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Ah, Knight Capital. The warning story for every quant trader / engineer. This is what people don't realize when they say HFT (high frequency trading) is risk-f

by tomp 3y ago

Ah, Knight Capital. The warning story for every quant trader / engineer. This is what people don't realize when they say HFT (high frequency trading) is risk-free, leeching off people, etc. You make a million every day with very little volatility (the traditional way of quantifying "risk" in finance) but one little mistake, and you're gone. The technical term is "picking up pennies in front of a steamroller (train)". Selling options is also like that.

loa_in_ 3y ago
I don't see how anything here goes against it leeching off people
- Nevermark 3y ago
  Leeching implies someone has found a way to skim value from you without providing value. Someone taking on loads of risk to carry out your commands efficiently is providing value. You can argue whether they are doing so competently or not, or whether they are pricing optimally or not, but they are not just ”takers” or “leeches”.
  - UncleMeat 3y ago
    How are they taking on loads of risk? Risk has a particular meaning in investment and "well, a bug can blow up my company" isn't part of that meaning. Simply creating risky (in the colloquial meaning) things is not itself a reason to deserve money.
    - siftrics 3y ago
      When you make markets you are literally paid the spread to assume the risk of holding the position.
      - piyh 3y ago
        Can you break this down a bit more? I've heard about making markets in relation to FTX but didn't really get the full picture.
        siftrics 3y ago
        You can Google it or ask an LLM. It's not magic. This is common knowledge.
      - UncleMeat 3y ago
        Okay. That's largely independent of the maximum damage caused by a bug.
        siftrics 3y ago
        No. In this case KCG was doing the opposite of making markets --- they were taking --- they were eating the spread over and over and over again until they ran out of money.
    - envsubst 3y ago
      > Risk has a particular meaning in investment Risk in finance definitely takes on more meaning than the narrow definition in modern portfolio theory (stddev of price).
    - pxmpxm 3y ago
      > How are they taking on loads of risk? This entire story is about a trading firm that lost 400m trying to provide market liquidity. Which part of the loads of risk isn't clear in this context?
  - jraph 3y ago
    What value do they provide?
    - callalex 3y ago
      They claim to provide liquidity, even though they are just front-running trades that are already happening anyway.
  - Guvante 3y ago
    What risk are they taking exactly? Bugs ruining the business isn't meaningful risk for the customer. It isn't like day traders are at risk of going bankrupt due to that after all. They claim liquidity is their value but given how they act they don't seem to be providing measurable liquidity, either in terms of price or volume. (Yes they increase volume by getting in the middle of trades but that isn't useful volume...)
    - hackerlight 3y ago
      Market risk isn't the only type of risk. Many businesses in other industries don't have market risk, that isn't abnormal. Even businesses that you would expect to be exposed to market risk aren't, since they hedge most or all of it. There's operational risk, like what brought down Knight Capital, that's a type of risk. Or the risk that you will be put out of business by competition because you were too slow to innovate while burning through all your cash runway. HFT firms face the same risks that other types of businesses face. Smaller HFT firms fail often, and larger firms tend to stay around (although sometimes they also fail and often they shrink), which is similar to many mature competitive industries. > given how they act they don't seem to be providing measurable liquidity I'm not sure "How they act" should inform one's perspective on the empirical question of whether or not they are adding to liquidity. There is a lot of serious debate and research that has gone into that question.
      - Guvante 3y ago
        How they act is the hyper focus on first to market. HFT wants to have the first buy or sell order at price X. Being first to market does not impact liquidity availability. After all someone else has an order at that price already. My points about risk are beyond going long or short for a meaningful amount of time (certainly not seconds, probably not minutes) trading quickly isn't hugely impactful on end users. Thus all of the downsides of trading quickly aren't reducing risk for them.
  - erik_seaberg 3y ago
    If a seller and a buyer are in market within seconds of each other, they would have traded successfully without a third party taking some of their money. As I understand it, HFTs are trying to avoid taking meaningful long-term positions (which is why latency matters to only them).
- dasil003 3y ago
  Depends on whether they truly take on the risk. Interestingly I can’t clearly tell from a quick google who exactly ended up holding the bag here, and what became of upper management.
deleted 3y ago
[deleted]
alpark3 3y ago
Most people confuse market making/risk holding with high frequency statistical arbitrage strategies. I'm not totally sure exactly what Knight Capital was running, but generally the only "little" mistakes that would cause HFT market takers such as Jump(for the most part) would blow up is some type of egregious technical error like this, or some type of assumption violations outside of market conditions(legal, structural, etc.). Compare this to market makers like Jane Street who hold market risk in exchange for EV, and thus could lose money just based off of market swings (not to blowup levels if they know what they're doing), and you can see the difference between the styles. I'm a proponent of both. But generally I hold more respect for actual market makers who hold positions and can warehouse risk.
qeternity 3y ago
> Selling options is also like that. There are plenty of bad options traders, particularly retail...but this is an oversimplification. You can buy an index fund, and it can go to zero (however unlikely). You're not guaranteed any return, whereas at least selling an option has some guaranteed fixed premium. Professional options traders are incredibly sophisticated, and most of the tail risk is offloaded to people who are always long biased. Options as a whole massively improve price discovery in markets.

by tomp 3y ago

loa_in_ 3y ago

I don't see how anything here goes against it leeching off people

Nevermark 3y ago
Leeching implies someone has found a way to skim value from you without providing value. Someone taking on loads of risk to carry out your commands efficiently is providing value. You can argue whether they are doing so competently or not, or whether they are pricing optimally or not, but they are not just ”takers” or “leeches”.
- UncleMeat 3y ago
  How are they taking on loads of risk? Risk has a particular meaning in investment and "well, a bug can blow up my company" isn't part of that meaning. Simply creating risky (in the colloquial meaning) things is not itself a reason to deserve money.
  - siftrics 3y ago
    When you make markets you are literally paid the spread to assume the risk of holding the position.
    - piyh 3y ago
      Can you break this down a bit more? I've heard about making markets in relation to FTX but didn't really get the full picture.
      - siftrics 3y ago
        You can Google it or ask an LLM. It's not magic. This is common knowledge.
    - UncleMeat 3y ago
      Okay. That's largely independent of the maximum damage caused by a bug.
      - siftrics 3y ago
        No. In this case KCG was doing the opposite of making markets --- they were taking --- they were eating the spread over and over and over again until they ran out of money.
  - envsubst 3y ago
    > Risk has a particular meaning in investment Risk in finance definitely takes on more meaning than the narrow definition in modern portfolio theory (stddev of price).
  - pxmpxm 3y ago
    > How are they taking on loads of risk? This entire story is about a trading firm that lost 400m trying to provide market liquidity. Which part of the loads of risk isn't clear in this context?
- jraph 3y ago
  What value do they provide?
  - callalex 3y ago
    They claim to provide liquidity, even though they are just front-running trades that are already happening anyway.
- Guvante 3y ago
  What risk are they taking exactly? Bugs ruining the business isn't meaningful risk for the customer. It isn't like day traders are at risk of going bankrupt due to that after all. They claim liquidity is their value but given how they act they don't seem to be providing measurable liquidity, either in terms of price or volume. (Yes they increase volume by getting in the middle of trades but that isn't useful volume...)
  - hackerlight 3y ago
    Market risk isn't the only type of risk. Many businesses in other industries don't have market risk, that isn't abnormal. Even businesses that you would expect to be exposed to market risk aren't, since they hedge most or all of it. There's operational risk, like what brought down Knight Capital, that's a type of risk. Or the risk that you will be put out of business by competition because you were too slow to innovate while burning through all your cash runway. HFT firms face the same risks that other types of businesses face. Smaller HFT firms fail often, and larger firms tend to stay around (although sometimes they also fail and often they shrink), which is similar to many mature competitive industries. > given how they act they don't seem to be providing measurable liquidity I'm not sure "How they act" should inform one's perspective on the empirical question of whether or not they are adding to liquidity. There is a lot of serious debate and research that has gone into that question.
    - Guvante 3y ago
      How they act is the hyper focus on first to market. HFT wants to have the first buy or sell order at price X. Being first to market does not impact liquidity availability. After all someone else has an order at that price already. My points about risk are beyond going long or short for a meaningful amount of time (certainly not seconds, probably not minutes) trading quickly isn't hugely impactful on end users. Thus all of the downsides of trading quickly aren't reducing risk for them.
- erik_seaberg 3y ago
  If a seller and a buyer are in market within seconds of each other, they would have traded successfully without a third party taking some of their money. As I understand it, HFTs are trying to avoid taking meaningful long-term positions (which is why latency matters to only them).
dasil003 3y ago
Depends on whether they truly take on the risk. Interestingly I can’t clearly tell from a quick google who exactly ended up holding the bag here, and what became of upper management.

deleted 3y ago

[deleted]

alpark3 3y ago

Most people confuse market making/risk holding with high frequency statistical arbitrage strategies. I'm not totally sure exactly what Knight Capital was running, but generally the only "little" mistakes that would cause HFT market takers such as Jump(for the most part) would blow up is some type of egregious technical error like this, or some type of assumption violations outside of market conditions(legal, structural, etc.). Compare this to market makers like Jane Street who hold market risk in exchange for EV, and thus could lose money just based off of market swings (not to blowup levels if they know what they're doing), and you can see the difference between the styles. I'm a proponent of both. But generally I hold more respect for actual market makers who hold positions and can warehouse risk.

qeternity 3y ago

> Selling options is also like that. There are plenty of bad options traders, particularly retail...but this is an oversimplification. You can buy an index fund, and it can go to zero (however unlikely). You're not guaranteed any return, whereas at least selling an option has some guaranteed fixed premium. Professional options traders are incredibly sophisticated, and most of the tail risk is offloaded to people who are always long biased. Options as a whole massively improve price discovery in markets.