8 ms·

HFT (the automation of human market makers) has provided enormous value by reducing bid/ask spreads by at least a factor of 10x.

by harryh 11y ago

dantiberian 11y ago
Was it HFT or the move to electronic trading that reduced the bid/ask spread by 10x?
- justinjlynn 11y ago
  Certainly electronic trading. I've found this to be an excellent article deflating HFT benefit myths: http://www.nanex.net/aqck2/4594.html http://www.nanex.net/aqck2/4594.html
  - MichaelGG 11y ago
    The article is a bit suspicious. It talks about Thor, which timed orders to different exchanges so they'd arrive simultaneously. This is because a market maker would notice a large order on one exchange, and raise his price. This is totally and utterly expected - why should a market maker take undue risk? Increase the latency - suppose a user submitted a large buy order to Exchange1, waited an hour, then sent it to Exchange2. Is it not reasonable that the price would go up? So why is it suddenly so controversial when it happens on shorter timeframes? Why should RBC be able to make big trades and not have to deal with price impact? Why should market makers be left holding the bag? Now whether or not HFT adds more value seems debatable. But it seems to be a fairly harmless result that naturally arises.
  - mrchicity 11y ago
    HFT has been around for a while longer than Reg NMS: http://www.bizjournals.com/kansascity/stories/2005/01/17/smallb1.html http://www.bizjournals.com/kansascity/stories/2005/01/17/sma... describes an major player doing something that sounds similar to modern HFT in Jan 2005, presumably they'd been trading that way for a while.
- harryh 11y ago
  HFT. It's basic automation. Taking (slow, expensive) human decision makers out of the loop drastically reduced costs.
- gnaritas 11y ago
  You cannot really separate the two. If you support electronic trading, no matter what artificial restrictions you put on speed, the first person to get his order in will win, they will always compete on latency.
  - MichaelGG 11y ago
    If you allowed arbitrary precision (or even 8 decimals) then there'd be a bit less emphasis on latency, right? As is, a penny is worth quite a bit so everyone has to queue up at the same price making speed win.
    - harmegido 11y ago
      No there's a minimum spread that will exist because market makers won't make markets so tight that they are losing money. If they can't make money on the spread, then what's the point of posting that spread? These discussions always happen whenever HFT is brought up. I've thought a LOT about how to remove a latency advantage from this game, and I just can't find a way to do it. I'd love to be proven wrong though. (And actually, so would the HFT shops - they hate the speed race).
      - MichaelGG 11y ago
        What stops an exchange from quantizing to, say, a second or so? Use proportional matching, or something even more clever like POSIT does. I'm sure there's a reason that this simple idea doesn't work but I haven't figured it out yet. As far as more decimals, it doesn't sound plausible that all the market makers are gonna come up with the same price to 8 decimals. So the time priority will give way a bit to price priority.
        gnaritas 11y ago
        > What stops an exchange from quantizing to, say, a second or so? That wouldn't be fair, an order book is a line, such a rule would allow people to cut line and get shares at better prices before you allowing them to drive the price up or down even though you were in line before them. > As far as more decimals, it doesn't sound plausible that all the market makers are gonna come up with the same price to 8 decimals. So the time priority will give way a bit to price priority. That's how it used to be, compete on price first, but a minimum decimal put in place by law, the sub penny rule, to try and dampen HFT, it's only made latency more important since HFT traders can no longer compete on price. And he's right, there's always a minimum price below which there is no profit, so whoever posts that price first wins. Orders compete on time and price because that what is fair. Latency is inherently part of fair trading, you can't remove it and keep the market fair.
hkmurakami 11y ago
Cliff Asness on how HFT has benefited retail investors. How HFT has changed the allocation of the pie between various market professionals is hard to say. But there has been one unambiguous winner, the retail investors who trade for themselves. Their small orders are a perfect match for today's narrow bid-offer spread, small average-trade-size market. For the first time in history, Main Street might have it rigged against Wall Street. http://www.wsj.com/news/articles/SB10001424052702303978304579475102237652362?mod=WSJ_Opinion_LEADTop&mg=reno64-wsj http://www.wsj.com/news/articles/SB1000142405270230397830457... Matt Levine's followup post. http://www.bloombergview.com/articles/2014-04-02/high-frequency-trading-may-be-too-efficient http://www.bloombergview.com/articles/2014-04-02/high-freque...
- gammarator 11y ago
  Except that most of Main Street owns stocks through mutual funds, which make large trades on their behalf...
  - harryh 11y ago
    Main Street mostly owns shares in index funds or other funds without alpha. They're much better served with faster price discovery.
  - HiLo 11y ago
    Meanwhile, nobody on here complaining about those mutual fund fees that are orders of magnitude bigger than HFT haircuts for the savers themselves :)
- HiLo 11y ago
  The only reason retail orders actually get matched up well is because they're flagged as retail, are known to contain less information, and are a statistically good bet to transact against. Fundamentally, this was around before HFT and still is. The funny thing is that even if it's helping them in this small way, the whole idea of retail investing is some of the best marketing in the face of contradictory facts I've ever seen.
ced 11y ago
How does that provide value? I have no personal experience in this, but I've heard that the order book is now very "shallow" due to HFT, such that it's hard to sell/buy a meaningful quantity of stocks at the market price. Does that make sense?
- harryh 11y ago
  The bid ask spread is a measure of how far behind you are the moment you buy a stock. If the ask is $10 but the bid is $9.75 you've lost 0.25 per share the second you make a trade. If the spread is only $0.01 (as is now common) you've only lost a penny. So smaller spreads are great. It's true that markets now respond faster to large sales so if you're a hedge fund trying to unload $BIGNUM shares of MSFT you'll have a harder time. But that's good for everyone else. If that hedge fund has proprietary information that MSFT is undervalued you want that information getting out to the market as fast as possible leading to more efficient prices.
  - ced 11y ago
    The bid ask spread is a measure of how far behind you are the moment you buy a stock. If the ask is $10 but the bid is $9.75 you've lost 0.25 per share the second you make a trade. That makes some sense, but who have you lost it to? I was thinking about it the other day, and it seems that the "liquidity is good" argument can make some sense if people are not willing to make a transaction immediately. If I want to sell a bag of apple for 1$ _right now_, and someone else is willing to buy that bag for up to 1.50$ in a week, then I can appreciate that there's a middleman (providing liquidity) willing to hold the bag for me during that time and that he makes some profit from the spread. However, if the buyer and seller are both willing to make the trade at roughly the same time, then it's much better if they do it themselves (splitting the 50 cents of value amongst themselves) than if a middleman gets into the picture. More or less the argument made here: http://smbc-comics.com/index.php?id=3890 http://smbc-comics.com/index.php?id=3890
    - harryh 11y ago
      You've lost it to a market making who is charing you for providing a service. Whenever you trade with a market maker you are buying liquidity (which used to be expensive but is now a lot cheaper). You're saying "I want to take the price you are offering right now and am not willing to take the risk that someone else will never come along to trade with me at a slightly better price." If you don't want to trade with a market maker you can avoid purchasing their liquidity by placing a limit order that doesn't cross the spread. You'll then wait until someone else comes along to trade with you. Of course, you're taking a risk that the stock price will move away from you and you'll never trade. Normally this is the risk the market maker takes for you (which is why you pay him) but you can always do it yourself if you want. In that comic the first caveman is getting a price that is right in front of him. He's not willing to wander around hoping to find a better price in another cave. That's a service that the 2nd caveman is performing for him. That's why the 2nd caveman gets paid. The key thing to realize is that market makers don't just "get into the picture" by muscling their way in when other people don't want them there. Think of them off to the side selling liquidity for anyone who wants to walk up to them and buy it.
gammarator 11y ago
"A U.S. Government Accountability Office study in 2005 showed that bid-ask spreads compressed by as much as 80% immediately following decimalization, well before high frequency trading came to dominate markets, and well before this author's time frame." http://www.amazon.com/review/R28Y8AI4PIPYZ2/ref=cm_cd_pg_next?ie=UTF8&asin=B00P0QI2M2&cdForum=Fx18U5VH3QDOTQY&cdPage=2&cdThread=Tx3HBK21NVZMJXG&store=digital-text#wasThisHelpful http://www.amazon.com/review/R28Y8AI4PIPYZ2/ref=cm_cd_pg_nex...

HFT (the automation of human market makers) has provided enormous value by reducing bid/ask spreads by at least a factor of 10x.

by harryh 11y ago

HFT (the automation of human market makers) has provided enormous value by reducing bid/ask spreads by at least a factor of 10x.

dantiberian 11y ago

Was it HFT or the move to electronic trading that reduced the bid/ask spread by 10x?

justinjlynn 11y ago
Certainly electronic trading. I've found this to be an excellent article deflating HFT benefit myths: http://www.nanex.net/aqck2/4594.html http://www.nanex.net/aqck2/4594.html
- MichaelGG 11y ago
  The article is a bit suspicious. It talks about Thor, which timed orders to different exchanges so they'd arrive simultaneously. This is because a market maker would notice a large order on one exchange, and raise his price. This is totally and utterly expected - why should a market maker take undue risk? Increase the latency - suppose a user submitted a large buy order to Exchange1, waited an hour, then sent it to Exchange2. Is it not reasonable that the price would go up? So why is it suddenly so controversial when it happens on shorter timeframes? Why should RBC be able to make big trades and not have to deal with price impact? Why should market makers be left holding the bag? Now whether or not HFT adds more value seems debatable. But it seems to be a fairly harmless result that naturally arises.
- mrchicity 11y ago
  HFT has been around for a while longer than Reg NMS: http://www.bizjournals.com/kansascity/stories/2005/01/17/smallb1.html http://www.bizjournals.com/kansascity/stories/2005/01/17/sma... describes an major player doing something that sounds similar to modern HFT in Jan 2005, presumably they'd been trading that way for a while.
harryh 11y ago
HFT. It's basic automation. Taking (slow, expensive) human decision makers out of the loop drastically reduced costs.
gnaritas 11y ago
You cannot really separate the two. If you support electronic trading, no matter what artificial restrictions you put on speed, the first person to get his order in will win, they will always compete on latency.
- MichaelGG 11y ago
  If you allowed arbitrary precision (or even 8 decimals) then there'd be a bit less emphasis on latency, right? As is, a penny is worth quite a bit so everyone has to queue up at the same price making speed win.
  - harmegido 11y ago
    No there's a minimum spread that will exist because market makers won't make markets so tight that they are losing money. If they can't make money on the spread, then what's the point of posting that spread? These discussions always happen whenever HFT is brought up. I've thought a LOT about how to remove a latency advantage from this game, and I just can't find a way to do it. I'd love to be proven wrong though. (And actually, so would the HFT shops - they hate the speed race).
    - MichaelGG 11y ago
      What stops an exchange from quantizing to, say, a second or so? Use proportional matching, or something even more clever like POSIT does. I'm sure there's a reason that this simple idea doesn't work but I haven't figured it out yet. As far as more decimals, it doesn't sound plausible that all the market makers are gonna come up with the same price to 8 decimals. So the time priority will give way a bit to price priority.
      - gnaritas 11y ago
        > What stops an exchange from quantizing to, say, a second or so? That wouldn't be fair, an order book is a line, such a rule would allow people to cut line and get shares at better prices before you allowing them to drive the price up or down even though you were in line before them. > As far as more decimals, it doesn't sound plausible that all the market makers are gonna come up with the same price to 8 decimals. So the time priority will give way a bit to price priority. That's how it used to be, compete on price first, but a minimum decimal put in place by law, the sub penny rule, to try and dampen HFT, it's only made latency more important since HFT traders can no longer compete on price. And he's right, there's always a minimum price below which there is no profit, so whoever posts that price first wins. Orders compete on time and price because that what is fair. Latency is inherently part of fair trading, you can't remove it and keep the market fair.

hkmurakami 11y ago

Cliff Asness on how HFT has benefited retail investors. How HFT has changed the allocation of the pie between various market professionals is hard to say. But there has been one unambiguous winner, the retail investors who trade for themselves. Their small orders are a perfect match for today's narrow bid-offer spread, small average-trade-size market. For the first time in history, Main Street might have it rigged against Wall Street. http://www.wsj.com/news/articles/SB10001424052702303978304579475102237652362?mod=WSJ_Opinion_LEADTop&mg=reno64-wsj http://www.wsj.com/news/articles/SB1000142405270230397830457... Matt Levine's followup post. http://www.bloombergview.com/articles/2014-04-02/high-frequency-trading-may-be-too-efficient http://www.bloombergview.com/articles/2014-04-02/high-freque...

gammarator 11y ago
Except that most of Main Street owns stocks through mutual funds, which make large trades on their behalf...
- harryh 11y ago
  Main Street mostly owns shares in index funds or other funds without alpha. They're much better served with faster price discovery.
- HiLo 11y ago
  Meanwhile, nobody on here complaining about those mutual fund fees that are orders of magnitude bigger than HFT haircuts for the savers themselves :)
HiLo 11y ago
The only reason retail orders actually get matched up well is because they're flagged as retail, are known to contain less information, and are a statistically good bet to transact against. Fundamentally, this was around before HFT and still is. The funny thing is that even if it's helping them in this small way, the whole idea of retail investing is some of the best marketing in the face of contradictory facts I've ever seen.

ced 11y ago

How does that provide value? I have no personal experience in this, but I've heard that the order book is now very "shallow" due to HFT, such that it's hard to sell/buy a meaningful quantity of stocks at the market price. Does that make sense?

harryh 11y ago
The bid ask spread is a measure of how far behind you are the moment you buy a stock. If the ask is $10 but the bid is $9.75 you've lost 0.25 per share the second you make a trade. If the spread is only $0.01 (as is now common) you've only lost a penny. So smaller spreads are great. It's true that markets now respond faster to large sales so if you're a hedge fund trying to unload $BIGNUM shares of MSFT you'll have a harder time. But that's good for everyone else. If that hedge fund has proprietary information that MSFT is undervalued you want that information getting out to the market as fast as possible leading to more efficient prices.
- ced 11y ago
  The bid ask spread is a measure of how far behind you are the moment you buy a stock. If the ask is $10 but the bid is $9.75 you've lost 0.25 per share the second you make a trade. That makes some sense, but who have you lost it to? I was thinking about it the other day, and it seems that the "liquidity is good" argument can make some sense if people are not willing to make a transaction immediately. If I want to sell a bag of apple for 1$ _right now_, and someone else is willing to buy that bag for up to 1.50$ in a week, then I can appreciate that there's a middleman (providing liquidity) willing to hold the bag for me during that time and that he makes some profit from the spread. However, if the buyer and seller are both willing to make the trade at roughly the same time, then it's much better if they do it themselves (splitting the 50 cents of value amongst themselves) than if a middleman gets into the picture. More or less the argument made here: http://smbc-comics.com/index.php?id=3890 http://smbc-comics.com/index.php?id=3890
  - harryh 11y ago
    You've lost it to a market making who is charing you for providing a service. Whenever you trade with a market maker you are buying liquidity (which used to be expensive but is now a lot cheaper). You're saying "I want to take the price you are offering right now and am not willing to take the risk that someone else will never come along to trade with me at a slightly better price." If you don't want to trade with a market maker you can avoid purchasing their liquidity by placing a limit order that doesn't cross the spread. You'll then wait until someone else comes along to trade with you. Of course, you're taking a risk that the stock price will move away from you and you'll never trade. Normally this is the risk the market maker takes for you (which is why you pay him) but you can always do it yourself if you want. In that comic the first caveman is getting a price that is right in front of him. He's not willing to wander around hoping to find a better price in another cave. That's a service that the 2nd caveman is performing for him. That's why the 2nd caveman gets paid. The key thing to realize is that market makers don't just "get into the picture" by muscling their way in when other people don't want them there. Think of them off to the side selling liquidity for anyone who wants to walk up to them and buy it.

gammarator 11y ago

"A U.S. Government Accountability Office study in 2005 showed that bid-ask spreads compressed by as much as 80% immediately following decimalization, well before high frequency trading came to dominate markets, and well before this author's time frame." http://www.amazon.com/review/R28Y8AI4PIPYZ2/ref=cm_cd_pg_next?ie=UTF8&asin=B00P0QI2M2&cdForum=Fx18U5VH3QDOTQY&cdPage=2&cdThread=Tx3HBK21NVZMJXG&store=digital-text#wasThisHelpful http://www.amazon.com/review/R28Y8AI4PIPYZ2/ref=cm_cd_pg_nex...