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An expected and uneducated statement. It's simple really: any participant who rests an order on the book is adding liquidity. Period. Many HFT strategies are la

by lrm242 14y ago

An expected and uneducated statement. It's simple really: any participant who rests an order on the book is adding liquidity. Period. Many HFT strategies are largely passive (market making, for example) and therefore entirely rely on resting orders (as Chris' article points out). Therefore, they add liquidity. Now, if you want to get into a discussion as to the quality of that liquidity then you have to go educate yourself a bit more. Once you do you'll find that the liquidity being added is not toxic nor fleeting. However, what you and most others don't understand is that it is also significantly more informed passive liquidity than it used to be. This may lead folks to believe that the liquidity is fleeting because they can cancel away before you can execute. However, that simply means they are better and faster than you, not that they are doing anything wrong. Why, then, don't we simply require them to rest their orders for a longer period of time? Simple: you want tight spreads. As spreads shrink market making becomes less profitable. When market making is less profitable market makers have to be more risk averse to avoid getting adversely selected and losing money. More intelligent models (they become more informed) and less latency (they can leverage that informedness to avoid being selected) is how market makers stay profitable in a market where the average spread is 1 penny.

_delirium 14y ago
How about rather than adding regulations, just discretize the market's clock? Would a market that performed a trade-resolution tick once every 100ms lose anything important? I believe arbitrage improves efficiency, but I'm less clear on the benefits of extremely high temporal resolution. Currently that's what the incentives encourage optimizing for, among other things. If you predict a market movement 10ms ahead of time, you can profit from that brief 10ms temporal-arbitrage window. And like any arbitrage, that does indeed improve the pricing signal in an absolute sense, in this case by taking a price change that was 10ms later than it "should've been", and moving it up in time via your trading. But it's not clear that 10ms-level pricing inefficiencies are actually something particularly important to smooth out via arbitrage, when you can just define them out of existence by going to a discrete-time market (which are fairly well-studied in the mathematical literature).
- yummyfajitas 14y ago
  Discretization often leads to instability, particularly if not done carefully. The prototypical example is naive discretizations of stable ODEs. Of course, all we have are toy models and speculation. The only real way to know is to try it. If I remember right, a couple of Asian equities markets have some sort of "auction on clock tick" mechanism, so we might be able to look to their experiences.
  - davidw 14y ago
    > Discretization often leads to instability ... > Of course, all we have are toy models and speculation These two statements could be construed to be in conflict, especially as I haven't the faintest idea what naive discretizations of stable ODE's is, and Google isn't of much assistance in providing an explanation that I can digest.
    - yummyfajitas 14y ago
      I didn't intend them to be in conflict - I listed a toy model, and acknowledged the limitations of it. An explanation of ODEs and instability (some math background is obviously required): https://en.wikipedia.org/wiki/Stiff_equation https://en.wikipedia.org/wiki/Stiff_equation
      - davidw 14y ago
        You lead with a fairly strong statement presented as a known fact and then later indicate it's just a model. To me the idea of slowing things down sounds vaguely sensible, but I also know that I don't know enough to really judge. So it sounds like no one else really knows either, but the entrenched players like things the way they are, which makes sense, because the ones who have the money to be at the table running things are probably also the ones who have the money to throw at HFT and come out ahead.
        yummyfajitas 14y ago
        It is a well known fact about dynamical systems in general. I.e., if you ask me about the stock market, a flight control system, an electric circuit, a biological system and a computer network, I'll tell you that continuity gives you a better shot at stability than discretization in most of them. I.e., if you don't know what you are talking about, lean towards continuity. If you do understand things, then explain the mechanics and back it up with empirics.
mattmanser 14y ago
There's no counter argument here nor does this come across as informed or educated. All you've done is talk about the process with as many technical words as you could without actually saying why 15ms liquidity gives us anything. Apart from mini-crashes. And massive profits for companies that create nothing and actually were the cause of the recent financial meltdown. Which is why many of us sit here scratching our heads or make sarcastic comments like the op.
- tptacek 14y ago
  I read his comment without any trouble. I don't work in finance but I'm perhaps a little more familiar with it than the typical HN reader. It certainly didn't come across as an attempt to snow the thread with jargon. A careful reread generates this list of domain-specific terms: resting orders, liquidity, HFT, passive trading, cancel, execute, spread, market making. Most of these mean what they sound like they mean. If "liquidity" is complicated, it's also the topic of the whole thread. "Passive trading" is probably the closest thing to jargon in the whole comment. It would be better if nobody made sarcastic comments, wouldn't it?
  - paulsutter 14y ago
    His complaint was that the post failed to explain why 15ms liquidity has any value, not the terminology. I didn't detect any sarcasm there.
    - tptacek 14y ago
      I think if you read his comment just a little more carefully you'll see what I was responding to. I don't have a "side" in this particular debate.
      - mattmanser 14y ago
        I totally don't understand what you're on about, sorry. Paul summed up my point perfectly. You seem to be forming a habit of ascribing things to me I didn't say. It's getting a little embarrassing/annoying.
davidw 14y ago
> However, that simply means they are better and faster than you, not that they are doing anything wrong. So it sounds like "the only winning move is not to play" if you are a small fish, because you're going to get screwed by people who invest a lot in this stuff? At least that's what I'm reading in that sort of message. I'm quite willing to be proven wrong, given I don't know much about the subject.
- tptacek 14y ago
  By "not play", let's be clear that with respect to HFT, the game is "active speculative trading". If your intent towards the market is to buy and hold a position, or to liquidate a long-term holding, the fact that there's a billion dollar game of Core Wars happening at the match engines is irrelevant to you except that you will probably pay a little less to execute your trade.
  - davidw 14y ago
    So where's all that cash being thrown at HFT coming from and going then? Also, just out of curiosity, you seem fairly defensive of HFT - any particular reason? I feel fairly ambivalent about it. I don't like the idea of trying to regulate stuff like that away, but it also appears to be fairly worthless / zero sum after a certain point, to the untrained eye. I'll freely admit I don't know a great deal either, though.
    - tptacek 14y ago
      Presumably from many of the same places GETCO's (significant) revenue comes from: by selling liquidity services. Market makers aren't a new concept. I find financial tech fascinating, have had a lot of projects that involved attacking them (sometimes at a financial-domain level; ie, constructing technology-centric frontrunning schemes by leveraging software bugs), and so have had a chance to learn a bit about the field. Not as much as others on this thread. I am defensive, it's true, but not about HFT (if exchanges adopted technical countermeasures to prohibit HFT, that'd actually be a win for me: one more thing for my team to test!) What bugs me is the knee-jerk comments, often from people with severely broken mental models of how trading markets work, piling on with "HFT flash-crashed the CDO meltdown" stuff.
paulsutter 14y ago
I'd like to get a better understanding of this liquidity. Assume the subset of market participants whose holding period is always > 1 day ("slow"). Assume another subset of market participants whose holding period is always < 1 minute ("fast"). Ignore everyone else in the market. Do these "slow" participants see any practical liquidity benefit from the "fast" participants? I don't see how. Financial guys envision these "slow" traders as grandmothers, but remember that most entrepreneurs have holding periods of > 5 years.
- nihilum 14y ago
  The entire point is that there are intermediate holding periods. Think about intraday speculators and statistical arbitrage funds who trade on scales of minutes to hours. They bridge the gap. Further out you have fundamental hedge funds, individual traders, pension funds, etc.
  - paulsutter 14y ago
    Thanks for the comment - this was the question I most wanted to understand. I realize that durations are on a continuous scale. I personally know people who operate across the full range of durations. But it's still far from clear to me that grandmothers (aka entrepreneurs) see any liquidity benefit from folks with short holding periods. I'm not saying it's a problem if grandmothers like me dont see a liquidity benefit from HFT. I'm just asking if it exists.
dpark 14y ago
> It's simple really: any participant who rests an order on the book is adding liquidity. Period. If a stock is trading at $100.00, and I put a buy order on the book at $0.01, how have I added liquidity? > This may lead folks to believe that the liquidity is fleeting because they can cancel away before you can execute. However, that simply means they are better and faster than you, not that they are doing anything wrong. The question is not whether it's right or wrong, but whether it is beneficial. I don't buy that HFT is intrinsically evil, but there seems to be little convincing evidence that it's actually beneficial, either. The system as you've described it basically involves scraping pennies off transactions that would have occurred anyway. That's not intrinsically evil, but it doesn't seem to actually benefit anyone except the HF trader. > Why, then, don't we simply require them to rest their orders for a longer period of time? Simple: you want tight spreads. As spreads shrink market making becomes less profitable. When market making is less profitable market makers have to be more risk averse to avoid getting adversely selected and losing money. More intelligent models (they become more informed) and less latency (they can leverage that informedness to avoid being selected) is how market makers stay profitable in a market where the average spread is 1 penny. What's missing here is an explanation of why we should build a system that enables HFT to be profitable. That's not something I care about. If lower profits for HFT means a better market overall, that's fine with me. Frankly, in markets where the spread is 1 penny, it seems like there's enough liquidity already.
- yummyfajitas 14y ago
  The system as you've described it basically involves scraping pennies off transactions that would have occurred anyway. Could you explain how to "scrape pennies" (as in specific mechanics, your explanation should involve limit orders or whatever), and why this strategy doesn't benefit the speculators the HFT is trading with?
  - dpark 14y ago
    > Could you explain how to "scrape pennies" (as in specific mechanics, your explanation should involve limit orders or whatever), Are you under the impression that you're assigning homework to students? This comes off as really rude. And no, I'm not going to write up a treatise on HFT for you. I don't pretend that this is an area of expertise for me. FTA: Most HFTs run a market making strategy. What this means is they play both sides of the table - they take no position on whether a stock will go up or down. Instead, they try to offer securities both to buy and sell. If you want to buy, they will sell to you at $20.10. If you want to sell, they’ll buy from you at $20. As long as their buys and sells match don’t get too out of whack, the HFT will collect $0.10 = $20.10 - 20.00. What is that if not "scraping pennies"? The entire goal is to jump between a buy and sell in order to skim a bit from the transaction. e.g. Alice wants to sell at $10.00. Bob wants to buy at $10.05. They could simply trade with each other, but if Eve gets her way, Eve will buy from Alice at $10.00, and then sell to Bob for $10.05, making $0.05 on each share that would otherwise have gone to Alice. Engaging in this is not evil, but I fail to see how it benefits anyone else. > and why this strategy doesn't benefit the speculators the HFT is trading with? Because when a HFT makes money, other parties involved make a little bit less. HFTs don't print money. They extract it from the market. Also, because stock markets are not exclusively limited to speculators and HFTs.
chernevik 14y ago
If you cancel faster than the market, you can stand first in line for everything and leave the line for those occasions where the trade isn't profitable. I don't see the difference between jumping to the head of the line for Good and standing in every line but jumping out for Bad. And I don't see how line-jumping adds liquidity. A bid I can never hit because it will be gone any time I'd actually want to hit it isn't much of a bid, at least as far as I'm concerned. If it's gone before anyone can hit it, then I think there's a definitional question of whether that's really a 'bid' for the intents and purposes of liquidity provision. Now I'm not saying such bids are Bad. They could be helpful in all sorts of ways. But I'm not sure that provision of liquidity is one of those.
- nihilum 14y ago
  >"A bid I can never hit because it will be gone any time I'd actually want to hit it..." Why should they let you hit them when they expect to lose? The HFT firms have some pretty decent traders. They're not going to sit there idle and let you pick them off. If you want to win this game, you have to be better than the competition.
  - chernevik 14y ago
    They shouldn't, and I don't expect them too. The point is that someone who is effectively jumping to the head of the line for profitable trades isn't really "providing liquidity". When I think of liquidity providers, I'm thinking of market makers who post prices at which they either buy or sell, offered long enough to allow other traders to hit either.

by lrm242 14y ago

_delirium 14y ago

How about rather than adding regulations, just discretize the market's clock? Would a market that performed a trade-resolution tick once every 100ms lose anything important? I believe arbitrage improves efficiency, but I'm less clear on the benefits of extremely high temporal resolution. Currently that's what the incentives encourage optimizing for, among other things. If you predict a market movement 10ms ahead of time, you can profit from that brief 10ms temporal-arbitrage window. And like any arbitrage, that does indeed improve the pricing signal in an absolute sense, in this case by taking a price change that was 10ms later than it "should've been", and moving it up in time via your trading. But it's not clear that 10ms-level pricing inefficiencies are actually something particularly important to smooth out via arbitrage, when you can just define them out of existence by going to a discrete-time market (which are fairly well-studied in the mathematical literature).

yummyfajitas 14y ago
Discretization often leads to instability, particularly if not done carefully. The prototypical example is naive discretizations of stable ODEs. Of course, all we have are toy models and speculation. The only real way to know is to try it. If I remember right, a couple of Asian equities markets have some sort of "auction on clock tick" mechanism, so we might be able to look to their experiences.
- davidw 14y ago
  > Discretization often leads to instability ... > Of course, all we have are toy models and speculation These two statements could be construed to be in conflict, especially as I haven't the faintest idea what naive discretizations of stable ODE's is, and Google isn't of much assistance in providing an explanation that I can digest.
  - yummyfajitas 14y ago
    I didn't intend them to be in conflict - I listed a toy model, and acknowledged the limitations of it. An explanation of ODEs and instability (some math background is obviously required): https://en.wikipedia.org/wiki/Stiff_equation https://en.wikipedia.org/wiki/Stiff_equation
    - davidw 14y ago
      You lead with a fairly strong statement presented as a known fact and then later indicate it's just a model. To me the idea of slowing things down sounds vaguely sensible, but I also know that I don't know enough to really judge. So it sounds like no one else really knows either, but the entrenched players like things the way they are, which makes sense, because the ones who have the money to be at the table running things are probably also the ones who have the money to throw at HFT and come out ahead.
      - yummyfajitas 14y ago
        It is a well known fact about dynamical systems in general. I.e., if you ask me about the stock market, a flight control system, an electric circuit, a biological system and a computer network, I'll tell you that continuity gives you a better shot at stability than discretization in most of them. I.e., if you don't know what you are talking about, lean towards continuity. If you do understand things, then explain the mechanics and back it up with empirics.

mattmanser 14y ago

There's no counter argument here nor does this come across as informed or educated. All you've done is talk about the process with as many technical words as you could without actually saying why 15ms liquidity gives us anything. Apart from mini-crashes. And massive profits for companies that create nothing and actually were the cause of the recent financial meltdown. Which is why many of us sit here scratching our heads or make sarcastic comments like the op.

tptacek 14y ago
I read his comment without any trouble. I don't work in finance but I'm perhaps a little more familiar with it than the typical HN reader. It certainly didn't come across as an attempt to snow the thread with jargon. A careful reread generates this list of domain-specific terms: resting orders, liquidity, HFT, passive trading, cancel, execute, spread, market making. Most of these mean what they sound like they mean. If "liquidity" is complicated, it's also the topic of the whole thread. "Passive trading" is probably the closest thing to jargon in the whole comment. It would be better if nobody made sarcastic comments, wouldn't it?
- paulsutter 14y ago
  His complaint was that the post failed to explain why 15ms liquidity has any value, not the terminology. I didn't detect any sarcasm there.
  - tptacek 14y ago
    I think if you read his comment just a little more carefully you'll see what I was responding to. I don't have a "side" in this particular debate.
    - mattmanser 14y ago
      I totally don't understand what you're on about, sorry. Paul summed up my point perfectly. You seem to be forming a habit of ascribing things to me I didn't say. It's getting a little embarrassing/annoying.

davidw 14y ago

> However, that simply means they are better and faster than you, not that they are doing anything wrong. So it sounds like "the only winning move is not to play" if you are a small fish, because you're going to get screwed by people who invest a lot in this stuff? At least that's what I'm reading in that sort of message. I'm quite willing to be proven wrong, given I don't know much about the subject.

tptacek 14y ago
By "not play", let's be clear that with respect to HFT, the game is "active speculative trading". If your intent towards the market is to buy and hold a position, or to liquidate a long-term holding, the fact that there's a billion dollar game of Core Wars happening at the match engines is irrelevant to you except that you will probably pay a little less to execute your trade.
- davidw 14y ago
  So where's all that cash being thrown at HFT coming from and going then? Also, just out of curiosity, you seem fairly defensive of HFT - any particular reason? I feel fairly ambivalent about it. I don't like the idea of trying to regulate stuff like that away, but it also appears to be fairly worthless / zero sum after a certain point, to the untrained eye. I'll freely admit I don't know a great deal either, though.
  - tptacek 14y ago
    Presumably from many of the same places GETCO's (significant) revenue comes from: by selling liquidity services. Market makers aren't a new concept. I find financial tech fascinating, have had a lot of projects that involved attacking them (sometimes at a financial-domain level; ie, constructing technology-centric frontrunning schemes by leveraging software bugs), and so have had a chance to learn a bit about the field. Not as much as others on this thread. I am defensive, it's true, but not about HFT (if exchanges adopted technical countermeasures to prohibit HFT, that'd actually be a win for me: one more thing for my team to test!) What bugs me is the knee-jerk comments, often from people with severely broken mental models of how trading markets work, piling on with "HFT flash-crashed the CDO meltdown" stuff.

paulsutter 14y ago

I'd like to get a better understanding of this liquidity. Assume the subset of market participants whose holding period is always > 1 day ("slow"). Assume another subset of market participants whose holding period is always < 1 minute ("fast"). Ignore everyone else in the market. Do these "slow" participants see any practical liquidity benefit from the "fast" participants? I don't see how. Financial guys envision these "slow" traders as grandmothers, but remember that most entrepreneurs have holding periods of > 5 years.

nihilum 14y ago
The entire point is that there are intermediate holding periods. Think about intraday speculators and statistical arbitrage funds who trade on scales of minutes to hours. They bridge the gap. Further out you have fundamental hedge funds, individual traders, pension funds, etc.
- paulsutter 14y ago
  Thanks for the comment - this was the question I most wanted to understand. I realize that durations are on a continuous scale. I personally know people who operate across the full range of durations. But it's still far from clear to me that grandmothers (aka entrepreneurs) see any liquidity benefit from folks with short holding periods. I'm not saying it's a problem if grandmothers like me dont see a liquidity benefit from HFT. I'm just asking if it exists.

dpark 14y ago

> It's simple really: any participant who rests an order on the book is adding liquidity. Period. If a stock is trading at $100.00, and I put a buy order on the book at $0.01, how have I added liquidity? > This may lead folks to believe that the liquidity is fleeting because they can cancel away before you can execute. However, that simply means they are better and faster than you, not that they are doing anything wrong. The question is not whether it's right or wrong, but whether it is beneficial. I don't buy that HFT is intrinsically evil, but there seems to be little convincing evidence that it's actually beneficial, either. The system as you've described it basically involves scraping pennies off transactions that would have occurred anyway. That's not intrinsically evil, but it doesn't seem to actually benefit anyone except the HF trader. > Why, then, don't we simply require them to rest their orders for a longer period of time? Simple: you want tight spreads. As spreads shrink market making becomes less profitable. When market making is less profitable market makers have to be more risk averse to avoid getting adversely selected and losing money. More intelligent models (they become more informed) and less latency (they can leverage that informedness to avoid being selected) is how market makers stay profitable in a market where the average spread is 1 penny. What's missing here is an explanation of why we should build a system that enables HFT to be profitable. That's not something I care about. If lower profits for HFT means a better market overall, that's fine with me. Frankly, in markets where the spread is 1 penny, it seems like there's enough liquidity already.

yummyfajitas 14y ago
The system as you've described it basically involves scraping pennies off transactions that would have occurred anyway. Could you explain how to "scrape pennies" (as in specific mechanics, your explanation should involve limit orders or whatever), and why this strategy doesn't benefit the speculators the HFT is trading with?
- dpark 14y ago
  > Could you explain how to "scrape pennies" (as in specific mechanics, your explanation should involve limit orders or whatever), Are you under the impression that you're assigning homework to students? This comes off as really rude. And no, I'm not going to write up a treatise on HFT for you. I don't pretend that this is an area of expertise for me. FTA: Most HFTs run a market making strategy. What this means is they play both sides of the table - they take no position on whether a stock will go up or down. Instead, they try to offer securities both to buy and sell. If you want to buy, they will sell to you at $20.10. If you want to sell, they’ll buy from you at $20. As long as their buys and sells match don’t get too out of whack, the HFT will collect $0.10 = $20.10 - 20.00. What is that if not "scraping pennies"? The entire goal is to jump between a buy and sell in order to skim a bit from the transaction. e.g. Alice wants to sell at $10.00. Bob wants to buy at $10.05. They could simply trade with each other, but if Eve gets her way, Eve will buy from Alice at $10.00, and then sell to Bob for $10.05, making $0.05 on each share that would otherwise have gone to Alice. Engaging in this is not evil, but I fail to see how it benefits anyone else. > and why this strategy doesn't benefit the speculators the HFT is trading with? Because when a HFT makes money, other parties involved make a little bit less. HFTs don't print money. They extract it from the market. Also, because stock markets are not exclusively limited to speculators and HFTs.

chernevik 14y ago

If you cancel faster than the market, you can stand first in line for everything and leave the line for those occasions where the trade isn't profitable. I don't see the difference between jumping to the head of the line for Good and standing in every line but jumping out for Bad. And I don't see how line-jumping adds liquidity. A bid I can never hit because it will be gone any time I'd actually want to hit it isn't much of a bid, at least as far as I'm concerned. If it's gone before anyone can hit it, then I think there's a definitional question of whether that's really a 'bid' for the intents and purposes of liquidity provision. Now I'm not saying such bids are Bad. They could be helpful in all sorts of ways. But I'm not sure that provision of liquidity is one of those.

nihilum 14y ago
>"A bid I can never hit because it will be gone any time I'd actually want to hit it..." Why should they let you hit them when they expect to lose? The HFT firms have some pretty decent traders. They're not going to sit there idle and let you pick them off. If you want to win this game, you have to be better than the competition.
- chernevik 14y ago
  They shouldn't, and I don't expect them too. The point is that someone who is effectively jumping to the head of the line for profitable trades isn't really "providing liquidity". When I think of liquidity providers, I'm thinking of market makers who post prices at which they either buy or sell, offered long enough to allow other traders to hit either.