6 ms·

Trading firms create value by providing liquidity. If they can buy low and sell high, they will be buying when there are relatively fewer other buyers, and sel

Trading firms create value by providing liquidity. If they can buy low and sell high, they will be buying when there are relatively fewer other buyers, and sell when there are relatively few other sellers. This activity creates value for other people who want to trade in those circumstances. If no value was created, there would be no value to capture. And the prima facie evidence that they are creating value is that they are capturing value from willing market participants. This is fundamental economics.

the_cat_kittles 9y ago
nah. its on such a small time scale, i really dont think it does.
- wayn3 9y ago
  If a company provided X amount of liquidity to both sides of the market, even if the company itself only entered a position for a millisecond, it still provided necessary liquidity. It did so in a very efficient manner and turned a profit on that. Saying that you dont provide liquidity just because you enter both sides of the trade is like saying that a cab going into and a cab going out of manhattan cancel each other out and provide 0 net value to their passengers.
  - the_cat_kittles 9y ago
    sorry, i guess there was an ambiguity. i didnt mean to say it didnt "provide liquidity". i meant that what it provided was pretty worthless, in the non-monetary sense.
    - wayn3 9y ago
      if you look at the market as a whole, there is a thing called the "efficient market hypothesis". It assumes that markets are perfect and you can not make money trading securities, because all information is already priced in. This is obviously not true, because HFT makes money, but you could say that HFT contributes to getting markets closer to being efficient. Having efficient markets is worthwhile for society because an efficient, liquid market provides a more accurate picture of the "actual" value of things. If you buy this argument, then HFT would be contributing to finding truth, which is inherently valuable in the eyes of many people. At the end of the day, HFT is one of those things that people just get jelly about because someone makes money on something they dont understand and gets insanely rich "doing nothing". What people get mad about is completely arbitrary. Everyone hates google because ads, but without google, their world would barely operate. Everyone hates facebook because fake news but nobody has the balls to actually not use facebook. A social network. Everyone hates uber because "scandals" and poor drivers not being paid but still uses it because comfortable. I'm not really in the stock market but when I want to sell stock, I'd rather there be some market maker who is obligated to buy it. Maybe he makes more money off of me than I ever will selling stock to him, but that one time when nobody else wants the falling stock and I potentially use a large chunk of my savings, I really need them. Consumers sit on some amazingly high horses sometimes.
      - anigbrowl 9y ago
        You are not in a position to talk about people on high horses after posting that. There is quite a lot of research from the behavioral economics field (tl;dr: most people are somewhat irrational) that undercuts the EMH. Also, there's a lot of straw man argumentation in your post. Consumers can and do make sacrifices of utility in line with their values, even if such behavior is a standard deviation or two outside the norm. And while your argument for market making is sound, do you really need to make that trade within milliseconds, or would you be equally happy as long as it closed within a couple of minutes? You seem oblivious to the possibility that your stock might be falling due to a liquidity event caused by a race condition, for example, although in cases such as the 'flash crash' such trades are usually unwound afterwards, presumably at considerable expense.
        wayn3 9y ago
        I'm being called oblivious by people who confuse HFT and market making which each other. That's cute. There are companies that provide liquidity. They do nothing else. They don't take a position in the market. Its their job to quote both a bid and an ask and to trade with anyone who wants to hit those quotes. They are not allowed to not quote a price, unless trading is suspended. Those are called market-makers. They need to be able to change their quotes quickly, because being taken out on one side of the market creates positional risk for them. The only time they make money is when they can trigger a buy and a sell at the same time. If they cant do that, they have to hedge their position. They have to compete on spread with other market makers, which is possible to do in 2 ways - being fastest to quote or having a narrower spread. Trades at the price are executed in the order of submission. There are companies that engage in statistical arbitrage. They look for opportunities that are statistical in nature. Think of technical analysis but in a way that works. Think stock A and stock B being more correlated than price reflects. They want to execute fast because those opportunities do not exist for long. This kind of trading smoothens out the curve and smooth curves are nice to have, mathematically speaking. There are HFT firms who scalp dodginess in price by renting colocated servers. Very tiny but almost guaranteed returns if they can get execution. Nothing wrong with that either. Low margin business model. Then there are companies, or rather teams inside companies, that send buy and sell orders into the exchange that they never want to execute, on millisecond timescales, to disrupt the market. They are trying, in simplified terms, to create signals for other market participants that do not really exist, and then execute trades that they know will be profitable by exploiting other participants for whom they generated buy signals. This is your evil HFT. The T in HFT is a misnomer, because they dont really trade. They abuse stock exchange mechanics to fuck with other market participants and then try to rob them. This is mostly illegal and not allowed by the exchanges themselves. The problem here is to prove that someone didnt play by the rules. Google "optiver the hammer" for an example of a couple years ago. They have counter-intelligence teams whose entire job is to not trade the market for profit but to ruin other companies profits to drive them out of business. But most of this is illegal, its just difficult to prosecute. The problem with banning folks is that most trading companies engage in all of these things at the same time. There are market making teams at optiver and there are evil HFT teams at optiver and if you ban optiver, you wipe out a major market maker which leaves the stock exchange exposed. Another problem with "banning HFT" is that where do you draw the line? Market participants can suddenly not try to get their trades executed anymore? Maybe that's beneficial to the market as a whole, but how do you even execute such a rule?
  - anigbrowl 9y ago
    But why is this liquidity necessary? Maybe if you can't find someone to take your trade that's an important price signal, which is being dampened by the liquidity. Forgive me for abusing the metaphor, but just as water is essential for life, consuming too much of it can kill you (by lowering the level of electrolytes and disrupting intracellular signaling). It's rare for people to die from drinking too much water at once, but that's not gonna be a lot of comfort if it happens to you, is it?
    - wayn3 9y ago
      liquidity is necessaryy because people need to be able to buy things. not having liquidity is like having empty grocery stores. doesnt sound like a big deal but oh so painful if it ever happens. people in this thread lump market makers and high frequency traders together which is not really correct, but market makers are hired by exchanges to make sure markets stay liquid. market makers guarantee that they will always be in the market for at least "x amount of security", typically 100 lots. that means that at any given point in time, you can at least 100 lots, which covers any kind of smalltime investor who doesn't have access to professional execution traders. this is important because you need to be able to get out of potentially deadly trades. this is not just for stocks. the potential loss of a stock is the price of the stock. that is finite. some options, even ordinary options, can generate potentially infinite losses and stock exchanges want for everyone to be able to move their stuff. as far as you are concerned about "signals", there is something called the order book. as a normal trader you dont see this, but the stock exchange lists every position in the market and you can pay to see that. there is literally no difference between no market makers in the market and market makers having their spread quoted on top of the available market, in terms of signals. market makers just make sure that you get a good, if not fair, price for the stuff you want to move. illiquid markets are extremely painful, especially for those companies that exist in them, because their value can be extremely misrepresented. to make an example, assume you are tesla, but you are traded on an exchange that only publishes spot once a year, in january. in august, you need to raise money at fair value and youve grown 3x since january, but nobody can give you fair price because you are quoted at januaries value. liquidity is a good thing for every market participant. you need to drink 5 liters of water over a period of 30 minutes to kill you potentially. thats not going to happen by accident and you will be in ridiculous amounts of pain long before you hit the lethal dose.
hsitz 9y ago
> Trading firms create value by providing liquidity. Obviously true when they're added to market with little to no liquidity. But hard to see as true when you're adding them to market that is already extremely liquid. At least, it's a statement that needs some empirical justification in that case, to show that the value from marginal liquidity being added (which is tiny) offsets the waste of the incredible amount of human effort used to create it.
- deleted 9y ago
  [deleted]
- tptacek 9y ago
  Just substitute "cost of trading" with "liquidity". It's true that at this point, now that market making is pretty much all automated, there isn't much more cost to squeeze out of this component of the market. But be careful not to imply that liquidity is binary: the more liquidity you have, the less it costs to buy or sell something.
  - hsitz 9y ago
    I'm not implying that liquidity is binary. I'm implying that it does not scale linearly, but rather exponentially towards an asymptote. That is, you can add as much as you want, the total amount approaches a limit. Said a different way, with your "trading costs" substitution: If x amount of human effort is required to reduce trading costs from, say, 5% of a transaction to 0.001%, perhaps (let's assume) that's justified. But is it then wise for a society to encourage expenditure of 10x more effort just to reduce costs to 0.0001%? (This analogy doesn't really hold, because cost of trading could be 0 and there could still be 0 liquidity, just no other parties interested in buying or selling, but it still seems to point at a real issue when restricted to talking about liquidity.)
    - consz 9y ago
      I think an interesting point you might consider -- let's suppose there is such a thing as "too much" liquidity, and as a corollary, there's a "perfect" amount of liquidity. What do you think happens when more liquidity than the perfect amount is introduced? I think a lot of arguments which support the idea of HFT being too much liquidity seem to take, as a premise, that the extra liquidity costs consumers -- namely, non-HFT participants in the market trading against the HFTs, the "buyers" of liquidity. Does it? If you have too much liquidity, doesn't that just mean that the buyers don't buy any of it? They saw as much liquidity as they needed, completed their trades, and went home. It seems like the actual cost of too much liquidity is HFT firms which send orders that don't get traded against, so they have no benefit (to the HFT), but still have a cost (the firm has to run, after all). Yes, there's some cost to society here, in the same way that there's a cost any time someone takes on a speculatively profitable business that turns out not to be. I'm sure there are some strong arguments you could make that HFTs are unnecessary, but the argument of "too much" liquidity always felt shaky to me (in part, because it's one of those arguments that relies on playing fast and loose with nebulous terms).
anigbrowl 9y ago
I don't buy this argument, whose implicit corollary is that there can never be too much liquidity. I'm not an expert and don't have an opposing theory, nor do I want to do a bullshit refutation by just citing something I found in a few seconds on Google, but: I feel there must be some ideal level of liquidity, which is after all subject to laws of supply and demand like everything else. Cannot an oversupply of liquidity result in fiscal inflation, as opposed to the monetarist kind? I'm reminded of the Asian financial crisis during the 1990s, when there was a ton of money flowinginto newly-developing markets int eh Asian region, but then a spasm of political uncertainty suddenly led to a catastrophic withdrawal. Echoing one of the other posters here, I don't feel that anyone at this firm or the firm itself is acting in bad faith, but assuming this mathematical demonstration is correct and it's virtually impossible for Virtu to lose money other than by abandoning its winning strategy, does this not invite an arms race and a stampede of eager traders hoping to also get rich by picking up pennies from in front of steamrollers? I don't want to say you're wrong, but to question the applicable scope of your premise. Virtu itself may not be big enough to cause market instability, but 100 firms doing the same thing might.
- tptacek 9y ago
  I apologize for repeating a point I just made, but I'll make it here too: You can mentally substitute "cost of trading" for "liquidity". It's true that you can get costs down to a point where they don't matter. But I think you'll have an easier and more intellectually honest time engaging with the issue if you avoid the jargon and focus on the impact of the jargon. Cost is why we care about liquidity. As markets get less liquid, spreads increase, and the market takes inflicts more and more of a penalty on us for trading at all.
  - anigbrowl 9y ago
    I get this. I just have an intuition that some friction in a dynamic system is actually a good thing, and also wonder if the growth of HFT might not lead to an unsustainable deviation from an underlying power law distribution of trading activity.
    - 9y ago
return0 9y ago
> prima facie evidence that they are creating value is that they are capturing value from willing market participants. is this referring to market value or economic value?

the_cat_kittles 9y ago

nah. its on such a small time scale, i really dont think it does.

wayn3 9y ago
If a company provided X amount of liquidity to both sides of the market, even if the company itself only entered a position for a millisecond, it still provided necessary liquidity. It did so in a very efficient manner and turned a profit on that. Saying that you dont provide liquidity just because you enter both sides of the trade is like saying that a cab going into and a cab going out of manhattan cancel each other out and provide 0 net value to their passengers.
- the_cat_kittles 9y ago
  sorry, i guess there was an ambiguity. i didnt mean to say it didnt "provide liquidity". i meant that what it provided was pretty worthless, in the non-monetary sense.
  - wayn3 9y ago
    if you look at the market as a whole, there is a thing called the "efficient market hypothesis". It assumes that markets are perfect and you can not make money trading securities, because all information is already priced in. This is obviously not true, because HFT makes money, but you could say that HFT contributes to getting markets closer to being efficient. Having efficient markets is worthwhile for society because an efficient, liquid market provides a more accurate picture of the "actual" value of things. If you buy this argument, then HFT would be contributing to finding truth, which is inherently valuable in the eyes of many people. At the end of the day, HFT is one of those things that people just get jelly about because someone makes money on something they dont understand and gets insanely rich "doing nothing". What people get mad about is completely arbitrary. Everyone hates google because ads, but without google, their world would barely operate. Everyone hates facebook because fake news but nobody has the balls to actually not use facebook. A social network. Everyone hates uber because "scandals" and poor drivers not being paid but still uses it because comfortable. I'm not really in the stock market but when I want to sell stock, I'd rather there be some market maker who is obligated to buy it. Maybe he makes more money off of me than I ever will selling stock to him, but that one time when nobody else wants the falling stock and I potentially use a large chunk of my savings, I really need them. Consumers sit on some amazingly high horses sometimes.
    - anigbrowl 9y ago
      You are not in a position to talk about people on high horses after posting that. There is quite a lot of research from the behavioral economics field (tl;dr: most people are somewhat irrational) that undercuts the EMH. Also, there's a lot of straw man argumentation in your post. Consumers can and do make sacrifices of utility in line with their values, even if such behavior is a standard deviation or two outside the norm. And while your argument for market making is sound, do you really need to make that trade within milliseconds, or would you be equally happy as long as it closed within a couple of minutes? You seem oblivious to the possibility that your stock might be falling due to a liquidity event caused by a race condition, for example, although in cases such as the 'flash crash' such trades are usually unwound afterwards, presumably at considerable expense.
      - wayn3 9y ago
        I'm being called oblivious by people who confuse HFT and market making which each other. That's cute. There are companies that provide liquidity. They do nothing else. They don't take a position in the market. Its their job to quote both a bid and an ask and to trade with anyone who wants to hit those quotes. They are not allowed to not quote a price, unless trading is suspended. Those are called market-makers. They need to be able to change their quotes quickly, because being taken out on one side of the market creates positional risk for them. The only time they make money is when they can trigger a buy and a sell at the same time. If they cant do that, they have to hedge their position. They have to compete on spread with other market makers, which is possible to do in 2 ways - being fastest to quote or having a narrower spread. Trades at the price are executed in the order of submission. There are companies that engage in statistical arbitrage. They look for opportunities that are statistical in nature. Think of technical analysis but in a way that works. Think stock A and stock B being more correlated than price reflects. They want to execute fast because those opportunities do not exist for long. This kind of trading smoothens out the curve and smooth curves are nice to have, mathematically speaking. There are HFT firms who scalp dodginess in price by renting colocated servers. Very tiny but almost guaranteed returns if they can get execution. Nothing wrong with that either. Low margin business model. Then there are companies, or rather teams inside companies, that send buy and sell orders into the exchange that they never want to execute, on millisecond timescales, to disrupt the market. They are trying, in simplified terms, to create signals for other market participants that do not really exist, and then execute trades that they know will be profitable by exploiting other participants for whom they generated buy signals. This is your evil HFT. The T in HFT is a misnomer, because they dont really trade. They abuse stock exchange mechanics to fuck with other market participants and then try to rob them. This is mostly illegal and not allowed by the exchanges themselves. The problem here is to prove that someone didnt play by the rules. Google "optiver the hammer" for an example of a couple years ago. They have counter-intelligence teams whose entire job is to not trade the market for profit but to ruin other companies profits to drive them out of business. But most of this is illegal, its just difficult to prosecute. The problem with banning folks is that most trading companies engage in all of these things at the same time. There are market making teams at optiver and there are evil HFT teams at optiver and if you ban optiver, you wipe out a major market maker which leaves the stock exchange exposed. Another problem with "banning HFT" is that where do you draw the line? Market participants can suddenly not try to get their trades executed anymore? Maybe that's beneficial to the market as a whole, but how do you even execute such a rule?
- anigbrowl 9y ago
  But why is this liquidity necessary? Maybe if you can't find someone to take your trade that's an important price signal, which is being dampened by the liquidity. Forgive me for abusing the metaphor, but just as water is essential for life, consuming too much of it can kill you (by lowering the level of electrolytes and disrupting intracellular signaling). It's rare for people to die from drinking too much water at once, but that's not gonna be a lot of comfort if it happens to you, is it?
  - wayn3 9y ago
    liquidity is necessaryy because people need to be able to buy things. not having liquidity is like having empty grocery stores. doesnt sound like a big deal but oh so painful if it ever happens. people in this thread lump market makers and high frequency traders together which is not really correct, but market makers are hired by exchanges to make sure markets stay liquid. market makers guarantee that they will always be in the market for at least "x amount of security", typically 100 lots. that means that at any given point in time, you can at least 100 lots, which covers any kind of smalltime investor who doesn't have access to professional execution traders. this is important because you need to be able to get out of potentially deadly trades. this is not just for stocks. the potential loss of a stock is the price of the stock. that is finite. some options, even ordinary options, can generate potentially infinite losses and stock exchanges want for everyone to be able to move their stuff. as far as you are concerned about "signals", there is something called the order book. as a normal trader you dont see this, but the stock exchange lists every position in the market and you can pay to see that. there is literally no difference between no market makers in the market and market makers having their spread quoted on top of the available market, in terms of signals. market makers just make sure that you get a good, if not fair, price for the stuff you want to move. illiquid markets are extremely painful, especially for those companies that exist in them, because their value can be extremely misrepresented. to make an example, assume you are tesla, but you are traded on an exchange that only publishes spot once a year, in january. in august, you need to raise money at fair value and youve grown 3x since january, but nobody can give you fair price because you are quoted at januaries value. liquidity is a good thing for every market participant. you need to drink 5 liters of water over a period of 30 minutes to kill you potentially. thats not going to happen by accident and you will be in ridiculous amounts of pain long before you hit the lethal dose.

hsitz 9y ago

> Trading firms create value by providing liquidity. Obviously true when they're added to market with little to no liquidity. But hard to see as true when you're adding them to market that is already extremely liquid. At least, it's a statement that needs some empirical justification in that case, to show that the value from marginal liquidity being added (which is tiny) offsets the waste of the incredible amount of human effort used to create it.

deleted 9y ago
[deleted]
tptacek 9y ago
Just substitute "cost of trading" with "liquidity". It's true that at this point, now that market making is pretty much all automated, there isn't much more cost to squeeze out of this component of the market. But be careful not to imply that liquidity is binary: the more liquidity you have, the less it costs to buy or sell something.
- hsitz 9y ago
  I'm not implying that liquidity is binary. I'm implying that it does not scale linearly, but rather exponentially towards an asymptote. That is, you can add as much as you want, the total amount approaches a limit. Said a different way, with your "trading costs" substitution: If x amount of human effort is required to reduce trading costs from, say, 5% of a transaction to 0.001%, perhaps (let's assume) that's justified. But is it then wise for a society to encourage expenditure of 10x more effort just to reduce costs to 0.0001%? (This analogy doesn't really hold, because cost of trading could be 0 and there could still be 0 liquidity, just no other parties interested in buying or selling, but it still seems to point at a real issue when restricted to talking about liquidity.)
  - consz 9y ago
    I think an interesting point you might consider -- let's suppose there is such a thing as "too much" liquidity, and as a corollary, there's a "perfect" amount of liquidity. What do you think happens when more liquidity than the perfect amount is introduced? I think a lot of arguments which support the idea of HFT being too much liquidity seem to take, as a premise, that the extra liquidity costs consumers -- namely, non-HFT participants in the market trading against the HFTs, the "buyers" of liquidity. Does it? If you have too much liquidity, doesn't that just mean that the buyers don't buy any of it? They saw as much liquidity as they needed, completed their trades, and went home. It seems like the actual cost of too much liquidity is HFT firms which send orders that don't get traded against, so they have no benefit (to the HFT), but still have a cost (the firm has to run, after all). Yes, there's some cost to society here, in the same way that there's a cost any time someone takes on a speculatively profitable business that turns out not to be. I'm sure there are some strong arguments you could make that HFTs are unnecessary, but the argument of "too much" liquidity always felt shaky to me (in part, because it's one of those arguments that relies on playing fast and loose with nebulous terms).

anigbrowl 9y ago

I don't buy this argument, whose implicit corollary is that there can never be too much liquidity. I'm not an expert and don't have an opposing theory, nor do I want to do a bullshit refutation by just citing something I found in a few seconds on Google, but: I feel there must be some ideal level of liquidity, which is after all subject to laws of supply and demand like everything else. Cannot an oversupply of liquidity result in fiscal inflation, as opposed to the monetarist kind? I'm reminded of the Asian financial crisis during the 1990s, when there was a ton of money flowinginto newly-developing markets int eh Asian region, but then a spasm of political uncertainty suddenly led to a catastrophic withdrawal. Echoing one of the other posters here, I don't feel that anyone at this firm or the firm itself is acting in bad faith, but assuming this mathematical demonstration is correct and it's virtually impossible for Virtu to lose money other than by abandoning its winning strategy, does this not invite an arms race and a stampede of eager traders hoping to also get rich by picking up pennies from in front of steamrollers? I don't want to say you're wrong, but to question the applicable scope of your premise. Virtu itself may not be big enough to cause market instability, but 100 firms doing the same thing might.

tptacek 9y ago
I apologize for repeating a point I just made, but I'll make it here too: You can mentally substitute "cost of trading" for "liquidity". It's true that you can get costs down to a point where they don't matter. But I think you'll have an easier and more intellectually honest time engaging with the issue if you avoid the jargon and focus on the impact of the jargon. Cost is why we care about liquidity. As markets get less liquid, spreads increase, and the market takes inflicts more and more of a penalty on us for trading at all.
- anigbrowl 9y ago
  I get this. I just have an intuition that some friction in a dynamic system is actually a good thing, and also wonder if the growth of HFT might not lead to an unsustainable deviation from an underlying power law distribution of trading activity.
  - 9y ago

return0 9y ago

> prima facie evidence that they are creating value is that they are capturing value from willing market participants. is this referring to market value or economic value?