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>Spread trading (or "market making") is also misunderstood. People see market makers as scalpers when in fact they're providing a valuable service: they're crea

>Spread trading (or "market making") is also misunderstood. People see market makers as scalpers when in fact they're providing a valuable service: they're creating liquidity. The reason you can buy or sell shares at any time (rather than waiting for a seller or buyer to show up) is because of market makers. Except market makers generally target markets which are already highly liquid, so I would guess most of them aren't providing a tangible service to anyone working at human timescales. I remember reading that Chi-X had only 1 (!) high frequency market maker for the first 1.5 years they were open and liquidity there was just fine. (link to the Chi-X paper: http://www.tinbergen.nl/discussionpapers/11076.pdf http://www.tinbergen.nl/discussionpapers/11076.pdf)

cletus 15y ago
The size of the spread and the liquidity of the market are inversely proportional. The spread on US government bonds is zero or close enough to be zero. The spread on the Swiss bond market is considerably higher. Market makers can't artificially widen the spread without taking a position--sometimes a significant position--which carries a lot more risk. Spread trading in its purest form is about holding enough stock much like a business holds cash as an operating budget to handle cash flow, not as an investment in and of itself.
- iskander 15y ago
  What I'm saying is that high frequency market makers are only need in very small numbers (if even that). When 2/3 of a market's volume is HFT position shuffling, you're not "improving liquidity" in a way that's meaningful or useful to anyone.
  - Nrsolis 15y ago
    So you'd prefer a single market-maker to control price discovery rather than have several parties compete to do the job? You can argue that /liquidity/ is fine if you have a small number of market-makers but price discovery (otherwise known as "value") is something altogether different. To put it another way, I can get all the $8 hotdogs and $12 beers at Yankee stadium I like. The liquidity is fine but the VALUE isn't.
    - iskander 15y ago
      1) There often isn't any sort of ideal price to discover at short timescales, just complicated interplay between HFT algorithms and the bizarre psychology of human traders (ie, "4th digit nearing zero, looks like it has momentum!"); both moving prices in ways unrelated to any fundamental value. 2) Just as no one is forced to do their weekly shopping at Yankee stadium, investors can choose which exchange to submit their orders to. Exchanges with shoddy market makers would lose customers.
      - Nrsolis 15y ago
        1) You couldn't be more wrong. Moment by moment psychology is and had been a part of the market from the beginning. The market is about INFORMATION, namely who knows something and who doesn't. Adding computers to the mix might have sped things up but hasn't fundamentally changed the game that's played. 2) I dont see any fundamental difference between multiple exchanges each with a dominant market marker and multiple market makers within a single exchange. In practical matters, retail investors dont select their exchange, their broker does.
  - yummyfajitas 15y ago
    When 2/3 of your packets are travelling from one server to another inside the data center, you're not "providing information to consumers" in a way that's meaningful or useful to anyone. See the fallacy here? Also, HFT's are present only in very small numbers (relative to the size of the financial industry in general).
    - pak 15y ago
      If those extra packets could suddenly and uncontrollably leak out on the Internet and destroy everything, requiring a trillion dollar government bailout to fix it and ten years to restore confidence in the infrastructure, yes I would be pissed and doubly so that this inadequate analogy was used to defend it.
      - yummyfajitas 15y ago
        When did HFT "destroy everything, requiring a trillion dollar government bailout" to fix?
        pak 15y ago
        Oh, just because it hasn't happened yet, we should pretend it isn't possible? You remember the flash crash. That took out the market for a day. People waved their hands and said it was an innocent mistake. Nothing changed. When scads of people were writing CDO's and swaps and other clearly garbage papers in 2007, they probably used your logic to justify their recklessness, and here we are.
        yummyfajitas 15y ago
        Oh, just because it hasn't happened yet, we should pretend it isn't possible? You remember the flash crash. You mean the minor event precipitated by a fat fingered human and corrected in an hour or so by HFTs? If you have a plausible disaster scenario involving HFT's, state it. So far, near as I can tell, your argument is merely "omfg finance stuff I don't understand it might destroy the world!"
- deleted 15y ago
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argv_empty 15y ago
This is why I'm skeptical of the claim that they're providing liquidity. If they can open and close a position in a matter of seconds, it sounds like they're mostly claiming credit for liquidity that was already present.

cletus 15y ago

The size of the spread and the liquidity of the market are inversely proportional. The spread on US government bonds is zero or close enough to be zero. The spread on the Swiss bond market is considerably higher. Market makers can't artificially widen the spread without taking a position--sometimes a significant position--which carries a lot more risk. Spread trading in its purest form is about holding enough stock much like a business holds cash as an operating budget to handle cash flow, not as an investment in and of itself.

iskander 15y ago
What I'm saying is that high frequency market makers are only need in very small numbers (if even that). When 2/3 of a market's volume is HFT position shuffling, you're not "improving liquidity" in a way that's meaningful or useful to anyone.
- Nrsolis 15y ago
  So you'd prefer a single market-maker to control price discovery rather than have several parties compete to do the job? You can argue that /liquidity/ is fine if you have a small number of market-makers but price discovery (otherwise known as "value") is something altogether different. To put it another way, I can get all the $8 hotdogs and $12 beers at Yankee stadium I like. The liquidity is fine but the VALUE isn't.
  - iskander 15y ago
    1) There often isn't any sort of ideal price to discover at short timescales, just complicated interplay between HFT algorithms and the bizarre psychology of human traders (ie, "4th digit nearing zero, looks like it has momentum!"); both moving prices in ways unrelated to any fundamental value. 2) Just as no one is forced to do their weekly shopping at Yankee stadium, investors can choose which exchange to submit their orders to. Exchanges with shoddy market makers would lose customers.
    - Nrsolis 15y ago
      1) You couldn't be more wrong. Moment by moment psychology is and had been a part of the market from the beginning. The market is about INFORMATION, namely who knows something and who doesn't. Adding computers to the mix might have sped things up but hasn't fundamentally changed the game that's played. 2) I dont see any fundamental difference between multiple exchanges each with a dominant market marker and multiple market makers within a single exchange. In practical matters, retail investors dont select their exchange, their broker does.
- yummyfajitas 15y ago
  When 2/3 of your packets are travelling from one server to another inside the data center, you're not "providing information to consumers" in a way that's meaningful or useful to anyone. See the fallacy here? Also, HFT's are present only in very small numbers (relative to the size of the financial industry in general).
  - pak 15y ago
    If those extra packets could suddenly and uncontrollably leak out on the Internet and destroy everything, requiring a trillion dollar government bailout to fix it and ten years to restore confidence in the infrastructure, yes I would be pissed and doubly so that this inadequate analogy was used to defend it.
    - yummyfajitas 15y ago
      When did HFT "destroy everything, requiring a trillion dollar government bailout" to fix?
      - pak 15y ago
        Oh, just because it hasn't happened yet, we should pretend it isn't possible? You remember the flash crash. That took out the market for a day. People waved their hands and said it was an innocent mistake. Nothing changed. When scads of people were writing CDO's and swaps and other clearly garbage papers in 2007, they probably used your logic to justify their recklessness, and here we are.
        yummyfajitas 15y ago
        Oh, just because it hasn't happened yet, we should pretend it isn't possible? You remember the flash crash. You mean the minor event precipitated by a fat fingered human and corrected in an hour or so by HFTs? If you have a plausible disaster scenario involving HFT's, state it. So far, near as I can tell, your argument is merely "omfg finance stuff I don't understand it might destroy the world!"
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argv_empty 15y ago

This is why I'm skeptical of the claim that they're providing liquidity. If they can open and close a position in a matter of seconds, it sounds like they're mostly claiming credit for liquidity that was already present.