5 ms·

This makes a lot of sense to me. What actual economic value is being captured by HFT?

by Jedi72 8y ago

auntienomen 8y ago
They are paid to take on risk. Same deal as insurance, really.
- mrchicity 8y ago
  Insurance is an apt analogy. Intuitively, if someone consistently makes money, they're just skimming without providing any value. People were astonished that Virtu made money almost every day, but wouldn't care if GEICO made money almost every day. In statistical expectation, you are better off not selling your stock to an HFT market maker. They are only buying from you, on average, when the spread you pay is more than they expect the stock to move. You could wait and sell to someone else for a tiny bit more, on average. In statistical expectation, you are better off not insuring your car. The insurance company writes the policy such that their expected payout over its lifetime is less than the premiums they collect. But real people don't live in the world of maximizing expected value. The guy selling his stocks is doing it a couple times a year, and doesn't want to risk losing a few % if the market gaps down, just to make a tenth of a penny more in expectation. Nobody wants to take out another car loan if their shiny new SUV gets hit driving out of the dealership. Bearing risks people don't want is valuable. So bizarrely, while these services may satisfy a need, consumers are only really happy when the provider loses. Nobody looks back on decades of crash-free driving reminiscing about paying those insurance premiums. Nobody likes to sell stock and see it tick up. (And I'm hand waving assuming you're a randomly selected trader or driver. If you have inside information, trading with anyone is positive EV. If you drive drunk at 100mph but have no tickets or DUIs on your record, insuring your car is positive EV. I'm also hand waving away comparative advantage. That better price an HFT market maker gets when turning over your trade may not be achievable for you. Maybe they can trade on more exchanges or predict prices better to get out at the right time. They do this all day so trading optimally is not a waste of their time, but it's probably a waste of yours. In that case, you may lose more and take more risk doing it yourself. I think that's closer to reality.)
  - JumpCrisscross 8y ago
    > you are better off not selling your stock to an HFT market maker You are also better off selling into a market containing at least on HFT market maker. Without them, spreads become fat. It is notable that the principle aggressors, at the political level and until recently, when HFT became an armchair economics term of art, against HFT were the old line market makers.
colechristensen 8y ago
I can't say for sure, but a big chunk of the people talking about it having value make money from it one way or another.
- mrchicity 8y ago
  That's fair, but the reason isn't entirely due to bias. Few people outside the industry really understand market microstructure. It's a dry and complex subject. Legitimate criticisms are pretty subtle and get lost in the noise of "zomg guys with lasers front running Joe Average's 3 share GOOG trade!" I no longer work in HFT. You can do everything better, smarter, faster than ever, and make less. It is one of the most brutally capitalist businesses: orders on exchanges are a pure undifferentiated commodity. The guy making the smallest spread fastest gets the trade. [1] Nobody cares if it's Virtu or Citadel or three guys in their garage. Think of a business like Wal-Mart's, but if someone finds a way to sell soap a half-cent cheaper, you sell 0 and go out of business. And for the end users of the markets, that's great. Let these guys compete to make tighter markets or arbitrage prices sooner. HFTs play an intermediation role, helping other traders transfer risk immediately to lock in a guaranteed price, rather than waiting for someone else to trade with them. They're basically like CarMax or a grocery store: research what things are worth, buy at wholesale prices, sell at retail prices, and control inventory risk. 1: https://meanderful.blogspot.com/2013/01/hfts-dirty-little-secret-where-money.html https://meanderful.blogspot.com/2013/01/hfts-dirty-little-se...
- auntienomen 8y ago
  If it makes you feel any better, I don't work for an HFT firm. Instead, my job involves trading against them. To do that effectively, it's necessary to understand what they're actually doing and how they make their money. I speak up here because it irritates me to see them maligned by people who know what they're talking about.
mmirate 8y ago
Liquidity.
- seren 8y ago
  So Humidity is preventing Liquidity.
  - testplzignore 8y ago
    You have a wet sense of humor.
hartator 8y ago
HFT means several banks are competiting for your orders very aggressively allowing a tighter spread. So, you sell a bit higher, and buy a bit lower. This is highly beneficial.
- panarky 8y ago
  HFT allows the faster trader to see that you're trying to buy (or sell), put their order to buy (or sell) in ahead of yours, then turn around fill your buy order at a higher price (or your sell order at a lower price). HFT allows better-connected traders to front-run you. You don't get the best price because the HFT guy extracted risk-free profits for himself at your expense. https://www.barrons.com/articles/BL-SWB-27750 https://www.barrons.com/articles/BL-SWB-27750
  - Raidion 8y ago
    Front running and HFT are two different things. Front running implies that you have access to the orders or other information and the ability to get your order in ahead of others. This is at worst, illegal as you're trading on non-public information (if you get an earnings report early), and at best, bad for business as front running would be a "tax" on every stock being sold on an exchange. This basically means that the exchange becomes less valuable (because you have to pay more for that exchange) and other brokers have the ability to offer "lower" prices for the same stock at the same moment in time as they can say that they're not providing advanced information. Not to say that it doesn't happen, but there is some "magic hand of the market" involved. Front running is accomplished by HFT, but not all HFT is front running. HFT is simply the ability to execute trades quickly on new information, like earnings reports, fed meeting notes, etc. HFT back in the 17th century would simply have been having the fastest couriers and horses to carry news, now it's having the fastest software and data connections. HFT has a couple beneficial sides too, as it tightens the bid/ask spread. Basically don't confuse a technology that can be used for bad purposes, to be the problem, blame the brokers and the regulators that allow it to happen.
    - munk-a 8y ago
bunderbunder 8y ago
HFT is just a technology for trading faster. It's not really all that much different from the open outcry system it replaces; the big change is traders feel each other out using computers rather than by waggling their fingers at each other. Access to the market is probably more equitable now than it used to be, since you can give more people direct access to the markets with electronic links. With pit trading, you were limited by the physical size of the pit. If you're going to give people electronic access to the markets, there's not really any sense in saying they aren't allowed to use whatever computer technology they see fit to trade with that access, as long as they aren't actually manipulating the market. As far as economic value, it has different uses to different players on the market. Speculators can take advantage of increasingly fleeting arbitrage opportunities, yes. But the flip side of that is that institutional investors can use it defensively, to make it harder to find and exploit those arbitrage opportunities. That basic game of cat-and-mouse has existed for centuries, and, here, almost 2 decades into the 21st century, it seems absurd to me to say that, of all the places people use technology to do things faster, nobody should be allowed to do it in this one particular case. Which when you get down to it, is essentially what people are suggesting when they say that high frequency trading is bad. If it stills seem unfair to you (and that's an entirely legitimate feeling), I'd submit that it isn't that that using technology is unfair in and of itself, so much as that technology has the potential to magnify the effects of unfairness that was already baked into the financial system to begin with.

This makes a lot of sense to me. What actual economic value is being captured by HFT?

by Jedi72 8y ago

This makes a lot of sense to me. What actual economic value is being captured by HFT?

auntienomen 8y ago

They are paid to take on risk. Same deal as insurance, really.

mrchicity 8y ago
Insurance is an apt analogy. Intuitively, if someone consistently makes money, they're just skimming without providing any value. People were astonished that Virtu made money almost every day, but wouldn't care if GEICO made money almost every day. In statistical expectation, you are better off not selling your stock to an HFT market maker. They are only buying from you, on average, when the spread you pay is more than they expect the stock to move. You could wait and sell to someone else for a tiny bit more, on average. In statistical expectation, you are better off not insuring your car. The insurance company writes the policy such that their expected payout over its lifetime is less than the premiums they collect. But real people don't live in the world of maximizing expected value. The guy selling his stocks is doing it a couple times a year, and doesn't want to risk losing a few % if the market gaps down, just to make a tenth of a penny more in expectation. Nobody wants to take out another car loan if their shiny new SUV gets hit driving out of the dealership. Bearing risks people don't want is valuable. So bizarrely, while these services may satisfy a need, consumers are only really happy when the provider loses. Nobody looks back on decades of crash-free driving reminiscing about paying those insurance premiums. Nobody likes to sell stock and see it tick up. (And I'm hand waving assuming you're a randomly selected trader or driver. If you have inside information, trading with anyone is positive EV. If you drive drunk at 100mph but have no tickets or DUIs on your record, insuring your car is positive EV. I'm also hand waving away comparative advantage. That better price an HFT market maker gets when turning over your trade may not be achievable for you. Maybe they can trade on more exchanges or predict prices better to get out at the right time. They do this all day so trading optimally is not a waste of their time, but it's probably a waste of yours. In that case, you may lose more and take more risk doing it yourself. I think that's closer to reality.)
- JumpCrisscross 8y ago
  > you are better off not selling your stock to an HFT market maker You are also better off selling into a market containing at least on HFT market maker. Without them, spreads become fat. It is notable that the principle aggressors, at the political level and until recently, when HFT became an armchair economics term of art, against HFT were the old line market makers.

colechristensen 8y ago

I can't say for sure, but a big chunk of the people talking about it having value make money from it one way or another.

mrchicity 8y ago
That's fair, but the reason isn't entirely due to bias. Few people outside the industry really understand market microstructure. It's a dry and complex subject. Legitimate criticisms are pretty subtle and get lost in the noise of "zomg guys with lasers front running Joe Average's 3 share GOOG trade!" I no longer work in HFT. You can do everything better, smarter, faster than ever, and make less. It is one of the most brutally capitalist businesses: orders on exchanges are a pure undifferentiated commodity. The guy making the smallest spread fastest gets the trade. [1] Nobody cares if it's Virtu or Citadel or three guys in their garage. Think of a business like Wal-Mart's, but if someone finds a way to sell soap a half-cent cheaper, you sell 0 and go out of business. And for the end users of the markets, that's great. Let these guys compete to make tighter markets or arbitrage prices sooner. HFTs play an intermediation role, helping other traders transfer risk immediately to lock in a guaranteed price, rather than waiting for someone else to trade with them. They're basically like CarMax or a grocery store: research what things are worth, buy at wholesale prices, sell at retail prices, and control inventory risk. 1: https://meanderful.blogspot.com/2013/01/hfts-dirty-little-secret-where-money.html https://meanderful.blogspot.com/2013/01/hfts-dirty-little-se...
auntienomen 8y ago
If it makes you feel any better, I don't work for an HFT firm. Instead, my job involves trading against them. To do that effectively, it's necessary to understand what they're actually doing and how they make their money. I speak up here because it irritates me to see them maligned by people who know what they're talking about.

mmirate 8y ago

Liquidity.

seren 8y ago
So Humidity is preventing Liquidity.
- testplzignore 8y ago
  You have a wet sense of humor.

hartator 8y ago

HFT means several banks are competiting for your orders very aggressively allowing a tighter spread. So, you sell a bit higher, and buy a bit lower. This is highly beneficial.

panarky 8y ago
HFT allows the faster trader to see that you're trying to buy (or sell), put their order to buy (or sell) in ahead of yours, then turn around fill your buy order at a higher price (or your sell order at a lower price). HFT allows better-connected traders to front-run you. You don't get the best price because the HFT guy extracted risk-free profits for himself at your expense. https://www.barrons.com/articles/BL-SWB-27750 https://www.barrons.com/articles/BL-SWB-27750
- Raidion 8y ago
  Front running and HFT are two different things. Front running implies that you have access to the orders or other information and the ability to get your order in ahead of others. This is at worst, illegal as you're trading on non-public information (if you get an earnings report early), and at best, bad for business as front running would be a "tax" on every stock being sold on an exchange. This basically means that the exchange becomes less valuable (because you have to pay more for that exchange) and other brokers have the ability to offer "lower" prices for the same stock at the same moment in time as they can say that they're not providing advanced information. Not to say that it doesn't happen, but there is some "magic hand of the market" involved. Front running is accomplished by HFT, but not all HFT is front running. HFT is simply the ability to execute trades quickly on new information, like earnings reports, fed meeting notes, etc. HFT back in the 17th century would simply have been having the fastest couriers and horses to carry news, now it's having the fastest software and data connections. HFT has a couple beneficial sides too, as it tightens the bid/ask spread. Basically don't confuse a technology that can be used for bad purposes, to be the problem, blame the brokers and the regulators that allow it to happen.
  - munk-a 8y ago

bunderbunder 8y ago

HFT is just a technology for trading faster. It's not really all that much different from the open outcry system it replaces; the big change is traders feel each other out using computers rather than by waggling their fingers at each other. Access to the market is probably more equitable now than it used to be, since you can give more people direct access to the markets with electronic links. With pit trading, you were limited by the physical size of the pit. If you're going to give people electronic access to the markets, there's not really any sense in saying they aren't allowed to use whatever computer technology they see fit to trade with that access, as long as they aren't actually manipulating the market. As far as economic value, it has different uses to different players on the market. Speculators can take advantage of increasingly fleeting arbitrage opportunities, yes. But the flip side of that is that institutional investors can use it defensively, to make it harder to find and exploit those arbitrage opportunities. That basic game of cat-and-mouse has existed for centuries, and, here, almost 2 decades into the 21st century, it seems absurd to me to say that, of all the places people use technology to do things faster, nobody should be allowed to do it in this one particular case. Which when you get down to it, is essentially what people are suggesting when they say that high frequency trading is bad. If it stills seem unfair to you (and that's an entirely legitimate feeling), I'd submit that it isn't that that using technology is unfair in and of itself, so much as that technology has the potential to magnify the effects of unfairness that was already baked into the financial system to begin with.