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Of course the retail guy gets hurt. Who do you think buys the mutual funds that pay a higher price. Seriously, I hear this all the time, but it’s only one step

by MR4D 8y ago

Of course the retail guy gets hurt. Who do you think buys the mutual funds that pay a higher price. Seriously, I hear this all the time, but it’s only one step removed. Why does everybody keep repeating this lie?

physguy1123 8y ago
Vanguard states that hft activities have lowered their trading costs, so I don't think this claim is necesarily true.
- qeternity 8y ago
  HFT has reduced costs under 99.99% of market environments. My direct cost and slippage is still so much lower than it would have been 30 years ago. Hell, even 10 years ago.
  - arcticfox 8y ago
    Where would the profits that go to HFT outfits go if HFT wasn't a thing? Genuine question, I have no idea how that works.
    - physguy1123 8y ago
      They would go to whomever else was marker makers, whomever else was doing short-term trading, and some of fhe rest to quant firms doing frequent but not hft trading. Mostly human traders/market makers in short.
    - mrchicity 8y ago
      They would simply vaporize. At the margin, people trade because the frictional costs (spreads, fees, pricing/tracking error, risk) of trading are low. Fewer people would trade. HFTs basically play an intermediary role: risking capital to buffer supply/demand imbalances, aiming to buy things at a discount or sell at a premium to their perceived value. The more transactions an intermediary does, the smaller his margins per transaction can be. Low margins fuel even more transactions in a virtuous cycle, and competition drives margins down. Take this thought experiment to an extreme level. What would happen if short term speculation were banned, all stocks traded January 1, and had to be held for a year? Only very wealthy people with high risk tolerance could participate in the market, since they couldn't sell companies at will to fund personal expenses or if the business underperformed. Volumes would plummet. Exchange/brokerage fees would be a significant percentage of the deal size, similar to what real estate agents charge, since they can only do a few transactions. Intermediaries would be something akin to a private equity fund, bidding 10-20%+ under value to cover the risk of holding for a year. Even with trading reduced to once a minute/hour/day, many trades HFTs take the other side of now--say a medium frequency quant fund believes a company is underpriced by 0.1%--simply would not exist anymore, because spreads and fees would increase. Most ETFs would disappear. The marginal cost for an HFT to make markets in some small ETF is basically 0, but a human would make more at McDonalds than market making an ETF that trades a few hundred thousand shares a day.
      - ISL 8y ago
        As noted elsewhere in this thread, I suspect new markets would spring up. If the underlying could only trade once a year, the options market would be huge.
qeternity 8y ago
Yes, this is indeed true. Not sure why you're being downvoted. The distinction is still one worth making, because average retail investors can typically have better transparency on this in a mutual fund vis-a-vis tracking error and management fees, whereas a retail trader in the open market is going to have almost no idea where the market really was for that market order they dumped into their Etrade account.
Lazare 8y ago
> Of course the retail guy gets hurt. Nope. Retail traders get better prices; it's the big hedge funds that lose. > Who do you think buys the mutual funds that pay a higher price. The big index funds are paying a lower price. > Why does everybody keep repeating this lie? Because it's true.
- MR4D 8y ago
  Can you explain to me why an index fund would pay less but a hedge fund would pay more? They are all buyers in the market, and index funds are more predictable, as they have to (roughly) adhere to their index. Once an index changes, they have a limited time to buy or sell. GE being kicked out of the Dow last week is a great example.
  - Lazare 8y ago
    > Can you explain to me why an index fund would pay less but a hedge fund would pay more? They are all buyers in the market, and index funds are more predictable And that's the reason. Market makers (and especially HFTs) profit from razor thin spreads on predictable orders, but they can lose money when they get hit by a big unpredictable order, so they avoid them and/or charge them more. A hedge fund's order is inherently dangerous to a market maker, because they have no idea before the fact if the hedge fund is just offloading 1k shares to rebalance their risk profile, or if they're liquidating their entire position, or taking a big short position. Hedge funds can change the entire market. Some guy calling up his broker and asking to sell his Apple shares won't. So retail orders and index funds are safe, so they can be charged lower spreads. And because they're profitable, market makers compete for the volume, driving down prices. And the data supports this - prices paid by retail investors has crashed, and complaints from hedge funds and big active investors has spiked. :)

by MR4D 8y ago

physguy1123 8y ago

Vanguard states that hft activities have lowered their trading costs, so I don't think this claim is necesarily true.

qeternity 8y ago
HFT has reduced costs under 99.99% of market environments. My direct cost and slippage is still so much lower than it would have been 30 years ago. Hell, even 10 years ago.
- arcticfox 8y ago
  Where would the profits that go to HFT outfits go if HFT wasn't a thing? Genuine question, I have no idea how that works.
  - physguy1123 8y ago
    They would go to whomever else was marker makers, whomever else was doing short-term trading, and some of fhe rest to quant firms doing frequent but not hft trading. Mostly human traders/market makers in short.
  - mrchicity 8y ago
    They would simply vaporize. At the margin, people trade because the frictional costs (spreads, fees, pricing/tracking error, risk) of trading are low. Fewer people would trade. HFTs basically play an intermediary role: risking capital to buffer supply/demand imbalances, aiming to buy things at a discount or sell at a premium to their perceived value. The more transactions an intermediary does, the smaller his margins per transaction can be. Low margins fuel even more transactions in a virtuous cycle, and competition drives margins down. Take this thought experiment to an extreme level. What would happen if short term speculation were banned, all stocks traded January 1, and had to be held for a year? Only very wealthy people with high risk tolerance could participate in the market, since they couldn't sell companies at will to fund personal expenses or if the business underperformed. Volumes would plummet. Exchange/brokerage fees would be a significant percentage of the deal size, similar to what real estate agents charge, since they can only do a few transactions. Intermediaries would be something akin to a private equity fund, bidding 10-20%+ under value to cover the risk of holding for a year. Even with trading reduced to once a minute/hour/day, many trades HFTs take the other side of now--say a medium frequency quant fund believes a company is underpriced by 0.1%--simply would not exist anymore, because spreads and fees would increase. Most ETFs would disappear. The marginal cost for an HFT to make markets in some small ETF is basically 0, but a human would make more at McDonalds than market making an ETF that trades a few hundred thousand shares a day.
    - ISL 8y ago
      As noted elsewhere in this thread, I suspect new markets would spring up. If the underlying could only trade once a year, the options market would be huge.

qeternity 8y ago

Yes, this is indeed true. Not sure why you're being downvoted. The distinction is still one worth making, because average retail investors can typically have better transparency on this in a mutual fund vis-a-vis tracking error and management fees, whereas a retail trader in the open market is going to have almost no idea where the market really was for that market order they dumped into their Etrade account.

Lazare 8y ago

> Of course the retail guy gets hurt. Nope. Retail traders get better prices; it's the big hedge funds that lose. > Who do you think buys the mutual funds that pay a higher price. The big index funds are paying a lower price. > Why does everybody keep repeating this lie? Because it's true.

MR4D 8y ago
Can you explain to me why an index fund would pay less but a hedge fund would pay more? They are all buyers in the market, and index funds are more predictable, as they have to (roughly) adhere to their index. Once an index changes, they have a limited time to buy or sell. GE being kicked out of the Dow last week is a great example.
- Lazare 8y ago
  > Can you explain to me why an index fund would pay less but a hedge fund would pay more? They are all buyers in the market, and index funds are more predictable And that's the reason. Market makers (and especially HFTs) profit from razor thin spreads on predictable orders, but they can lose money when they get hit by a big unpredictable order, so they avoid them and/or charge them more. A hedge fund's order is inherently dangerous to a market maker, because they have no idea before the fact if the hedge fund is just offloading 1k shares to rebalance their risk profile, or if they're liquidating their entire position, or taking a big short position. Hedge funds can change the entire market. Some guy calling up his broker and asking to sell his Apple shares won't. So retail orders and index funds are safe, so they can be charged lower spreads. And because they're profitable, market makers compete for the volume, driving down prices. And the data supports this - prices paid by retail investors has crashed, and complaints from hedge funds and big active investors has spiked. :)