7 ms·

How High Frequency Trading Benefits All Investors

21 points by ad 17y ago

youngian 17y ago
I usually hate TL;DR comments, but if someone provided a short summary of the argument here (and for bonus points, a critique of the argument's strength), I would be very grateful.
- sparky 17y ago
  The argument is essentially: 1) High-frequency traders (HFTs) increase liquidity. For the benefit of those who don't know what that means: there are actually a finite amount of shares of each company, and you cannot buy shares unless someone is willing to sell theirs to you, and you cannot sell shares unless someone is willing to buy them from you. You can imagine that you might not be able to sell your shares the instant you want them to if humans are in the loop on the buyer side (i.e., if a human has to review your selling price and decide whether or not to buy), and vice-versa. In contrast, if somebody has programmed a computer to automatically execute trades if certain conditions are met, you can buy and sell shares very quickly. This is what HFTs do. 2) HFTs provide transparent price discovery. This means that the computer programs the HFTs have set up will quickly and unambiguously tell you at what price they are willing to buy and sell shares. Contrast this with a hypothetical process in which you had to haggle with human representatives of each shareholder or potential buyer in order to figure out the price. It's similar to consumer vs. enterprise software sales (sticker price vs. "well, how much can you afford?"). In theory, transparent price discovery promotes fairness (everyone sees the same price) and encourages trading due to decreased latency and hassle. 3) Lots of repetition of 1 and 2. Also an assertion that HFT decreases volatility (average dPrice/dt), while most commentary on the matter assumes that it would increase volatility, due to algorithms that are either busted ( e.g., http://arstechnica.com/business/news/2010/01/how-a-stray-mouse-click-choked-the-nyse-cost-a-bank-150k.ars http://arstechnica.com/business/news/2010/01/how-a-stray-mou...) or interacting with one another in a bad way. It is disconcerting to me that the author cites empirical evidence without a hint of intuition or insight to help the reader generalize it; however, it is difficult to dismiss the evidence off-hand without looking at it more closely and/or being more expert than I in the matter. Points 1 and 2 are by far the most common and obvious arguments for HFT, and the analysis in TFA is not bad, but not exemplary either. The rest of the article is basically redundant and comes off a little defensive. I found this article interesting ( http://www.zerohedge.com/article/whoa-glitch-hft http://www.zerohedge.com/article/whoa-glitch-hft ), though its tone is also less-than-objective.
  - rgarcia 17y ago
    The last section makes an interesting point about the type of speculation that HFT does, i.e. it's not long-term (no positions carried overnight) and thus it can't create the types of asset bubbles that we've seen in the past
  - _delirium 17y ago
    The rest of the article seems to make some rather dubious strong claims, also. For example: "High frequency traders can only trade profitably when their trades push a stock price towards fair value." I don't see why there's any particular reason that's true. High-frequency traders can trade profitably whenever their trades are in line with (very) short-term price movements. Ideally everything works together to push prices towards fair value, but you can't assume that as an axiom, since that's the main point being disputed in that section (the one on volatility).
    - Rimpinths 17y ago
      One other aspect of HFT that was not mentioned in the article is that HFTers often seek arbitrage opportunities. For example, the value of many ETFs such as SPY (i.e. an ETF tracking the S&P 500) are derived from the value of underlying securities. If the value of SPY versus the value of the underlying securities becomes out of sync, HFTers may go long one and short the other and then profit when they converge again. In this sense, HFTers only profit if the market returns to fair value. This applies to many ETFs, convertible securities, and options.
pdoughtie 17y ago
Keep in mind that this is appearing in a magazine that is successful because of the success of high frequency trading and that the article is written by the member of a company that bases its profits on the ability to conduct high frequency trading.
- rgarcia 17y ago
  http://www.paulgraham.com/disagree.html http://www.paulgraham.com/disagree.html DH1
  - _delirium 17y ago
    PG articles are not scripture that you can just link to a quote from to end debate, you know. =] I do think it's legitimate to look at sources for articles, especially when there are strong conflicts of interest.
    - falsestprophet 17y ago
      "Everyone must submit himself to the governing authorities, for there is no authority except that which God has established." Romans 13:1
      - gjm11 17y ago
        The Bible is not scripture that you can just link to a quote from to end debate, you know.
        falsestprophet 17y ago
        Stack Overflow
    - rgarcia 17y ago
      My intention wasn't to end the debate, but rather to steer it away from the substance-lessness that characterizes most debates about HFT. That being said (disclaimer: I am a HFTer), this article is a pretty weak defense of HFT. Like others have pointed out it makes a lot of assertions not based on data/fact. However, I've yet to read a criticism of HFT that doesn't commit the same mistake (and I've read a lot of them). For a defense of HFT that uses hard data I'd direct people here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1501135 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1501135
thstart 17y ago
here is what I found FYI: http://blog.t3live.com/2010/02/prop...lation-tax.html http://blog.t3live.com/2010/02/prop...lation-tax.html "While most retail investors probably have little concept of what high frequency trading is or its impacts, active equity traders have seen its pronounced imprint on the markets. High frequency trading is an entirely legitimate strategy of using computer algorithms to execute trading strategies with ultra-low latency. Yet, the explosion in HFT has led to a major structural flaw in equity markets. This flaw is the abuse of uncharged bidding and offering for shares. Level II traders know exactly what this is as they see it day after day in every stock they trade. The book of bids and offers is supposed to be a top-to-bottom list of the prices every player in the market is willing to buy and sell a stock. In this idealized world, there is price transparency as everyone can see who wants to buy and who wants to sell should the participant chose to place a limit order. The price at any given second then is an accurate reflection of the current supply and demand for shares (ignoring the use of dark pools, hidden orders, etc.). Limit orders are meant to be the showing of an explicit intention to buy or sell shares at a predetermined price. Should a trader not want to show his hand, he can execute market orders or use reserve orders. Yet, the book no longer acts in accordance with the idealized world. Every single listed stock’s order book is filled with false bids and false offers. These limit orders are constantly used to manipulate prices back and forth to the HFT’s advantage. Nearly every higher volume, lower priced stock has a book that is stacked with offers and bids at nearly every penny increment but the vast majority of these quotes are fake. The HFTs submitting the bulk of these orders do not have the objective of being filled on their orders. The purpose is to manipulate the price in some way. This is clearly a deceptive practice occurring in nearly every stock in the current hybrid and fully electronic markets. The high frequency trader has the explicit goal of tricking other traders into believing there is something real there when there is not. Bidding and offering without the intention of actually filling the order is nothing more than a mechanism to mislead other traders. This game, as played by HFTs, is an obscenely inefficient allocation of resources. " Directly from the source: http://www.nasdaqtrader.com/content...ms_revshare.pdf http://www.nasdaqtrader.com/content...ms_revshare.pdf From the Nasdaq note, take a look at Quote vs. Trade: "Quote vs. trade: The plans then allocate to each SRO a portion of each issue’s income pool for quotes and trades. Quotes and trades in total per security are eligible for approximately 50% each of the symbol’s income allocation subject to the $4.00 cap per eligible trade report. • Quotes are allocated value based on time and size at the inside market • Trades are allocated value based on the number of eligible trade reports and reported dollar volume" Exchanges now earn revenue for not only trade reporting but for quote reporting. And, to attract more quotes, the exchanges are very aggressive in rebating these fees to the subscribers who post the quotes. Also, this research is interesting too: Equity Trading and the Allocation of Market Data Revenue http://wpcarey.asu.edu/fin/upload/C...May-27-2009.pdf http://wpcarey.asu.edu/fin/upload/C...May-27-2009.pdf "Exchanges devised revenue-sharing and rebate programs that rewarded order-flow providers for tape shredding, and encouraged algorithmic traders to execute strategies involving large numbers of small trades. We provide evidence that data revenue allocation has influenced the trading process In this paper, we show that the allocation formula has had a significant impact on the trading process. In particular, we demonstrate that average trade size is sensitive to changes in the marginal revenue per trade. We also find evidence that rebate programs are a key institutional mechanism through which the allocation rule influences the trading process." So, what you guys are thinking about this? Are there is any reason to subscribe to tick by tick data with bid/ask quotes? What a Level II is telling you actually today?
barrkel 17y ago
I am somewhat confused by this double-negative: "No serious market observer disputes the claim that volatility would not be higher without the liquidity provided by high frequency traders." The author seems to be trying to say that high frequency traders reduce volatility. But I parse the claim differently: it seems to me to be saying that volatility could only be lower in the absence of liquidity from high frequency traders. As to the rest of the argument, it seems to be structured along these lines: * More efficient markets with lower spreads between buy and sell are good. I think this is a valid claim, but I don't think it follows from the existence of high frequency trading, but rather from more efficient, automated trading systems. * High frequency trading helps supply market liquidity, and this liquidity is good. I can buy the first part of this, and the second part seems mostly true. * Old-fashioned purchasers seem to be annoyed that when they make a large purchase, the price for the last share is higher than the price for the first share, because the market has already reacted to the change in supply and demand. He also makes the argument that were this not so, the sellers of shares would in effect be subsidizing purchasers. His case seems solid enough to me. * But he then makes another claim that seems to contradict it. He suggests that companies with stocks that have low volume turnover are unduly affected by small purchases, and since high frequency trading increases volume, the impact is reduced. * Finally, it seems he would like to claim that because "our nation's equity markets are far fairer, more efficient, more liquid and have lower transaction costs for investors than ever before", high frequency trading should claim a substantial portion of the credit.
- thstart 17y ago
  HFT market participants are having the privilege to place and cancel orders up to 30 seconds. For free. No charge. If a big order is coming they can get all available shares and sell it at higher price to the who places the big order. For free.
- kscaldef 17y ago
  It actually seems to be more like a quadruple-negative. Let's try to simplify. "No serious market observer disputes the claim that volatility would not be higher without the liquidity provided by high frequency traders." "[serious market observers believe] that volatility would not be higher without the liquidity provided by high frequency traders." "[serious market observers believe] that volatility would [be lower] without the liquidity provided by high frequency traders." "[serious market observers believe] that volatility would [be lower] without ... high frequency traders." "[serious market observers believe] that volatility [is higher with] ... high frequency traders." "[high frequency traders increase volatility]" This, of course, is exactly the opposite of what the author proceeds to argue in the following paragraphs. My conclusion is that the author managed to create a sentence so overly complicated that even he could not understand what he was saying.
brownegg 17y ago
I am a professional trader, and by almost any definition I operate in the "high frequency" space. First, let's establish that Traders is an authority on the real world of financial markets in the same sense that PC World is an authority in the world of technology. So I've not read the linked article, nor am I going to. But I will say this: HFT does perform a viable, necessary economic function. A well-functioning capital market absolutely requires this kind of activity. HOWEVER, like most mainstream-media memes, what gets talked about / opined on is almost never relevant to what is actually important and/or controversial: in this case, the question of whether HFT creates a two-tiered playing field where individual (read: non-technically-sophisticated) investors suffer at the hands of the "pros". Most arguments against HFT basically say that algorithms are purely predatory and only serve to hurt the performance of large investors. This is naive at best and deceptive at worst; for every share I purchase "ahead of" a big order, a seller has been filled at the price he desired. Every transaction has two sides; you can't just pick one and say they got screwed. The other side has to have done as well as the other did poorly (assuming a fictional frictionless world). The reality is that HFT requires tons of knowledge and a technology budget of seven figures per annum at the barest minimum, and this provides a very real barrier to entry. What should be talked about, but never is: is that ok? Why or why not? What ramifications does it have?
- richardw 17y ago
  Each time you buy ahead of someone they lose the money you make. It's a zero-sum transaction. Instead of being between a buyer and seller, it's now the buyer, you and the seller. You make enough money over the year to justify the seven-figure technology budget, and all of your profit has to come from the other two parties. (Well, and the money you might get as rebates from the exchange.)
  - brownegg 17y ago
    You make the assumption that they would trade. That assumption is only valid because of people like me. I don't need to justify my activity, nor do I want to go that route--my point is that the fact that participants can realistically expect a fill is not something that happens because of magic.
thstart 17y ago
Some HFT is Good, Some HFT is Bad, But the Market Structure is Ugly http://blog.themistrading.com/?p=701 http://blog.themistrading.com/?p=701

21 points by ad 17y ago

I usually hate TL;DR comments, but if someone provided a short summary of the argument here (and for bonus points, a critique of the argument's strength), I would be very grateful.

sparky 17y ago
The argument is essentially: 1) High-frequency traders (HFTs) increase liquidity. For the benefit of those who don't know what that means: there are actually a finite amount of shares of each company, and you cannot buy shares unless someone is willing to sell theirs to you, and you cannot sell shares unless someone is willing to buy them from you. You can imagine that you might not be able to sell your shares the instant you want them to if humans are in the loop on the buyer side (i.e., if a human has to review your selling price and decide whether or not to buy), and vice-versa. In contrast, if somebody has programmed a computer to automatically execute trades if certain conditions are met, you can buy and sell shares very quickly. This is what HFTs do. 2) HFTs provide transparent price discovery. This means that the computer programs the HFTs have set up will quickly and unambiguously tell you at what price they are willing to buy and sell shares. Contrast this with a hypothetical process in which you had to haggle with human representatives of each shareholder or potential buyer in order to figure out the price. It's similar to consumer vs. enterprise software sales (sticker price vs. "well, how much can you afford?"). In theory, transparent price discovery promotes fairness (everyone sees the same price) and encourages trading due to decreased latency and hassle. 3) Lots of repetition of 1 and 2. Also an assertion that HFT decreases volatility (average dPrice/dt), while most commentary on the matter assumes that it would increase volatility, due to algorithms that are either busted ( e.g., http://arstechnica.com/business/news/2010/01/how-a-stray-mouse-click-choked-the-nyse-cost-a-bank-150k.ars http://arstechnica.com/business/news/2010/01/how-a-stray-mou...) or interacting with one another in a bad way. It is disconcerting to me that the author cites empirical evidence without a hint of intuition or insight to help the reader generalize it; however, it is difficult to dismiss the evidence off-hand without looking at it more closely and/or being more expert than I in the matter. Points 1 and 2 are by far the most common and obvious arguments for HFT, and the analysis in TFA is not bad, but not exemplary either. The rest of the article is basically redundant and comes off a little defensive. I found this article interesting ( http://www.zerohedge.com/article/whoa-glitch-hft http://www.zerohedge.com/article/whoa-glitch-hft ), though its tone is also less-than-objective.
- rgarcia 17y ago
  The last section makes an interesting point about the type of speculation that HFT does, i.e. it's not long-term (no positions carried overnight) and thus it can't create the types of asset bubbles that we've seen in the past
- _delirium 17y ago
  The rest of the article seems to make some rather dubious strong claims, also. For example: "High frequency traders can only trade profitably when their trades push a stock price towards fair value." I don't see why there's any particular reason that's true. High-frequency traders can trade profitably whenever their trades are in line with (very) short-term price movements. Ideally everything works together to push prices towards fair value, but you can't assume that as an axiom, since that's the main point being disputed in that section (the one on volatility).
  - Rimpinths 17y ago
    One other aspect of HFT that was not mentioned in the article is that HFTers often seek arbitrage opportunities. For example, the value of many ETFs such as SPY (i.e. an ETF tracking the S&P 500) are derived from the value of underlying securities. If the value of SPY versus the value of the underlying securities becomes out of sync, HFTers may go long one and short the other and then profit when they converge again. In this sense, HFTers only profit if the market returns to fair value. This applies to many ETFs, convertible securities, and options.

pdoughtie 17y ago

Keep in mind that this is appearing in a magazine that is successful because of the success of high frequency trading and that the article is written by the member of a company that bases its profits on the ability to conduct high frequency trading.

rgarcia 17y ago
http://www.paulgraham.com/disagree.html http://www.paulgraham.com/disagree.html DH1
- _delirium 17y ago
  PG articles are not scripture that you can just link to a quote from to end debate, you know. =] I do think it's legitimate to look at sources for articles, especially when there are strong conflicts of interest.
  - falsestprophet 17y ago
    "Everyone must submit himself to the governing authorities, for there is no authority except that which God has established." Romans 13:1
    - gjm11 17y ago
      The Bible is not scripture that you can just link to a quote from to end debate, you know.
      - falsestprophet 17y ago
        Stack Overflow
  - rgarcia 17y ago
    My intention wasn't to end the debate, but rather to steer it away from the substance-lessness that characterizes most debates about HFT. That being said (disclaimer: I am a HFTer), this article is a pretty weak defense of HFT. Like others have pointed out it makes a lot of assertions not based on data/fact. However, I've yet to read a criticism of HFT that doesn't commit the same mistake (and I've read a lot of them). For a defense of HFT that uses hard data I'd direct people here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1501135 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1501135

thstart 17y ago

here is what I found FYI: http://blog.t3live.com/2010/02/prop...lation-tax.html http://blog.t3live.com/2010/02/prop...lation-tax.html "While most retail investors probably have little concept of what high frequency trading is or its impacts, active equity traders have seen its pronounced imprint on the markets. High frequency trading is an entirely legitimate strategy of using computer algorithms to execute trading strategies with ultra-low latency. Yet, the explosion in HFT has led to a major structural flaw in equity markets. This flaw is the abuse of uncharged bidding and offering for shares. Level II traders know exactly what this is as they see it day after day in every stock they trade. The book of bids and offers is supposed to be a top-to-bottom list of the prices every player in the market is willing to buy and sell a stock. In this idealized world, there is price transparency as everyone can see who wants to buy and who wants to sell should the participant chose to place a limit order. The price at any given second then is an accurate reflection of the current supply and demand for shares (ignoring the use of dark pools, hidden orders, etc.). Limit orders are meant to be the showing of an explicit intention to buy or sell shares at a predetermined price. Should a trader not want to show his hand, he can execute market orders or use reserve orders. Yet, the book no longer acts in accordance with the idealized world. Every single listed stock’s order book is filled with false bids and false offers. These limit orders are constantly used to manipulate prices back and forth to the HFT’s advantage. Nearly every higher volume, lower priced stock has a book that is stacked with offers and bids at nearly every penny increment but the vast majority of these quotes are fake. The HFTs submitting the bulk of these orders do not have the objective of being filled on their orders. The purpose is to manipulate the price in some way. This is clearly a deceptive practice occurring in nearly every stock in the current hybrid and fully electronic markets. The high frequency trader has the explicit goal of tricking other traders into believing there is something real there when there is not. Bidding and offering without the intention of actually filling the order is nothing more than a mechanism to mislead other traders. This game, as played by HFTs, is an obscenely inefficient allocation of resources. " Directly from the source: http://www.nasdaqtrader.com/content...ms_revshare.pdf http://www.nasdaqtrader.com/content...ms_revshare.pdf From the Nasdaq note, take a look at Quote vs. Trade: "Quote vs. trade: The plans then allocate to each SRO a portion of each issue’s income pool for quotes and trades. Quotes and trades in total per security are eligible for approximately 50% each of the symbol’s income allocation subject to the $4.00 cap per eligible trade report. • Quotes are allocated value based on time and size at the inside market • Trades are allocated value based on the number of eligible trade reports and reported dollar volume" Exchanges now earn revenue for not only trade reporting but for quote reporting. And, to attract more quotes, the exchanges are very aggressive in rebating these fees to the subscribers who post the quotes. Also, this research is interesting too: Equity Trading and the Allocation of Market Data Revenue http://wpcarey.asu.edu/fin/upload/C...May-27-2009.pdf http://wpcarey.asu.edu/fin/upload/C...May-27-2009.pdf "Exchanges devised revenue-sharing and rebate programs that rewarded order-flow providers for tape shredding, and encouraged algorithmic traders to execute strategies involving large numbers of small trades. We provide evidence that data revenue allocation has influenced the trading process In this paper, we show that the allocation formula has had a significant impact on the trading process. In particular, we demonstrate that average trade size is sensitive to changes in the marginal revenue per trade. We also find evidence that rebate programs are a key institutional mechanism through which the allocation rule influences the trading process." So, what you guys are thinking about this? Are there is any reason to subscribe to tick by tick data with bid/ask quotes? What a Level II is telling you actually today?

barrkel 17y ago

I am somewhat confused by this double-negative: "No serious market observer disputes the claim that volatility would not be higher without the liquidity provided by high frequency traders." The author seems to be trying to say that high frequency traders reduce volatility. But I parse the claim differently: it seems to me to be saying that volatility could only be lower in the absence of liquidity from high frequency traders. As to the rest of the argument, it seems to be structured along these lines: * More efficient markets with lower spreads between buy and sell are good. I think this is a valid claim, but I don't think it follows from the existence of high frequency trading, but rather from more efficient, automated trading systems. * High frequency trading helps supply market liquidity, and this liquidity is good. I can buy the first part of this, and the second part seems mostly true. * Old-fashioned purchasers seem to be annoyed that when they make a large purchase, the price for the last share is higher than the price for the first share, because the market has already reacted to the change in supply and demand. He also makes the argument that were this not so, the sellers of shares would in effect be subsidizing purchasers. His case seems solid enough to me. * But he then makes another claim that seems to contradict it. He suggests that companies with stocks that have low volume turnover are unduly affected by small purchases, and since high frequency trading increases volume, the impact is reduced. * Finally, it seems he would like to claim that because "our nation's equity markets are far fairer, more efficient, more liquid and have lower transaction costs for investors than ever before", high frequency trading should claim a substantial portion of the credit.

thstart 17y ago
HFT market participants are having the privilege to place and cancel orders up to 30 seconds. For free. No charge. If a big order is coming they can get all available shares and sell it at higher price to the who places the big order. For free.
kscaldef 17y ago
It actually seems to be more like a quadruple-negative. Let's try to simplify. "No serious market observer disputes the claim that volatility would not be higher without the liquidity provided by high frequency traders." "[serious market observers believe] that volatility would not be higher without the liquidity provided by high frequency traders." "[serious market observers believe] that volatility would [be lower] without the liquidity provided by high frequency traders." "[serious market observers believe] that volatility would [be lower] without ... high frequency traders." "[serious market observers believe] that volatility [is higher with] ... high frequency traders." "[high frequency traders increase volatility]" This, of course, is exactly the opposite of what the author proceeds to argue in the following paragraphs. My conclusion is that the author managed to create a sentence so overly complicated that even he could not understand what he was saying.

brownegg 17y ago

I am a professional trader, and by almost any definition I operate in the "high frequency" space. First, let's establish that Traders is an authority on the real world of financial markets in the same sense that PC World is an authority in the world of technology. So I've not read the linked article, nor am I going to. But I will say this: HFT does perform a viable, necessary economic function. A well-functioning capital market absolutely requires this kind of activity. HOWEVER, like most mainstream-media memes, what gets talked about / opined on is almost never relevant to what is actually important and/or controversial: in this case, the question of whether HFT creates a two-tiered playing field where individual (read: non-technically-sophisticated) investors suffer at the hands of the "pros". Most arguments against HFT basically say that algorithms are purely predatory and only serve to hurt the performance of large investors. This is naive at best and deceptive at worst; for every share I purchase "ahead of" a big order, a seller has been filled at the price he desired. Every transaction has two sides; you can't just pick one and say they got screwed. The other side has to have done as well as the other did poorly (assuming a fictional frictionless world). The reality is that HFT requires tons of knowledge and a technology budget of seven figures per annum at the barest minimum, and this provides a very real barrier to entry. What should be talked about, but never is: is that ok? Why or why not? What ramifications does it have?

richardw 17y ago
Each time you buy ahead of someone they lose the money you make. It's a zero-sum transaction. Instead of being between a buyer and seller, it's now the buyer, you and the seller. You make enough money over the year to justify the seven-figure technology budget, and all of your profit has to come from the other two parties. (Well, and the money you might get as rebates from the exchange.)
- brownegg 17y ago
  You make the assumption that they would trade. That assumption is only valid because of people like me. I don't need to justify my activity, nor do I want to go that route--my point is that the fact that participants can realistically expect a fill is not something that happens because of magic.

thstart 17y ago

Some HFT is Good, Some HFT is Bad, But the Market Structure is Ugly http://blog.themistrading.com/?p=701 http://blog.themistrading.com/?p=701