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Is there any empirical evidence that these perceived benefits to society actually ever materialize? It's clear that there is a benefit to a trader from knowing

Is there any empirical evidence that these perceived benefits to society actually ever materialize? It's clear that there is a benefit to a trader from knowing something milliseconds before the rest of the market (otherwise Goldman wouldn't be doing this), but it's not clear at all to me that it helps the rest of us.

grenoire 7y ago
We know, empirically, that a lack of liquidity increases trading costs, which in turn is directly channeled to the prices of goods and services that rely on this liquidity (more or less everything in the world, even more indirectly ones like education). It's difficult to say 'things would be X% more expensive' because of the interconnected complexity the GP was talking about, but there is definitely a very apparent benefit.
- codetrotter 7y ago
  > a lack of liquidity increases trading costs Sure but, does a couple of milliseconds to or from affect that?
  - grenoire 7y ago
    You have to consider some form of multiplier effect that comes into play. Because the prices of assets are derivatives of others (incl. many, many other variables, of course) these millisecond savings end up turning into seconds, even minutes en masse.
  - dcolkitt 7y ago
    Yes, and I'll tell you exactly why. Markets consist of informed and uninformed traders. For example your typical Joe Sixpack rebalancing his 401k is uninformed. His trading does not tell you anything about the underlying value of the stocks. The typical informed trader is a hedge fund manager, who's investing tons of resources in gaining an informational edge. If he's buying a stock at a particular time that is in and of itself a signal that said stock is worth more than you thought it was otherwise. Liquidity providers love trading with uninformed traders. The problem with informed traders is that you don't want to be on the other side of their trades. Since liquidity providers are the immediate counterparties to most order flow, they're the ones that primarily eat this cost. To counter this, liquidity providers invest enormous resources in profiling order flow to try to identify when to what degree its informed. This allows them to provide lower costs and more liquidity to uninformed traders, like Joe Sixpack. It's analogous to how requiring a checkup allows life insurance companies to provide lower premiums, particularly to those who are healthy. One of the most important ways to profile order flow is to quickly adjust quotes as market conditions evolve. For example said hedge fund manager may be trading a thesis that the chipmakers are all undervalued. He may come in and buy Intel, AMD and Nvidia in one swoop. If an HFT sees a huge buy hit Intel, it can bump its quotes on AMD for a few milliseconds. If its a cigar-chomping hedge fund manager executing a basket algorithm, it's quite likely that he'll try to hit AMD and thus pay the higher price. But if its Joe Sixpack the probability that his trade just coincidentally lands in a 5 millisecond time window is vanishingly small.
- bodyfour 7y ago
  I think the question is at what point does liquidity have diminishing returns? If a security could only be traded once per 10 years then it's obvious that its lack of liquidity would make it less valuable. Holding it would tie up your capital quite significantly. However, if you had a turn-based market where every trade got cleared at the top of the minute it's not clear to me at all whether that would effectively be less liquid than what we have now. It seems to me that a model where traders all compete for how many nanoseconds away their HFT servers are from the action doesn't really benefit the market as a whole. If anything it just makes things like flash crashes more likely.
  - grenoire 7y ago
    In reality the way that markets are cleared wasn't necessarily so much more different than a turn-based one, even in one where the clearing happens by the minute. The issue is, indeed, mostly with HFT. However, you shouldn't consider HFTs to be market participants in the traditional sense. Most of them focus solely on moving stuff around very fast instead of actually trying to purchase or sell things for a separate economic goal (e.g. production, hedging, short- and long-term investments). Once you disregard the rapid transactions that do not have a significant effect on the price, your average human investor is probably putting down some fill-or-kills or limit orders and actually benefits from HF liquidity trading. It's hard for me to understand, let alone explain, why milliseconds would matter for the human investor, but I what I can tell you is that GS is not investing 100M USD just for buying derivatives every other minute.
    - turk73 7y ago
      I highly doubt that. I think the "average trader" is being milked dry by systems that front run the orders on both sides of the trade.
  - lazulicurio 7y ago
    I think part of the problem is that "liquidity" is an imprecise term. It implies both velocity and flexibility. HFT definitely increases velocity, but it can make the market either more or less rigid depending on the circumstances.
- varshithr 7y ago
  Forgive me for asking but what does GP here stand for?
  - umanwizard 7y ago
    Grandparent comment, i.e., two links up in the comment tree. (It's a common term on internet forums -- I learned it from Slashdot years ago)
    - varshithr 7y ago
      Thank you very much. I thought of searching the web but GP is too generic a term.
  - toofy 7y ago
    GrandParent comment. The comment directly above is the parent, and the comment above the parent is the grandparent—in this case the GP they’re referring to was 1e-9’s comment.
  - dcsan 7y ago
    GP grand parent https://news.ycombinator.com/item?id=8363625 https://news.ycombinator.com/item?id=8363625
- pedrocr 7y ago
  Not all liquidity is the same. I've seen calculations that stated that HFT doesn't actually add valuable liquidity to markets because the moments you need that extra liquidity are price uncertainty moments where HFT traders disappear. I don't have the reference on hand though.
  - growse 7y ago
    And yet Vanguard say that HFT helps lower their costs by adding market liquidity and therefore reducing spreads: https://www.forbes.com/sites/timworstall/2014/04/28/bill-mcnabb-of-vanguard-says-that-hft-is-beneficial-to-investors/ https://www.forbes.com/sites/timworstall/2014/04/28/bill-mcn...
- blindwatchmaker 7y ago
  Not a hostile question, I'm genuinely trying to understand this: How is liquidity provided by, for example, someone interjecting themselves into a trade that was already going to happen?
  - SeanAppleby 7y ago
    If you want to move a large amount of money into an asset, you either have to place bids and wait for people to take your order at a particular price, or you have to pay a slight premium to dig into the ask side of the book and pay more money as you consume orders and liquidity. If you place an ask and the price moves down it might not fill, so you have to move it over time while the price slips. People provide liquidity by seeing your new sell order and filling it quickly, or by leaving a large number sell orders that people can take immediately, which results in money moving more quickly and consistently.
  - navigatesol 7y ago
    Willingness to accept a smaller spread, but more volume?
- FabHK 7y ago
  > lack of liquidity increases trading costs Sure, that's almost tautologically true, but that does not mean that the benefits to society materialise: * Traders getting faster access to an exchange have an advantage against other traders (and might make more money), but that does not imply at all that the market will be more liquid. * The volume of actual utilitarian trades (investing, borrowing, asset exchanging, hedging) is relatively small compared to overall trading activity. A pension fund investing, someone taking out a mortgage, people exchanging currency for the holidays, the often cited farmer hedging his crop - they trade infrequently, and certainly don't care about some milliseconds. * The dynamics are those of an arms race. Arms races are wasteful, by and large. Building a "straighter" fibre glass connection between NY and Chicago, and then building a series of micro wave towers (because the speed of light in the air is greater than in the fibre) - how does that benefit society? Just postulating higher liquidity and lower costs is not enough to justify it, I think. (I am reminded of the earlier discussion about advertising - once Cola does it, Pepsi has to do it, too. Are we thus better off, or would we get cheaper sodas if both didn't?)
Merrill 7y ago
Business produces goods and services. Finance is an online multiplayer game. They are two weakly-connected systems.
- jasode 7y ago
  >Business produces goods and services. Finance is an online multiplayer game. But finance is also products & services. Think of a corn farmer. It's easier to think of him adding tangible value to society because "corn == food". In contrast, finance just seems like useless office workers copy pasting numbers around in Excel spreadsheets. (This is probably true in many cases.) But the farmer often wants to sell "futures" which is a product & service provided by the financial industry. Instead of using the jargon of "futures", we can just say the farmer wants a product/service to give him a "guaranteed-selling-price-regardless-of-future-volatility-of-corn-prices-so-I-can-sleep-at-night". Other examples of desirable finance products that farmers want include crop insurance and equipment loans/leases. >They are two weakly-connected systems. Farmers' food crops and the financial products/services of of futures is an example of how businesses making tangible products and the finance industry are strongly connected.
  - Merrill 7y ago
    Those are the weak connections I referred to. Last I looked, the volume of financial transactions was about two orders of magnitude larger than the volume of purchases of goods and services. So maybe a couple percent of futures transactions involve actual buyers and sellers of the commodity, while most trades are among financial system players.
  - penagwin 7y ago
    But for example the crypto market has no goods or services - only the market trading aspect. Yet it's value swings wildly anyway.
- dcsan 7y ago
  finance is the meta-game. "All problems in computer science can be solved by another level of indirection"
KUcxrAVrtI 7y ago
If a market can't be cleared using a spreadsheet with 2^16 rows and 2^8 columns then the market is not efficient. Largely because most of the trade strategies live in ancient xls files no one dares edit.
jellicle 7y ago
Nope, it's pure loss to everyone else. Every dollar that an HFT makes by front-running your trade is a dollar you don't make as an investor. The money isn't coming out of nowhere.
- merpnderp 7y ago
  HFT's are purely parasitic unless you're another HFT benefitting from the faster trades. But what's a solution that doesn't add so much friction the house of cards falls down?

grenoire 7y ago

We know, empirically, that a lack of liquidity increases trading costs, which in turn is directly channeled to the prices of goods and services that rely on this liquidity (more or less everything in the world, even more indirectly ones like education). It's difficult to say 'things would be X% more expensive' because of the interconnected complexity the GP was talking about, but there is definitely a very apparent benefit.

codetrotter 7y ago
> a lack of liquidity increases trading costs Sure but, does a couple of milliseconds to or from affect that?
- grenoire 7y ago
  You have to consider some form of multiplier effect that comes into play. Because the prices of assets are derivatives of others (incl. many, many other variables, of course) these millisecond savings end up turning into seconds, even minutes en masse.
- dcolkitt 7y ago
  Yes, and I'll tell you exactly why. Markets consist of informed and uninformed traders. For example your typical Joe Sixpack rebalancing his 401k is uninformed. His trading does not tell you anything about the underlying value of the stocks. The typical informed trader is a hedge fund manager, who's investing tons of resources in gaining an informational edge. If he's buying a stock at a particular time that is in and of itself a signal that said stock is worth more than you thought it was otherwise. Liquidity providers love trading with uninformed traders. The problem with informed traders is that you don't want to be on the other side of their trades. Since liquidity providers are the immediate counterparties to most order flow, they're the ones that primarily eat this cost. To counter this, liquidity providers invest enormous resources in profiling order flow to try to identify when to what degree its informed. This allows them to provide lower costs and more liquidity to uninformed traders, like Joe Sixpack. It's analogous to how requiring a checkup allows life insurance companies to provide lower premiums, particularly to those who are healthy. One of the most important ways to profile order flow is to quickly adjust quotes as market conditions evolve. For example said hedge fund manager may be trading a thesis that the chipmakers are all undervalued. He may come in and buy Intel, AMD and Nvidia in one swoop. If an HFT sees a huge buy hit Intel, it can bump its quotes on AMD for a few milliseconds. If its a cigar-chomping hedge fund manager executing a basket algorithm, it's quite likely that he'll try to hit AMD and thus pay the higher price. But if its Joe Sixpack the probability that his trade just coincidentally lands in a 5 millisecond time window is vanishingly small.
bodyfour 7y ago
I think the question is at what point does liquidity have diminishing returns? If a security could only be traded once per 10 years then it's obvious that its lack of liquidity would make it less valuable. Holding it would tie up your capital quite significantly. However, if you had a turn-based market where every trade got cleared at the top of the minute it's not clear to me at all whether that would effectively be less liquid than what we have now. It seems to me that a model where traders all compete for how many nanoseconds away their HFT servers are from the action doesn't really benefit the market as a whole. If anything it just makes things like flash crashes more likely.
- grenoire 7y ago
  In reality the way that markets are cleared wasn't necessarily so much more different than a turn-based one, even in one where the clearing happens by the minute. The issue is, indeed, mostly with HFT. However, you shouldn't consider HFTs to be market participants in the traditional sense. Most of them focus solely on moving stuff around very fast instead of actually trying to purchase or sell things for a separate economic goal (e.g. production, hedging, short- and long-term investments). Once you disregard the rapid transactions that do not have a significant effect on the price, your average human investor is probably putting down some fill-or-kills or limit orders and actually benefits from HF liquidity trading. It's hard for me to understand, let alone explain, why milliseconds would matter for the human investor, but I what I can tell you is that GS is not investing 100M USD just for buying derivatives every other minute.
  - turk73 7y ago
    I highly doubt that. I think the "average trader" is being milked dry by systems that front run the orders on both sides of the trade.
- lazulicurio 7y ago
  I think part of the problem is that "liquidity" is an imprecise term. It implies both velocity and flexibility. HFT definitely increases velocity, but it can make the market either more or less rigid depending on the circumstances.
varshithr 7y ago
Forgive me for asking but what does GP here stand for?
- umanwizard 7y ago
  Grandparent comment, i.e., two links up in the comment tree. (It's a common term on internet forums -- I learned it from Slashdot years ago)
  - varshithr 7y ago
    Thank you very much. I thought of searching the web but GP is too generic a term.
- toofy 7y ago
  GrandParent comment. The comment directly above is the parent, and the comment above the parent is the grandparent—in this case the GP they’re referring to was 1e-9’s comment.
- dcsan 7y ago
  GP grand parent https://news.ycombinator.com/item?id=8363625 https://news.ycombinator.com/item?id=8363625
pedrocr 7y ago
Not all liquidity is the same. I've seen calculations that stated that HFT doesn't actually add valuable liquidity to markets because the moments you need that extra liquidity are price uncertainty moments where HFT traders disappear. I don't have the reference on hand though.
- growse 7y ago
  And yet Vanguard say that HFT helps lower their costs by adding market liquidity and therefore reducing spreads: https://www.forbes.com/sites/timworstall/2014/04/28/bill-mcnabb-of-vanguard-says-that-hft-is-beneficial-to-investors/ https://www.forbes.com/sites/timworstall/2014/04/28/bill-mcn...
blindwatchmaker 7y ago
Not a hostile question, I'm genuinely trying to understand this: How is liquidity provided by, for example, someone interjecting themselves into a trade that was already going to happen?
- SeanAppleby 7y ago
  If you want to move a large amount of money into an asset, you either have to place bids and wait for people to take your order at a particular price, or you have to pay a slight premium to dig into the ask side of the book and pay more money as you consume orders and liquidity. If you place an ask and the price moves down it might not fill, so you have to move it over time while the price slips. People provide liquidity by seeing your new sell order and filling it quickly, or by leaving a large number sell orders that people can take immediately, which results in money moving more quickly and consistently.
- navigatesol 7y ago
  Willingness to accept a smaller spread, but more volume?
FabHK 7y ago
> lack of liquidity increases trading costs Sure, that's almost tautologically true, but that does not mean that the benefits to society materialise: * Traders getting faster access to an exchange have an advantage against other traders (and might make more money), but that does not imply at all that the market will be more liquid. * The volume of actual utilitarian trades (investing, borrowing, asset exchanging, hedging) is relatively small compared to overall trading activity. A pension fund investing, someone taking out a mortgage, people exchanging currency for the holidays, the often cited farmer hedging his crop - they trade infrequently, and certainly don't care about some milliseconds. * The dynamics are those of an arms race. Arms races are wasteful, by and large. Building a "straighter" fibre glass connection between NY and Chicago, and then building a series of micro wave towers (because the speed of light in the air is greater than in the fibre) - how does that benefit society? Just postulating higher liquidity and lower costs is not enough to justify it, I think. (I am reminded of the earlier discussion about advertising - once Cola does it, Pepsi has to do it, too. Are we thus better off, or would we get cheaper sodas if both didn't?)

Merrill 7y ago

Business produces goods and services. Finance is an online multiplayer game. They are two weakly-connected systems.

jasode 7y ago
>Business produces goods and services. Finance is an online multiplayer game. But finance is also products & services. Think of a corn farmer. It's easier to think of him adding tangible value to society because "corn == food". In contrast, finance just seems like useless office workers copy pasting numbers around in Excel spreadsheets. (This is probably true in many cases.) But the farmer often wants to sell "futures" which is a product & service provided by the financial industry. Instead of using the jargon of "futures", we can just say the farmer wants a product/service to give him a "guaranteed-selling-price-regardless-of-future-volatility-of-corn-prices-so-I-can-sleep-at-night". Other examples of desirable finance products that farmers want include crop insurance and equipment loans/leases. >They are two weakly-connected systems. Farmers' food crops and the financial products/services of of futures is an example of how businesses making tangible products and the finance industry are strongly connected.
- Merrill 7y ago
  Those are the weak connections I referred to. Last I looked, the volume of financial transactions was about two orders of magnitude larger than the volume of purchases of goods and services. So maybe a couple percent of futures transactions involve actual buyers and sellers of the commodity, while most trades are among financial system players.
- penagwin 7y ago
  But for example the crypto market has no goods or services - only the market trading aspect. Yet it's value swings wildly anyway.
dcsan 7y ago
finance is the meta-game. "All problems in computer science can be solved by another level of indirection"

KUcxrAVrtI 7y ago

If a market can't be cleared using a spreadsheet with 2^16 rows and 2^8 columns then the market is not efficient. Largely because most of the trade strategies live in ancient xls files no one dares edit.

jellicle 7y ago

Nope, it's pure loss to everyone else. Every dollar that an HFT makes by front-running your trade is a dollar you don't make as an investor. The money isn't coming out of nowhere.

merpnderp 7y ago
HFT's are purely parasitic unless you're another HFT benefitting from the faster trades. But what's a solution that doesn't add so much friction the house of cards falls down?