very vested interest in being the first to cancel and move your order to the newest price level. Exchanges have tried introducing some order types to alleviate this constant send/cancel routine such as the order type "Hide not Slide" but people tend to get upset at these order types. Once you understand this, you start to realize that almost all HFT firms aren't quote stuffing, they are just jockeying for position at the top of the order book. I've never really understood quote stuffing, the same firm that quote stuffs still has to deal with those quotes coming back, its not like the market data has a flag saying ignore this quote change as its caused by your own quote stuffing. The way most markets are setup is that quotes come from gateways and multiple symbols all share a single gateway, usually assigned alphabetically, so A-F tickers all share the same gateway. This means that if someone is actually slowing down market data for say AAPL then they are also slowing down quotes for AMZN as well but again, the same firm that is quote stuffing also has to deal with their own mess so I can't see the benefit. Another comment complains that HFT firms don't like the fragmented market. That is true to a point, but keep in mind most HFT strategies only work due to the fragmented markets and RegNMS. So while they may not like 11 venues, they certainly want atleast 3 or 4, and many of hte top HFT firms run their own dark pools, adding to the problem:) As far as Hillary Clinton introducing legislation to curb HFT trading, she was the senator for New York. I'm dubious of her coming down hard on Wall Street.
- dclusin 11y ago
  Quote stuffing works because you know before hand which orders to filter out and don't need to expend resources considering them while everyone else does. An advanced player can build this into an FPGA to achieve greater performance.
HiLo 11y ago
John Arnold (former Enron energy trader) also posted something on Bloomberg View, and the main gist of the article was: Front-running is profitable against traditional orders entered by humans. But with spoofers in the mix, the picture looks quite different: When the front-running HFT algorithm jumps ahead of a spoof order, the front-runner gets fooled and loses money. The HFT’s front-running algorithm can't easily distinguish between legitimate orders and spoofs. Suddenly the front-runner faces real market risk and makes the rational choice to do less front-running. In short, spoofing poses the risk of making front-running unprofitable. Because spoofing is only profitable if front-running exists, allowing both would ensure that neither is widespread. http://www.bloombergview.com/articles/2015-01-23/high-frequency-trading-spoofers-and-front-running http://www.bloombergview.com/articles/2015-01-23/high-freque...
- zeeshanm 11y ago
  That's why most of these HFT-sponsored exchanges (read: BATS, CHX, etc) pay retail brokers (e.g. eTrade, Scottrade, etc.) for their flow.
  - neomantra 11y ago
    I would be interested in your source for that comment, as I think it is untrue (at least for US exchanges, I don't know rules in other countries). I am not saying payment-for-order-flow doesn't exist, but the buyers are firms like Citadel and other "internalizers", not exchanges. If by "paying" you are referring to the maker/taker rebate model, that is paid to any market participant, not just retail brokers.
    - elecengin 11y ago
      https://www.nyse.com/publicdocs/nyse/markets/liquidity-programs/arca_rlp_fact_sheet.pdf https://www.nyse.com/publicdocs/nyse/markets/liquidity-progr... http://cdn.batstrading.com/resources/release_notes/2012/BATS-Introduces-Retail-Price-Improvement-Program.pdf http://cdn.batstrading.com/resources/release_notes/2012/BATS...
amelius 11y ago
> the story of high-frequency trading is basically one of small smart firms undercutting big banks by being smarter and more automated and more efficient Is that true? Isn't there a high barrier of entry? I was under the impression that large trading firms were building high-speed connections, which is obviously not something a small firm could ever do.
- omellet 11y ago
  It's not an especially high barrier if your strategy doesn't require you to build physical infrastructure (most strategies don't require this). You have programmers, hardware, colocation costs, direct exchange connection costs, trading fees, etc. The programmers are by far the most expensive component.
- elecengin 11y ago
  Good question. HFT is a spectrum. At the lowest latency (approximately 5 microseconds), the barriers to entry are massive - multi-million dollar startup costs. For "kind of fast" - 10-100 microseconds - there are a variety of brokerages that can get you started with costs of approximately $1000-10,000 a month. This is rapidly changing though - the exchanges have been continuously increasing the prices of their market data to the point where consuming the entire US equity market proprietary feeds costs around $50,000/mo in licensing.
- juziozd 11y ago
  These days you can rent a co-located computer with direct connection to the exchange. The cost is a few grands per month. Not very cheap but definitely within reach of a small business. There are many small HF firms based all over the country that just rent 1 or 2 computers close to exchanges. This is bad for big investment banks like Goldman because they no longer have a location advantage - you do not need an office in Manhattan to compete with big guys anymore.
  - amelius 11y ago
    Then my followup question would be: why do we actually need trading to be faster than the regular internet allows? For the objects being traded (companies) have time-constants that are far greater than the millisecond-range. And I hope the answer is not "because everybody else does it" :)
digital-rubber 11y ago
Since they have a single goal of raking in as much money as possible, let me do a guess? To get rich?!
mkinitcpio 11y ago
Disclaimer: I work in HFT The article uses the term "front-running" incorrectly. Front-running is where a firm places their own trades ahead of trades they're placing for a client, to capitalize on the price movement that client order might generate. This is illegal. What the market makers in the article are doing isn't front-running. It's just being smart with their orders. And that's generally why HFTs cancel orders- they're reacting to market conditions that exist on the span of microseconds and will want to change their market positions very quickly- including canceling orders that they no longer think are suitable.
- yummyfajitas 11y ago
  The author put "front-running" in scare quotes for a reason. See footnote 6, where he explains he's using the term in the Michael Lewis/IEX sense.
  - elecengin 11y ago
    Agreed. Matt Levine is one of the few commentators that fully understands market microstructure. The Bloomberg View linked in a different comment (by John Arnold) is horrible with terminology, though.
    - philipov 11y ago
      Doesn't the fact that he understands, and intentionally uses pejorative language make him dishonest?
      - evanpw 11y ago
        "Scare quotes ... may be used to imply that a particular expression is not necessarily how the author would have worded a concept." https://en.wikipedia.org/wiki/Scare_quotes https://en.wikipedia.org/wiki/Scare_quotes
        aaronchall 11y ago
Variance 11y ago
It's great to see Matt Levine on HN - for those interested in finance, his Money Stuff [0] daily column is absolutely excellent. His writing has a really fantastic funny and informal style. He does a great job presenting a fair and deep view of a lot of finance issues, like HFT or Unicorn valuations. [0] http://www.bloombergview.com/topics/money-stuff http://www.bloombergview.com/topics/money-stuff
- jevgeni 11y ago
  Matt is brilliant. A little bit more mature and reserved than during his time at Dealbreaker, but still awesome.
- lloydde 11y ago
  I agree. His Bloomberg articles have been regularly rising to the HN front page in the last months. When I follow the link and see his avatar, I take the time to read the article.
devit 11y ago
"Updating" orders seems a far more accurate terminology than "cancelling" in the market maker case. Although of course making such a distinction by law is problematic, because updating an order to be "out-of-the-money" (have an absurdly low or high price) is almost equivalent to canceling, and objectively determining if an order is "out-of-the-money" is problematic.
gbhn 11y ago
Something this article ignores, and which is ignored by most articles on HFT, is that the process is ilegible to the public. "No no we're doing you a favor!" is not reassuring when the activity consumes a bunch of resources on zero sum activity. Ultimately investing runs on trust. HFT is consuming public trust in the financial system at a prodigious rate. Is it a trillion dollars a year? A billion? Hard to be sure. But it certainly isn't clear the tiny market-making improvements are worth it.
- harryh 11y ago
  Lots of things are illegible to the public. Explain to me all the processes involved in building the smart phone in your pocket. You can't. I can't. Probably no single person in the world can. Who cares?
  - dopamean 11y ago
    I think the illegibility of it is important if it is affecting other people's finances.
    - harryh 11y ago
      Nearly every good or service that you purchase is backed by a nearly illegible process of global trade. That doesn't affect your finances?
      - pjc50 11y ago
        Doesn't it? The illegibility of offshore money affecting overall tax take and therefore government spending, services, and jobs? The illegibility of jobs disappearing to ... somewhere? Not knowing if you've bought products that have been manufactured by slave labour or just awful working conditions? It's not clear.
      - crdoconnor 11y ago
        >Nearly every good or service that you purchase is backed by a nearly illegible process of global trade. That doesn't affect your finances? Yes it has, but why would you consider that a good thing? CAFTA and NAFTA have been pretty horrendous for the finances of Americans and TTIP and TPP are likely to be even worse. They can't be killed unless enough people understand them, either.
shasta 11y ago
I guess I see why high frequency trades are necessary in the current trading framework, but looking at the situation from a high level, isn't it obvious that the resources being spent on microsecond level response improvements don't benefit anyone but the winners? Can someone argue otherwise?
- vasilipupkin 11y ago
  It's the opposite. The resources being spent on microsecond speed race is a form of a tax imposed on HFT by society. If all big HFT firms spent on getting faster, they don't benefit in expectation, since all the competitors will be equally fast, but society benefits because that spending goes to wider economy outside HFT
  - shasta 11y ago
    Right, that's the obvious situation that I see. I'm wondering if anyone can argue otherwise? If not, why isn't there a bigger push for market infrastructure that doesn't advantage high frequency trades? I don't know that most high frequency microtrades are a real problem either way, since it seems mostly zero sum among the people playing that game. But whenever there is a macro change in a price that takes place over a tiny time scale, it seems that we shouldn't be advantaging speed in getting there first.
    - vasilipupkin 11y ago
      "If not, why isn't there a bigger push for market infrastructure that doesn't advantage high frequency trades?" because most of those who could do the pushing are ignorant and/or confused about the economics of competitive markets and how competition benefits society as a whole and not really those who are competing
- tptacek 11y ago
  You're right, although you should also build into that argument the benefits that accrue to technologists that work at HFT firms, and to technology vendors who sell to them.
astine 11y ago
"Here you have an industry that has undercut the business of the big banks, irritated hedge fund managers and been great for small investors. Why would cracking down on that business be populist? Why would it alienate wealthy donors?" For the same reason that people don't generally cheer when a gang war happens. Just because the gangsters are mainly shooting other gangsters doesn't mean the violence isn't costly to society. The same with Wall Street. Just because people don't trust big banks and suspect them of rooking the common man doesn't mean that they want to legitimize said rooking, or that it isn't costly to society when banks rip each other off.
- harryh 11y ago
  Viciously competing to provide services at the lowest possible cost to the customer is not the same thing as ripping each other off. There is no violence here. Only competition.
- kasey_junk 11y ago
  I think you are missing his point. HFT is not typically banks ripping each other off. Its a new outside entity that has made the service the banks and traditional market makers provided to their customers much cheaper at the expense of hedge funds and bank profits. In most industries we applaud this disruption.
  - astine 11y ago
    But, in the mind of the populist masses that Mr Levine it criticizing it is. I don't work in finance and I'm not going to make any judgments on the industry, just to say that people who are opposed to it would be opposed to HFTs as well. Also, the people who applaud 'disruption' are not this sort of populist, they don't cheer because of the damage done to incumbents but because the disruption will hopefully mean better products/services/prices for customers. HFT just does the job of the old investment bankers slightly more efficiently. If you think investment bankers are bad, you're not going to think that more efficient investment are an improvement.
    - 11y ago
frandroid 11y ago
TL;DR: Market makers put a buy and a sell offer, separated by one or more cents, on every trade; when someone big enough picks one side, they cancel the other side and re-issue new buy and sell offers with new goal-posts.
sjbase 11y ago
The "new" part of this news, which not many have responded to here, is the notion of an HFT tax. The arguments on either side of HFT (liquidity/spread/etc. vs. cost/unfairness/etc.) have been largely unchanged for the last few years. There simply isn't enough data made public to declare a victor. As far as the tax: personally I'm very in favor of slowing down trading... unfortunately, what's being proposed introduces as much structural game theory as it eliminates. What's the dominant strategy for a trader faced with a rule like "any trades resting for less than 300 micros get taxed"? To be as fast as possible without triggering the tax; staying just above the threshold. All that economic waste on low-latency tech will just be redirected to low-jitter tech. Those who can reliably land an order within +1 microsecond of the tax line will outperform those who only have an accuracy of +10. I'd like to see more exchanges experimenting with things like random variance in speed bump size, frequent batch auctions, etc.
- kasey_junk 11y ago
  Or you could just get rid of the sub-penny rule and let HFT compete on price.
- yummyfajitas 11y ago
  There is enough data to declare that a transaction tax is a loser. Canada tried it. The bid/ask spread rose 9%. This resulted in a transfer of wealth from retail investors to institutional ones. http://qed.econ.queensu.ca/pub/faculty/milne/322/IIROC_FeeChange_submission_KM_AP3.pdf http://qed.econ.queensu.ca/pub/faculty/milne/322/IIROC_FeeCh...
- Mikeb85 11y ago
  > personally I'm very in favor of slowing down trading... As a retail trader, no. As an example, yesterday I placed a sell order on $90,000HK worth of a stock. Once I hit 'send', my order was fulfilled before my browser could load the confirmation page, and at the market price I was quoted seconds before. This is, in large part, thanks to market makers who use HFT. Before this, the broker/market maker might take a spread worth half a percent or more (and being a retail investor, you probably wouldn't get the 'market' price), now it's pennies or less, and at the market price. Thanks to HFT, spreads are smaller, execution quicker, and it definitely 'levels' the playing field.
deleted 11y ago
[deleted]
blazespin 11y ago
Ahem, buried in the middle of the article (I wonder why) "Navinder Sarao is accused of spoofing in the S&P 500 futures market, entering and cancelling lots of orders to create an illusion of demand, in suspicious proximity to the flash crash of 2010." This happens a lot more than you might think. There is always a temptation to stuff the order book to keep it going in a direction profitable for you (ie, fake volatility). This is the #1 reason why canceled ordered from HFT are suspect. It's too easy to stuff the order book and cheat a little. You really need highly credible market makers who have proven not to do this sort of thing. Even then, such folks are very rare and hard to appreciate. Your algorithms get so complex and obfuscated it's hard to tell what's stuffing the order book and what's simple market making. The fact is, everyone is stuffing the order book. Sarao is more a patsy than anything else. His biggest crime wasn't belonging to a Goldman Sachs paying bribes to political entities.
- tptacek 11y ago
  There is always a temptation to stuff the order book to keep it going in a direction profitable for you (ie, fake volatility). Is this something you have personal experience in? I ask because a lot of people relate this concern because they read about it in Zero Hedge, which is regarded by people in the industry as (as someone here once put it) "a conspiracy theory site without the theories".
  - beagle3 11y ago
    The description of ZeroHedge is funny and not entirely untrue, but if you regard them as an aggregator of opinions, (which they mostly are, even though they do offer their own opinions), it is unmatched in its breadth of coverage, despite having a rather low signal coverage. WRT suffing the order book - at least as far back as 2003, in Eurex, there was a swiss trader who would do that in bond futures. There were a lot of comlpaints, and even death threats IIRC, but a Eurex investigation at the time found he did nothing wrong - their main finding was that he would occasionally get those "stuffing" orders executed, which means that (as far as they are concerned) they are not false or misleading in any way. That's probably the gist of it: as long as you are willing to take the hit if your bluff goes against you, there's nothing "fake" about it. It's been years since, and I know not of any (officially investigated) cases back then, or of any recent cases - but I'd be surprised if it's not very prevalent. (Also, I've been out of the HFT world for a while).
patio11 11y ago
I happen to have 144 lines of Ruby which implement the world's most braindead market making algorithm, coded by someone who had literally never written a trading system before. It cancels ~98% of orders before they are hit when running on a single stock on a single venue.
- ycombobreaker 11y ago
  Is it profitable? Or just paper trading/simulated? Braindead stuff works if it is the fastest in the world, but as you slow down you need to get smarter to cover losses due to getting "picked off" more frequently.
  - JoachimSchipper 11y ago
    I'm pretty sure it's a competitor for Patrick's StarFighter game. It's not supposed to be impossible to beat.
ehosca 11y ago
it's called "discovery" ...
mjevans 11y ago
A better question is why do we even have 'High Frequency Traders'? Wouldn't the market be better served by a window structure with a scale on a more human timespan? Say a 5 min process in which: * for 4 min orders are taken in confidential secret. * there is a 1 min blackout window in which no orders are taken, and in which any results of settling the outcome of orders is not published. * At the end of that period the new results are published. (It doesn't matter who reacts first, it's who reacts best.) The profit between what sellers are asking for and what the buyers are willing to pay still needs to be accounted for. This could be the market's operating fee (the cost of the sale's commission), it could be attributed to the government as a form of sales tax, it could be returned in some way to the parties involved (buyers pay less, sellers earn more), other, or some combination of the above.
- jrockway 11y ago
  The price of equities is not known. The market is how that price is calculated. You could slow down the process, but that adds risk (that one party is getting the wrong price). The market makers would say, I'll sell you one 1 share for $1, 10 shares for $1.20, 100 shares for $2, 1000 shares for $10. So then someone who wants to buy 1000 shares for $1 a share will buy only 1 share at $1. Then in the quiet period, the market makers will adjust their prices. 1 share for $1.01, etc. Then you'll sell another share for $1.01. Then you'll wait 5 minutes, and the market makers will adjust their price. The market is going to work the same way at 5 minute delay as it works at nanosecond delay, but just be slower. The market makers won't be getting you a better price, and your large transaction won't not affect the share price.
- tomp 11y ago
  Would you, as an investor, rather trade on exchange A, where there is a given spread and market depth, so you know approximately what price your order will execute at in the next few seconds, or at exchange B, where the most recent price and depth is up to 5 minutes old, and where your orders will be executed at an unknown price sometime in the next 5 minutes?
- Alupis 11y ago
  > A better question is why do we even have 'High Frequency Traders'? High Frequency Traders (HFT) do a lot of positive things for a market - mainly providing liquidity where they might otherwise not be. They also act as a sort-of balancing force for undervalued or overvalued stocks (in the volume the HFT's trade with over time), "normalizing" the VWAP and TWAP (among other health indicators) for a given ticker. In other words, markets want (and benefit from) HFT's.
curiousjorge 11y ago
what benefit does high frequency traders provide to rest of society? none. they raise the cost of transactions of all investors. it should be banned and those brought to justice.

206 points by yummyfajitas 11y ago

This article brings up something that HF traders have been bemoaning for a long time: the fragmented US market structure. In US equities, you need to monitor almost a dozen exchanges to be competitive. The popular book "Flash Boys" gave the impression that HF traders loved this market structure and used it to extract more money out of the market. In the majority of cases, this is wrong. In fact, the fragmented market results in huge costs (4 datacenters worth of infrastructure, low latency connectivity, etc) In reality, most market makers would vastly prefer to simplify this away. This is one of the reasons many traders have moved to alternative markets that have fewer trading venues (for example, many futures and options trade primarily on a single venue)

bko 11y ago
Bare in mind that the system used to be centralized and, as mentioned in the article, was much costlier [0]. The fragmentation has downsides and no one likes redundancies, but it is a direct response to the older, less competitive system. The fact that a decentralized system is better is exhibited in the lower price and the participation in the smaller exchanges. [0] http://www.bloombergview.com/articles/2014-03-31/michael-lewis-doesn-t-like-high-frequency-traders http://www.bloombergview.com/articles/2014-03-31/michael-lew...
- elecengin 11y ago
  Completely agree - in the single exchange markets you see a lot of monopolistic behavior with the operators. In this current, though, we have three major operators with 2-3 exchanges each - many with single digit percentages of market share. I suspect that the savings in execution cost due to competition are vastly overwhelmed by the increased cost of infrastructure for most market participants (excluding the largest firms).
CyberDildonics 11y ago
Fragmented exchanges are better for everyone except for high frequency traders. Then they actually have to do low latency arbitration to make money instead of full on front running like they do now. Arbitration between physical locations is something that can't be helped. The other things ways that high frequency traders make money can be helped by better systems, but there are no incentives to make those systems when exchanges make so much of their money from high frequency traders themselves.
- elecengin 11y ago
  > Fragmented exchanges are better for everyone except for high frequency traders. Then they actually have to do low latency arbitration to make money instead of full on front running like they do now. This is a very strong statement with little support. I agree that some competition among exchange operators is important, but how do you justify exchanges like CHX, with approximately 1% market share? I am not sure how to respond to your comment regarding front running without more detail. Many sources have already debunked the Michael-Lewis-style argument regarding front running. Where do you see front running? (Using the proper definition of trading ahead of a customer order based on knowledge of that order)
  - CyberDildonics 11y ago
    > how do you justify exchanges like CHX, with approximately 1% market share? What needs to be justified? It is competition and decentralization.
- Rimpinths 11y ago
  Some HFT strategies depend on fragmented exchanges. Look up "latency arbitrage" for examples.
  - CyberDildonics 11y ago
    Yes that is one way they make money but not the only way and not even the most effective way since they are splitting their profits with anyone that can compete with them and there is only so much to be made. The fact that there are multiple issues with high frequency trading is one of the reasons it ends up being so polarizing. It ends up being an ambiguous term that sometimes means something that is a natural result of decentralization, and sometime means techniques that would be grating to most people's common sense of what should be legal.
kevin_thibedeau 11y ago
The HFT guys love the fragmentation. If not they wouldn't be building out private microwave links between Chicago and NY to "beat the market".
- minimax 11y ago
  The NY/Chicago arb trade is futures vs equities. In other words it's two separate products with highly correlated prices. On one side are the futures contracts and on the other side are the underlying stocks (and ETFs). As long as the two separate products exist, you'll always have fast arbitrageurs. This is true whether the matching engines are 1000 miles apart or in the same rack.
- joosters 11y ago
  I'm sure they'd rather not be paying for microwave links, but they have to because everyone else is doing it. End result: everyone wastes lots of money to get no additional benefit.
- harmegido 11y ago
  That makes no sense. Here let me rephrase it: "Americans love commuting. If not, they wouldn't be spending millions of hours in their cars each year to get to work!

MisterMashable 11y ago

Legalized quote stuffing.

NickHaflinger 11y ago

Because they're gaming the market. How it works: place a large order, wait for others to make a bid, then cancel the order and sell your own at a mark-up.

deleted 11y ago

[deleted]

jstanley 11y ago
Read the article.

chollida1 11y ago

I think to understand most HFT market makers you have to understand how the markets pay. Most work on a maker taker model. Which means the trader who initiates the trade pays a small fee and the trader who is the passive side, the one who had their order in the market already, gets paid a small fee. as a side note there are inverted markets but lets leave those aside for now. This means to get paid you want to be at the top of the book, which means you are the first order to get filled when someone crosses the spread to get their order filled. the way priority is determined is first by price and second by time. So you have a very vested interest in being the first to cancel and move your order to the newest price level. Exchanges have tried introducing some order types to alleviate this constant send/cancel routine such as the order type "Hide not Slide" but people tend to get upset at these order types. Once you understand this, you start to realize that almost all HFT firms aren't quote stuffing, they are just jockeying for position at the top of the order book. I've never really understood quote stuffing, the same firm that quote stuffs still has to deal with those quotes coming back, its not like the market data has a flag saying ignore this quote change as its caused by your own quote stuffing. The way most markets are setup is that quotes come from gateways and multiple symbols all share a single gateway, usually assigned alphabetically, so A-F tickers all share the same gateway. This means that if someone is actually slowing down market data for say AAPL then they are also slowing down quotes for AMZN as well but again, the same firm that is quote stuffing also has to deal with their own mess so I can't see the benefit. Another comment complains that HFT firms don't like the fragmented market. That is true to a point, but keep in mind most HFT strategies only work due to the fragmented markets and RegNMS. So while they may not like 11 venues, they certainly want atleast 3 or 4, and many of hte top HFT firms run their own dark pools, adding to the problem:) As far as Hillary Clinton introducing legislation to curb HFT trading, she was the senator for New York. I'm dubious of her coming down hard on Wall Street.

dclusin 11y ago
Quote stuffing works because you know before hand which orders to filter out and don't need to expend resources considering them while everyone else does. An advanced player can build this into an FPGA to achieve greater performance.

HiLo 11y ago

John Arnold (former Enron energy trader) also posted something on Bloomberg View, and the main gist of the article was: Front-running is profitable against traditional orders entered by humans. But with spoofers in the mix, the picture looks quite different: When the front-running HFT algorithm jumps ahead of a spoof order, the front-runner gets fooled and loses money. The HFT’s front-running algorithm can't easily distinguish between legitimate orders and spoofs. Suddenly the front-runner faces real market risk and makes the rational choice to do less front-running. In short, spoofing poses the risk of making front-running unprofitable. Because spoofing is only profitable if front-running exists, allowing both would ensure that neither is widespread. http://www.bloombergview.com/articles/2015-01-23/high-frequency-trading-spoofers-and-front-running http://www.bloombergview.com/articles/2015-01-23/high-freque...

zeeshanm 11y ago
That's why most of these HFT-sponsored exchanges (read: BATS, CHX, etc) pay retail brokers (e.g. eTrade, Scottrade, etc.) for their flow.
- neomantra 11y ago
  I would be interested in your source for that comment, as I think it is untrue (at least for US exchanges, I don't know rules in other countries). I am not saying payment-for-order-flow doesn't exist, but the buyers are firms like Citadel and other "internalizers", not exchanges. If by "paying" you are referring to the maker/taker rebate model, that is paid to any market participant, not just retail brokers.
  - elecengin 11y ago
    https://www.nyse.com/publicdocs/nyse/markets/liquidity-programs/arca_rlp_fact_sheet.pdf https://www.nyse.com/publicdocs/nyse/markets/liquidity-progr... http://cdn.batstrading.com/resources/release_notes/2012/BATS-Introduces-Retail-Price-Improvement-Program.pdf http://cdn.batstrading.com/resources/release_notes/2012/BATS...

amelius 11y ago

> the story of high-frequency trading is basically one of small smart firms undercutting big banks by being smarter and more automated and more efficient Is that true? Isn't there a high barrier of entry? I was under the impression that large trading firms were building high-speed connections, which is obviously not something a small firm could ever do.

omellet 11y ago
It's not an especially high barrier if your strategy doesn't require you to build physical infrastructure (most strategies don't require this). You have programmers, hardware, colocation costs, direct exchange connection costs, trading fees, etc. The programmers are by far the most expensive component.
elecengin 11y ago
Good question. HFT is a spectrum. At the lowest latency (approximately 5 microseconds), the barriers to entry are massive - multi-million dollar startup costs. For "kind of fast" - 10-100 microseconds - there are a variety of brokerages that can get you started with costs of approximately $1000-10,000 a month. This is rapidly changing though - the exchanges have been continuously increasing the prices of their market data to the point where consuming the entire US equity market proprietary feeds costs around $50,000/mo in licensing.
juziozd 11y ago
These days you can rent a co-located computer with direct connection to the exchange. The cost is a few grands per month. Not very cheap but definitely within reach of a small business. There are many small HF firms based all over the country that just rent 1 or 2 computers close to exchanges. This is bad for big investment banks like Goldman because they no longer have a location advantage - you do not need an office in Manhattan to compete with big guys anymore.
- amelius 11y ago
  Then my followup question would be: why do we actually need trading to be faster than the regular internet allows? For the objects being traded (companies) have time-constants that are far greater than the millisecond-range. And I hope the answer is not "because everybody else does it" :)

digital-rubber 11y ago

Since they have a single goal of raking in as much money as possible, let me do a guess? To get rich?!

mkinitcpio 11y ago

Disclaimer: I work in HFT The article uses the term "front-running" incorrectly. Front-running is where a firm places their own trades ahead of trades they're placing for a client, to capitalize on the price movement that client order might generate. This is illegal. What the market makers in the article are doing isn't front-running. It's just being smart with their orders. And that's generally why HFTs cancel orders- they're reacting to market conditions that exist on the span of microseconds and will want to change their market positions very quickly- including canceling orders that they no longer think are suitable.

yummyfajitas 11y ago
The author put "front-running" in scare quotes for a reason. See footnote 6, where he explains he's using the term in the Michael Lewis/IEX sense.
- elecengin 11y ago
  Agreed. Matt Levine is one of the few commentators that fully understands market microstructure. The Bloomberg View linked in a different comment (by John Arnold) is horrible with terminology, though.
  - philipov 11y ago
    Doesn't the fact that he understands, and intentionally uses pejorative language make him dishonest?
    - evanpw 11y ago
      "Scare quotes ... may be used to imply that a particular expression is not necessarily how the author would have worded a concept." https://en.wikipedia.org/wiki/Scare_quotes https://en.wikipedia.org/wiki/Scare_quotes
      - aaronchall 11y ago

Variance 11y ago

It's great to see Matt Levine on HN - for those interested in finance, his Money Stuff [0] daily column is absolutely excellent. His writing has a really fantastic funny and informal style. He does a great job presenting a fair and deep view of a lot of finance issues, like HFT or Unicorn valuations. [0] http://www.bloombergview.com/topics/money-stuff http://www.bloombergview.com/topics/money-stuff

jevgeni 11y ago
Matt is brilliant. A little bit more mature and reserved than during his time at Dealbreaker, but still awesome.
lloydde 11y ago
I agree. His Bloomberg articles have been regularly rising to the HN front page in the last months. When I follow the link and see his avatar, I take the time to read the article.

devit 11y ago

"Updating" orders seems a far more accurate terminology than "cancelling" in the market maker case. Although of course making such a distinction by law is problematic, because updating an order to be "out-of-the-money" (have an absurdly low or high price) is almost equivalent to canceling, and objectively determining if an order is "out-of-the-money" is problematic.

gbhn 11y ago

Something this article ignores, and which is ignored by most articles on HFT, is that the process is ilegible to the public. "No no we're doing you a favor!" is not reassuring when the activity consumes a bunch of resources on zero sum activity. Ultimately investing runs on trust. HFT is consuming public trust in the financial system at a prodigious rate. Is it a trillion dollars a year? A billion? Hard to be sure. But it certainly isn't clear the tiny market-making improvements are worth it.

harryh 11y ago
Lots of things are illegible to the public. Explain to me all the processes involved in building the smart phone in your pocket. You can't. I can't. Probably no single person in the world can. Who cares?
- dopamean 11y ago
  I think the illegibility of it is important if it is affecting other people's finances.
  - harryh 11y ago
    Nearly every good or service that you purchase is backed by a nearly illegible process of global trade. That doesn't affect your finances?
    - pjc50 11y ago
      Doesn't it? The illegibility of offshore money affecting overall tax take and therefore government spending, services, and jobs? The illegibility of jobs disappearing to ... somewhere? Not knowing if you've bought products that have been manufactured by slave labour or just awful working conditions? It's not clear.
    - crdoconnor 11y ago
      >Nearly every good or service that you purchase is backed by a nearly illegible process of global trade. That doesn't affect your finances? Yes it has, but why would you consider that a good thing? CAFTA and NAFTA have been pretty horrendous for the finances of Americans and TTIP and TPP are likely to be even worse. They can't be killed unless enough people understand them, either.

shasta 11y ago

I guess I see why high frequency trades are necessary in the current trading framework, but looking at the situation from a high level, isn't it obvious that the resources being spent on microsecond level response improvements don't benefit anyone but the winners? Can someone argue otherwise?

vasilipupkin 11y ago
It's the opposite. The resources being spent on microsecond speed race is a form of a tax imposed on HFT by society. If all big HFT firms spent on getting faster, they don't benefit in expectation, since all the competitors will be equally fast, but society benefits because that spending goes to wider economy outside HFT
- shasta 11y ago
  Right, that's the obvious situation that I see. I'm wondering if anyone can argue otherwise? If not, why isn't there a bigger push for market infrastructure that doesn't advantage high frequency trades? I don't know that most high frequency microtrades are a real problem either way, since it seems mostly zero sum among the people playing that game. But whenever there is a macro change in a price that takes place over a tiny time scale, it seems that we shouldn't be advantaging speed in getting there first.
  - vasilipupkin 11y ago
    "If not, why isn't there a bigger push for market infrastructure that doesn't advantage high frequency trades?" because most of those who could do the pushing are ignorant and/or confused about the economics of competitive markets and how competition benefits society as a whole and not really those who are competing
tptacek 11y ago
You're right, although you should also build into that argument the benefits that accrue to technologists that work at HFT firms, and to technology vendors who sell to them.

astine 11y ago

"Here you have an industry that has undercut the business of the big banks, irritated hedge fund managers and been great for small investors. Why would cracking down on that business be populist? Why would it alienate wealthy donors?" For the same reason that people don't generally cheer when a gang war happens. Just because the gangsters are mainly shooting other gangsters doesn't mean the violence isn't costly to society. The same with Wall Street. Just because people don't trust big banks and suspect them of rooking the common man doesn't mean that they want to legitimize said rooking, or that it isn't costly to society when banks rip each other off.

harryh 11y ago
Viciously competing to provide services at the lowest possible cost to the customer is not the same thing as ripping each other off. There is no violence here. Only competition.
kasey_junk 11y ago
I think you are missing his point. HFT is not typically banks ripping each other off. Its a new outside entity that has made the service the banks and traditional market makers provided to their customers much cheaper at the expense of hedge funds and bank profits. In most industries we applaud this disruption.
- astine 11y ago
  But, in the mind of the populist masses that Mr Levine it criticizing it is. I don't work in finance and I'm not going to make any judgments on the industry, just to say that people who are opposed to it would be opposed to HFTs as well. Also, the people who applaud 'disruption' are not this sort of populist, they don't cheer because of the damage done to incumbents but because the disruption will hopefully mean better products/services/prices for customers. HFT just does the job of the old investment bankers slightly more efficiently. If you think investment bankers are bad, you're not going to think that more efficient investment are an improvement.
  - 11y ago

frandroid 11y ago

TL;DR: Market makers put a buy and a sell offer, separated by one or more cents, on every trade; when someone big enough picks one side, they cancel the other side and re-issue new buy and sell offers with new goal-posts.

sjbase 11y ago

The "new" part of this news, which not many have responded to here, is the notion of an HFT tax. The arguments on either side of HFT (liquidity/spread/etc. vs. cost/unfairness/etc.) have been largely unchanged for the last few years. There simply isn't enough data made public to declare a victor. As far as the tax: personally I'm very in favor of slowing down trading... unfortunately, what's being proposed introduces as much structural game theory as it eliminates. What's the dominant strategy for a trader faced with a rule like "any trades resting for less than 300 micros get taxed"? To be as fast as possible without triggering the tax; staying just above the threshold. All that economic waste on low-latency tech will just be redirected to low-jitter tech. Those who can reliably land an order within +1 microsecond of the tax line will outperform those who only have an accuracy of +10. I'd like to see more exchanges experimenting with things like random variance in speed bump size, frequent batch auctions, etc.

kasey_junk 11y ago
Or you could just get rid of the sub-penny rule and let HFT compete on price.
yummyfajitas 11y ago
There is enough data to declare that a transaction tax is a loser. Canada tried it. The bid/ask spread rose 9%. This resulted in a transfer of wealth from retail investors to institutional ones. http://qed.econ.queensu.ca/pub/faculty/milne/322/IIROC_FeeChange_submission_KM_AP3.pdf http://qed.econ.queensu.ca/pub/faculty/milne/322/IIROC_FeeCh...
Mikeb85 11y ago
> personally I'm very in favor of slowing down trading... As a retail trader, no. As an example, yesterday I placed a sell order on $90,000HK worth of a stock. Once I hit 'send', my order was fulfilled before my browser could load the confirmation page, and at the market price I was quoted seconds before. This is, in large part, thanks to market makers who use HFT. Before this, the broker/market maker might take a spread worth half a percent or more (and being a retail investor, you probably wouldn't get the 'market' price), now it's pennies or less, and at the market price. Thanks to HFT, spreads are smaller, execution quicker, and it definitely 'levels' the playing field.

deleted 11y ago

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blazespin 11y ago

Ahem, buried in the middle of the article (I wonder why) "Navinder Sarao is accused of spoofing in the S&P 500 futures market, entering and cancelling lots of orders to create an illusion of demand, in suspicious proximity to the flash crash of 2010." This happens a lot more than you might think. There is always a temptation to stuff the order book to keep it going in a direction profitable for you (ie, fake volatility). This is the #1 reason why canceled ordered from HFT are suspect. It's too easy to stuff the order book and cheat a little. You really need highly credible market makers who have proven not to do this sort of thing. Even then, such folks are very rare and hard to appreciate. Your algorithms get so complex and obfuscated it's hard to tell what's stuffing the order book and what's simple market making. The fact is, everyone is stuffing the order book. Sarao is more a patsy than anything else. His biggest crime wasn't belonging to a Goldman Sachs paying bribes to political entities.

tptacek 11y ago
There is always a temptation to stuff the order book to keep it going in a direction profitable for you (ie, fake volatility). Is this something you have personal experience in? I ask because a lot of people relate this concern because they read about it in Zero Hedge, which is regarded by people in the industry as (as someone here once put it) "a conspiracy theory site without the theories".
- beagle3 11y ago
  The description of ZeroHedge is funny and not entirely untrue, but if you regard them as an aggregator of opinions, (which they mostly are, even though they do offer their own opinions), it is unmatched in its breadth of coverage, despite having a rather low signal coverage. WRT suffing the order book - at least as far back as 2003, in Eurex, there was a swiss trader who would do that in bond futures. There were a lot of comlpaints, and even death threats IIRC, but a Eurex investigation at the time found he did nothing wrong - their main finding was that he would occasionally get those "stuffing" orders executed, which means that (as far as they are concerned) they are not false or misleading in any way. That's probably the gist of it: as long as you are willing to take the hit if your bluff goes against you, there's nothing "fake" about it. It's been years since, and I know not of any (officially investigated) cases back then, or of any recent cases - but I'd be surprised if it's not very prevalent. (Also, I've been out of the HFT world for a while).

patio11 11y ago

I happen to have 144 lines of Ruby which implement the world's most braindead market making algorithm, coded by someone who had literally never written a trading system before. It cancels ~98% of orders before they are hit when running on a single stock on a single venue.

ycombobreaker 11y ago
Is it profitable? Or just paper trading/simulated? Braindead stuff works if it is the fastest in the world, but as you slow down you need to get smarter to cover losses due to getting "picked off" more frequently.
- JoachimSchipper 11y ago
  I'm pretty sure it's a competitor for Patrick's StarFighter game. It's not supposed to be impossible to beat.

ehosca 11y ago

it's called "discovery" ...

mjevans 11y ago

A better question is why do we even have 'High Frequency Traders'? Wouldn't the market be better served by a window structure with a scale on a more human timespan? Say a 5 min process in which: * for 4 min orders are taken in confidential secret. * there is a 1 min blackout window in which no orders are taken, and in which any results of settling the outcome of orders is not published. * At the end of that period the new results are published. (It doesn't matter who reacts first, it's who reacts best.) The profit between what sellers are asking for and what the buyers are willing to pay still needs to be accounted for. This could be the market's operating fee (the cost of the sale's commission), it could be attributed to the government as a form of sales tax, it could be returned in some way to the parties involved (buyers pay less, sellers earn more), other, or some combination of the above.

jrockway 11y ago
The price of equities is not known. The market is how that price is calculated. You could slow down the process, but that adds risk (that one party is getting the wrong price). The market makers would say, I'll sell you one 1 share for $1, 10 shares for $1.20, 100 shares for $2, 1000 shares for $10. So then someone who wants to buy 1000 shares for $1 a share will buy only 1 share at $1. Then in the quiet period, the market makers will adjust their prices. 1 share for $1.01, etc. Then you'll sell another share for $1.01. Then you'll wait 5 minutes, and the market makers will adjust their price. The market is going to work the same way at 5 minute delay as it works at nanosecond delay, but just be slower. The market makers won't be getting you a better price, and your large transaction won't not affect the share price.
tomp 11y ago
Would you, as an investor, rather trade on exchange A, where there is a given spread and market depth, so you know approximately what price your order will execute at in the next few seconds, or at exchange B, where the most recent price and depth is up to 5 minutes old, and where your orders will be executed at an unknown price sometime in the next 5 minutes?
Alupis 11y ago
> A better question is why do we even have 'High Frequency Traders'? High Frequency Traders (HFT) do a lot of positive things for a market - mainly providing liquidity where they might otherwise not be. They also act as a sort-of balancing force for undervalued or overvalued stocks (in the volume the HFT's trade with over time), "normalizing" the VWAP and TWAP (among other health indicators) for a given ticker. In other words, markets want (and benefit from) HFT's.

curiousjorge 11y ago

what benefit does high frequency traders provide to rest of society? none. they raise the cost of transactions of all investors. it should be banned and those brought to justice.