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Paperclip maximizing AI. It's so interesting that the long-form narrative of a trading house omits to dive into the detail of a single actual trade!
by drtillberg 6y ago
Paperclip maximizing AI. It's so interesting that the long-form narrative of a trading house omits to dive into the detail of a single actual trade!
- andrepd 6y agoAn excellent analogy for the financial markets which largely control our economic lives.
- an_opabinia 6y agoBecause all the computer hocus pocus is obscuring how they make money: they launder arbitrage banks are not allowed to do to their own clients in exchange for a large fee.
- Ntrails 6y agoI am going to need a pretty good citation on that
- cma 6y agoPaying for "dumb money" order flow, it's how everyone was able to go commission free, by selling access to it.
- sesuximo 6y agoThis isn’t true for every firm, but a lot of them do it. I think it’s bad (it’s weird/unfair), but on the other hand I am happy not paying commission/getting orders filled at prices often a bit better than advertised on my broker’s app, so maybe it’s ok? Idk.
- sp527 6y agoI’d argue it’s not bad at all. It very cleanly aligns incentives in a way that benefits both sides. Another way to look at it is that there’s an “implied commission”, paid in the form of a perhaps slightly inflated purchase price, that largely doesn’t affect retail investors. And this all works out for quant firms because they make money off this at volume, at near zero marginal cost. In fact, it’s odd that commission free trading didn’t happen a lot sooner. Etrade, Schwab, etc were rent seekers.
- badfrog 6y ago> I think it’s bad (it’s weird/unfair) How is it bad or unfair? Everybody wins: you get a better price, the market maker does a trade they're happy with, and your broker gets a little bit of money.
- sesuximo 6y agoI think it’s a little unfair compared to letting people put their orders on exchanges directly
- badfrog 6y agoYou are guaranteed a price that is equal or better than what you'd get on the exchange. Why would you want to bypass that?
- sesuximo 6y agoWell “the price” might be totally different if there were no off-exchange orders. But I’m sort of being a devil’s advocate... I agree with your argument in practice since I don’t expect to see such open exchanges anytime soon
- badfrog 6y ago> Well “the price” might be totally different if there were no off-exchange orders. I'm not sure what that means, but there's no scenario in which you'd get a worse price. That would be illegal under the Reg NMS order protection rule. https://www.investopedia.com/terms/o/order-protection-rule.asp https://www.investopedia.com/terms/o/order-protection-rule.a...
- sesuximo 6y agoYou won’t get a worse price than what the exchange says is the price, but that price Is a moving target; if all competitors could see all orders, the price would move. Idk if it makes a difference on average but it is a difference
- fractionalhare 6y agoOrder flow has been sold for much longer than the more recent commission-free trading trend, which was primarily driven by Robinhood. Robinhood just decided they'd sell order flow without also taking commission. More to the point: the primary consumer of order flow is market making HFTs, which DE Shaw is not. Stat arb/quant trading firms don't rely on market making rebates for trading profits.
- Ntrails 6y agoThe suggestion above is that GP simply doesn't believe stat arb is a thing. Which I know to be untrue, or the level of cover up is quite impressive
- smabie 6y agoQuant fund are not involved in latency arbitrage. HFT is a completely different space, and most HFT firms are prop shops, not funds. Most quant strategies aren't really dependent on insanely fast execution. They may hold a position for weeks or months at a time.
- nojito 6y agoMost if not all the highly successful and most secretive quant funds execute hundreds of thousands trades per day...while not considered to be "HFT"...the idea of trading hundreds or thousands positions per second is quite a high frequency.
- hchz 6y agoThis is algo trading, or execution optimization. They aren't measuring the market / order book and then reacting at high frequency. They are reacting at low frequency and then the execution is optimized to minimize losses caused by market feedback. This is a very important distinction if you hold the view that HFT risks destabilizing markets.
- smabie 6y agoMost quant shops are not turning over thousands of positions everyday, the trading costs alone would be ridiculous. But regardless, HFT usually means latency arb, not just trading a lot. There's a misperception that quant funds are making money on slight mispricings, but while I can't speak for all funds of course, this isn't generally true. Quant funds are much closer to buy and hold long term investors than they are to HFT firms.
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- an_opabinia 6y agoThere isn't going to be documentation out there, in some pithy Bloomberg article, "Banks have prized relationships with arbitrageurs that help them monetize opportunities that plainly violate fiduciary duty." Information about how hedge funds work - like information about say how ad tech firms work - is incommensurable with HN's Reddit/Wiki-style way of disseminating knowledge. I hope that information without citations could be tolerated more, I have no dog in this race, I just like sharing knowledge. Shaw and many hedge funds that have been around for decades acquire smaller arbitrage firms that can be thought of as having "licenses" to perform arbitrage. This portfolio of arb is how they scale to their AUM. There is nothing actually secret or protectable about what an individual arb firm does to execute the trade. For example a particular HFT trading algorithm. Such firms that rely on actual secrets do not last long and so in a Darwinian way do not wind up in the portfolios of huge funds like DE Shaw. The arb shops that last a while have permission, from a bank, that depends on a relationship with a real human being, that is exclusive to the firm granted, to launder a particular form of arb the bank would like to do but could not. For example you're allowed to take a spread as a bond trading desk, but wouldn't you like to sell the bank's bonds instead of its competitors bonds? That's plainly against fiduciary so it "doesn't happen." Instead you go to an anonymous arb firm, for $1m in bonds, and you say, "okay we're going to sell you the bond that is actually ours, you will sell it back to us, here is your fee, now we can sell this bond back to the client and wash the fact that it is ours." Nobody says that! But that is the economics of the trade, why the arb firm can make money for so long, why banks work with them despite seeming to be "parasites," etc. The computers are just part of the hocus pocus of laundering that arb. Shaw doesn't actually come up with this arb or necessarily source the relationship. Instead it finds the little anonymous arb firm and buys it, and carefully scales the relationship for $1m of bonds with 1 bank to $1b in bonds with 10 banks. The risks in Shaw's business are that you lose the license to arb. The upside is from investors persistently underpricing the ability for Shaw to scale this arb from $1m to $1b. No, they basically pull a rabbit out of a hat every year and continue to scale a particular arb further than people thought was possible. Also, nobody is going to want to just give Shaw, a bunch of rich people, a bunch of free money. But you can't fight their ability to acquire little arb firms. This is the way.
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- stainforth 6y agoCan your rephrase that last part or explain what that means?
- throwlogon 6y agoWhat does "launder arbitrage" mean?