8 ms·

The industry as a whole provides net value to the market by via higher liquidity and tighter spreads. The arms race is a necessity due to rising competition.

The industry as a whole provides net value to the market by via higher liquidity and tighter spreads. The arms race is a necessity due to rising competition. HFTs cannibalize each other every year. People on the outside seem to think being in HFT inherently means you’re printing money but they don’t acknowledge how tough the business actually is. Many firms have either collapsed or have been bought out over the past decade. Market makers specifically (who inherently have to operate in HFT time horizons) don't even compete with low-mid frequency hedge funds and props. They don't compete with retail investors. They strictly compete against other MMs to capture the spread.

gas9S9zw3P9c 6y ago
Out of curiosity, why do MMs have to operate on HFT time horizons? Couldn't they operate on a somewhat lower frequencies by quoting wider? Sure, they won't see the same profits, but why is it impossible?
- AllanHoustonSt 6y ago
  Traders (be it hedge funds, props, retail, anyone) will only "take your action" if you price competitively. You'll never get your orders filled. The open bid and ask as per whatever the exchange quotes are really the only prices that matter when it comes to what actually gets executed. Also even if you do quote wider, to effectively capture the spread, your buy on one side and your sell on the other side still have to basically occur simultaneously which is where the demand for latency comes in so you really can't escape it. That said there are ways to still be profitable even if you know you're not the fastest gun in the west across the most exchanges. Without going into too many details you'd have to selectively choose where/what you trade. Which is not trivial at all of course.
  - gas9S9zw3P9c 6y ago
    Hm, maybe I'm fundamentally misunderstanding something. Let's just say the price is a random walk. It's not directly relevant to the argument, but for simplicity. An HFT MM will make money by continuously quoting ask/bid at the best price, i.e. a lot of trades, capturing a very small spread each time. Given that it's a random walk, buy and sell don't always occur simultaneously either, e.g. in a trending regime where the HFT MM may start pulling quotes due to risk checks and/or inventory/hedging concerns. So if I am an MM that quotes a wider but gets fewer executions at larger time intervals, shouldn't I be able to also make profit? After all, my queue position is in front of the HFT MM because I put in orders earlier (since I am quoting wider), latency here is irrelevant. Can you explain where my logic is faulty?
    - AllanHoustonSt 6y ago
      I guess I would say, it depends? Existing profitable MMs aren't all equally fast. So the slower ones that trade on the same exchanges or even the same indices have to be profitably trading at a wider spread. HFT isn't a concrete term so I guess technically there's no hard line to draw for how fast your roundtrip times have to be to be profitable. But if you are trading wide enough where you think latency isn't a factor, aren't you really just predicting where you think the book will go "far" ahead in the future? MM is inherently a reactionary business (with some effort put into anticipating the price moving against you in the very very short term).
      - gas9S9zw3P9c 6y ago
        > But if you are trading wide enough where you think latency isn't a factor, aren't you really just predicting where you think the book will go "far" ahead in the future Yep, or rather, predicting where the market will not go to avoid the price moving against my quote. My impression was that HFT is all about being fast, as opposed to smart, since you can't make complex predictions on nanosecond scales. Complex models don't fit on an FPGA. So couldn't you get an edge by being just a little bit smarter with predictions but slower and quoting wider spreads? And just to be clear, I'm not talking about minutes here, but maybe milliseconds to seconds, which I think wouldn't be considered HFT today?
        AllanHoustonSt 6y ago
        There is trading activity in the milliseconds-seconds horizon as well. I'm sure all the big HFT players participate plenty. These just wouldn't be considered MM strategies. Your original question was why MMs have to operate at HFT horizons. MMs by definition are liquidity providers (which means high availability and high volume at competitive prices). In some cases (DMMs) they're legally obligated to do so at some well defined baseline. And in that specific context HFT speeds are required.
        gas9S9zw3P9c 6y ago
- pgwhalen 6y ago
  It's interesting the way you connect quoting with wider with lower profits. In a vacuum, clearly the opposite is true. But you're leaving out the part that you only stand a chance to trade and therefore profit if you have the very best price, so you can't quote wider otherwise your competitors will get the trade. If your quote is a million dollars wide, you won't make a million dollars less frequently - you'll never make anything at all. That's all true for the very strictest definition of a market maker, which is pretty much necessarily HFT (in list US equities). But there are other types of traders that are successful of course, because their edge comes from thinking about the market in a different way. In situations where finely-tuned, data-informed, low-latency algorithms do not have the confidence to give good prices (e.g. illiquid securities or during times of volatility), these traders might be more successful.
  - gas9S9zw3P9c 6y ago
    Oh yeah, when I said "lower profits" I didn't mean per roundtrip, but overall lower profits over a longer period of time due to fewer trades happening at wider quotes. HFT almost always quotes minimum spreads, so my question was why you couldn't be successful quoting larger spreads (not $1M, but let's say 2-10x the normal spread) while trying to be "smarter" as opposed to faster, since with wider spreads you'd already be in front of the order queue when the price moves, in front of the HFT trader who has to react to the movement to quote his tiny spread. I'm trying to understand where the market maker = necessarily HFT comes from. After all, we had markets makers well before HFT too. I understand that MM can be particularly profitable when doing HFT, but why is HFT a necessity?
    - pgwhalen 6y ago
      Your intuition is good, I think it's the terminology/semantics that are causing you confusion. What you're describing is a valid way to make money as a trader, but most people don't call it market making. The wider you quote relative to other market participants, the more risk you take on - because your volume is lower, you have to hold on to your positions longer, exposing you to greater fluctuations in price. Market making is very much about not exposing yourself to this kind of risk. In real terms, if you quote a penny wide market, there's a much greater change that you can both buy and sell in a short period of time to capture that penny. However, if you quote a 10c wide market (when everyone else is quoting a penny), you might buy shares at $10, but it might be a much longer time before anyone wants to buy them back from you at $10.10 - in fact it might be never, they could go straight to 0! Again, quoting that 10c spread is perfectly valid, it just means that your edge begins to be less about capturing "flow" as much as it is about predicting the direction of the stock over a longer time horizon.
- quickthrowman 6y ago
  In short, someone else will quote a tighter spread and capture it.

gas9S9zw3P9c 6y ago

Out of curiosity, why do MMs have to operate on HFT time horizons? Couldn't they operate on a somewhat lower frequencies by quoting wider? Sure, they won't see the same profits, but why is it impossible?

AllanHoustonSt 6y ago
Traders (be it hedge funds, props, retail, anyone) will only "take your action" if you price competitively. You'll never get your orders filled. The open bid and ask as per whatever the exchange quotes are really the only prices that matter when it comes to what actually gets executed. Also even if you do quote wider, to effectively capture the spread, your buy on one side and your sell on the other side still have to basically occur simultaneously which is where the demand for latency comes in so you really can't escape it. That said there are ways to still be profitable even if you know you're not the fastest gun in the west across the most exchanges. Without going into too many details you'd have to selectively choose where/what you trade. Which is not trivial at all of course.
- gas9S9zw3P9c 6y ago
  Hm, maybe I'm fundamentally misunderstanding something. Let's just say the price is a random walk. It's not directly relevant to the argument, but for simplicity. An HFT MM will make money by continuously quoting ask/bid at the best price, i.e. a lot of trades, capturing a very small spread each time. Given that it's a random walk, buy and sell don't always occur simultaneously either, e.g. in a trending regime where the HFT MM may start pulling quotes due to risk checks and/or inventory/hedging concerns. So if I am an MM that quotes a wider but gets fewer executions at larger time intervals, shouldn't I be able to also make profit? After all, my queue position is in front of the HFT MM because I put in orders earlier (since I am quoting wider), latency here is irrelevant. Can you explain where my logic is faulty?
  - AllanHoustonSt 6y ago
    I guess I would say, it depends? Existing profitable MMs aren't all equally fast. So the slower ones that trade on the same exchanges or even the same indices have to be profitably trading at a wider spread. HFT isn't a concrete term so I guess technically there's no hard line to draw for how fast your roundtrip times have to be to be profitable. But if you are trading wide enough where you think latency isn't a factor, aren't you really just predicting where you think the book will go "far" ahead in the future? MM is inherently a reactionary business (with some effort put into anticipating the price moving against you in the very very short term).
    - gas9S9zw3P9c 6y ago
      > But if you are trading wide enough where you think latency isn't a factor, aren't you really just predicting where you think the book will go "far" ahead in the future Yep, or rather, predicting where the market will not go to avoid the price moving against my quote. My impression was that HFT is all about being fast, as opposed to smart, since you can't make complex predictions on nanosecond scales. Complex models don't fit on an FPGA. So couldn't you get an edge by being just a little bit smarter with predictions but slower and quoting wider spreads? And just to be clear, I'm not talking about minutes here, but maybe milliseconds to seconds, which I think wouldn't be considered HFT today?
      - AllanHoustonSt 6y ago
        There is trading activity in the milliseconds-seconds horizon as well. I'm sure all the big HFT players participate plenty. These just wouldn't be considered MM strategies. Your original question was why MMs have to operate at HFT horizons. MMs by definition are liquidity providers (which means high availability and high volume at competitive prices). In some cases (DMMs) they're legally obligated to do so at some well defined baseline. And in that specific context HFT speeds are required.
        gas9S9zw3P9c 6y ago
pgwhalen 6y ago
It's interesting the way you connect quoting with wider with lower profits. In a vacuum, clearly the opposite is true. But you're leaving out the part that you only stand a chance to trade and therefore profit if you have the very best price, so you can't quote wider otherwise your competitors will get the trade. If your quote is a million dollars wide, you won't make a million dollars less frequently - you'll never make anything at all. That's all true for the very strictest definition of a market maker, which is pretty much necessarily HFT (in list US equities). But there are other types of traders that are successful of course, because their edge comes from thinking about the market in a different way. In situations where finely-tuned, data-informed, low-latency algorithms do not have the confidence to give good prices (e.g. illiquid securities or during times of volatility), these traders might be more successful.
- gas9S9zw3P9c 6y ago
  Oh yeah, when I said "lower profits" I didn't mean per roundtrip, but overall lower profits over a longer period of time due to fewer trades happening at wider quotes. HFT almost always quotes minimum spreads, so my question was why you couldn't be successful quoting larger spreads (not $1M, but let's say 2-10x the normal spread) while trying to be "smarter" as opposed to faster, since with wider spreads you'd already be in front of the order queue when the price moves, in front of the HFT trader who has to react to the movement to quote his tiny spread. I'm trying to understand where the market maker = necessarily HFT comes from. After all, we had markets makers well before HFT too. I understand that MM can be particularly profitable when doing HFT, but why is HFT a necessity?
  - pgwhalen 6y ago
    Your intuition is good, I think it's the terminology/semantics that are causing you confusion. What you're describing is a valid way to make money as a trader, but most people don't call it market making. The wider you quote relative to other market participants, the more risk you take on - because your volume is lower, you have to hold on to your positions longer, exposing you to greater fluctuations in price. Market making is very much about not exposing yourself to this kind of risk. In real terms, if you quote a penny wide market, there's a much greater change that you can both buy and sell in a short period of time to capture that penny. However, if you quote a 10c wide market (when everyone else is quoting a penny), you might buy shares at $10, but it might be a much longer time before anyone wants to buy them back from you at $10.10 - in fact it might be never, they could go straight to 0! Again, quoting that 10c spread is perfectly valid, it just means that your edge begins to be less about capturing "flow" as much as it is about predicting the direction of the stock over a longer time horizon.
quickthrowman 6y ago
In short, someone else will quote a tighter spread and capture it.