6 ms·

One point that is bothering me is this: how much of the existence of HFTs is an artifact of the rules of the exchange? In particular, the rule that the first bi

One point that is bothering me is this: how much of the existence of HFTs is an artifact of the rules of the exchange? In particular, the rule that the first bid gets priority in executing the trade. It strikes me that the entire existence of HFTs seems to be taking advantage of this failure of mechanism design.

fr0sty 15y ago
There was an extensive discussion on this point in the previous HN thread: http://news.ycombinator.com/item?id=3855610 http://news.ycombinator.com/item?id=3855610 The short summary is no one can come up with something better than price-time priority for matching orders.
- btilly 15y ago
  I still like my suggestion at http://news.ycombinator.com/item?id=3855846 http://news.ycombinator.com/item?id=3855846. True, the HFT folks would still try to provide liquidity by maintaining a bid/ask spread. But every trade that executes because someone wanted to trade while the price was somewhere between the bid and the ask would cut the HFT folks out of the loop to the benefit of everyone else. And scary anomalies like the flash crash would be impossible. After careful thought I am sure that it would not eliminate HFT. But it would reduce their size and impact on the market.
  - alphaBetaGamma 15y ago
    As far as I understand your suggestion, it exactly describes the way current markets work.
    - btilly 15y ago
      Then you did not understand the suggestion. :-( The key point of what I suggested is that the price drifts slowly, and orders can only execute at the current price. In today's market the price can move instantaneously. That's a pretty big difference.
      - sokoloff 15y ago
        You're creating a new notion that doesn't currently exist: that there is "a price" in a stable equilibrium condition, when in fact, there is a spread. (I think if you draw out an order book of bids and asks, and then try to overlay your notion of a "single price" on it, you will find that your system is not an improvement, at least not for people who value certainty.) Part of the problem that others are having understanding you (assuming your system is, in fact, better) is that you don't seem to be giving a full explanation that relates to the actual order book initial conditions and new incoming order flow. I'm not an expert by any means, but I can't understand, concretely, EXACTLY how your proposal is intended to work. It feels hand-wavy to me, which usually means that an idea isn't fully-formed. (I mean no disrespect here; just stating my perception.) I WANT the price to move instantaneously, even though my only interface is via Etrade's retail and mobile site, and I probably execute 400 trades a year. I strongly prefer instant over a few pennies here and there, even though I'm at a (at least theoretical) disadvantage in terms of market access as compared to the HFTs.
        yummyfajitas 15y ago
        I think what he calls "price" is an arbitrary variable the exchange defines (along with some set of rules that price follows), and then imposes the rule that trades occur at it.
        btilly 15y ago
        Exactly.
  - yummyfajitas 15y ago
    ...every trade that executes because someone wanted to trade while the price was somewhere between the bid and the ask would cut the HFT folks out of the loop... See the first post in the series. This is exactly how the markets work. The best price always wins. If the bid/ask is $10.00/10.05, and I offer to buy at $10.05, I will trade immediately. If I offer to buy at $10.03, I jump the queue and will be the first to trade (provided someone is willing to sell at $10.03 or lower).
    - btilly 15y ago
      You either did not read my suggestion, or did not understand it, because it is very different from how the markets work today. Suppose that the bid/ask is $10.00/10.05. Suppose that I am willing to buy at $10.20. In today's market I will immediately make the trade at $10.05. In my suggested market there is another fact to consider, the price. Suppose that it is $10.03. Then I become an outstanding buy order, and for as long as I am outstanding, the price will drift up. If the price reaches $10.05 without finding a seller, then I will trade at $10.05 with the HFT folks. But if a seller who is willing to sell at $9.90 comes along before that happens, we will trade with each other at the current price and leave the HFT folks out of the loop. My suspicion is that, if this were implemented, a large fraction of trades would actually execute in the middle ground between what the HFT traders are willing to offer as a bid/ask. Therefore this would be even better for actual speculators than the current system. HFT players would still be in that market, but they would not be as important. In short the difference with my system is that trades may have a small delay before they execute, but should execute at the same or better price for me than the existing market mechanism.
      - yummyfajitas 15y ago
        I definitely misunderstood what you proposed. Your idea is definitely interesting. It certainly slows down price discovery, though probably not enough to matter. I'd need to think more carefully about whether it's a good idea or not, but it's definitely the best suggested tweak to market mechanics I've heard in this thread (or the last one).
- unabridged 15y ago
  I still think discretizing the exchange (bucketing all orders every N milliseconds) is the best way to go, no one in that thread was able to show why it would be worse than our current method. All we lose is the ability for entities to change prices during the round, and we level the playing field for traders who cannot afford colocation with the exchange.
growse 15y ago
How else would you do it? At random? Why would that be better?
- jcampbell1 15y ago
  Possibly. It would stop the arms race that adds little value to the economy. The same arms race happened in the pits, except it was height, not latency. It seems a bit ridiculous that a taller trader would make more money that a smarter one, and that a faster algorithm makes more money than a smarter one.
  - kiba 15y ago
    Intelligence is also a function of speed. All else being equal, a faster solver will win over the slow one. A faster learner will accumulate much more knowledge in less time. In warfare, it pays to react faster than your opponents. You don't have time to think slowly about how you're going to shoot. You'll just have to shoot accurately and utilize tactics that you already know.
    - yummyfajitas 15y ago
      Much like warfare, the race to trade is a zero sum game. Either Leela or Bender is going to provide liquidity, but no one (besides Leela and Bender) cares which one does. There is no compelling social reason why we should reward smarts in this case.
    - jcampbell1 15y ago
      Should all the spoils of market making go to the fastest trader, or should the trader who is willing to offer the most volume be rewarded? The goal is liquidity, and it is not obvious which answer is best. Don't dismiss the tradeoff. At any rate, the current system is much better than rewarding the tallest guy with the ugliest jacket.
  - deleted 15y ago
    [deleted]
  - 15y ago
chrisaycock 15y ago
Not all exchanges have time priority. NASDAQ PSX and most of the derivatives exchanges use a pro-rata allocation based on how large the quote size is. Also, NYSE gives "parity" to their floor brokers and designated market makers, effectively letting them jump the queue over other liquidity providers. See this discussion on the Quant Finance Stack Exchange: http://quant.stackexchange.com/q/2278/35 http://quant.stackexchange.com/q/2278/35
andrewla 15y ago
Not all exchanges do time-based priority. For example, the Philadelphia Stock Exchange (PSX) operated by NASDAQ uses a pro-rata allocation based on order size at a given price level. See rule 3307, "Book Processing", at http://nasdaqomxphlx.cchwallstreet.com/NASDAQOMXPHLXTools/PlatformViewer.asp?selectednode=chp_1_3&manual=%2Fnasdaqomxphlx%2Fphlx%2Fphlx-rulesbrd%2F http://nasdaqomxphlx.cchwallstreet.com/NASDAQOMXPHLXTools/Pl....
yread 15y ago
I wonder if http://en.wikipedia.org/wiki/Dutch_auction http://en.wikipedia.org/wiki/Dutch_auction could be useful

fr0sty 15y ago

There was an extensive discussion on this point in the previous HN thread: http://news.ycombinator.com/item?id=3855610 http://news.ycombinator.com/item?id=3855610 The short summary is no one can come up with something better than price-time priority for matching orders.

btilly 15y ago
I still like my suggestion at http://news.ycombinator.com/item?id=3855846 http://news.ycombinator.com/item?id=3855846. True, the HFT folks would still try to provide liquidity by maintaining a bid/ask spread. But every trade that executes because someone wanted to trade while the price was somewhere between the bid and the ask would cut the HFT folks out of the loop to the benefit of everyone else. And scary anomalies like the flash crash would be impossible. After careful thought I am sure that it would not eliminate HFT. But it would reduce their size and impact on the market.
- alphaBetaGamma 15y ago
  As far as I understand your suggestion, it exactly describes the way current markets work.
  - btilly 15y ago
    Then you did not understand the suggestion. :-( The key point of what I suggested is that the price drifts slowly, and orders can only execute at the current price. In today's market the price can move instantaneously. That's a pretty big difference.
    - sokoloff 15y ago
      You're creating a new notion that doesn't currently exist: that there is "a price" in a stable equilibrium condition, when in fact, there is a spread. (I think if you draw out an order book of bids and asks, and then try to overlay your notion of a "single price" on it, you will find that your system is not an improvement, at least not for people who value certainty.) Part of the problem that others are having understanding you (assuming your system is, in fact, better) is that you don't seem to be giving a full explanation that relates to the actual order book initial conditions and new incoming order flow. I'm not an expert by any means, but I can't understand, concretely, EXACTLY how your proposal is intended to work. It feels hand-wavy to me, which usually means that an idea isn't fully-formed. (I mean no disrespect here; just stating my perception.) I WANT the price to move instantaneously, even though my only interface is via Etrade's retail and mobile site, and I probably execute 400 trades a year. I strongly prefer instant over a few pennies here and there, even though I'm at a (at least theoretical) disadvantage in terms of market access as compared to the HFTs.
      - yummyfajitas 15y ago
        I think what he calls "price" is an arbitrary variable the exchange defines (along with some set of rules that price follows), and then imposes the rule that trades occur at it.
        btilly 15y ago
        Exactly.
- yummyfajitas 15y ago
  ...every trade that executes because someone wanted to trade while the price was somewhere between the bid and the ask would cut the HFT folks out of the loop... See the first post in the series. This is exactly how the markets work. The best price always wins. If the bid/ask is $10.00/10.05, and I offer to buy at $10.05, I will trade immediately. If I offer to buy at $10.03, I jump the queue and will be the first to trade (provided someone is willing to sell at $10.03 or lower).
  - btilly 15y ago
    You either did not read my suggestion, or did not understand it, because it is very different from how the markets work today. Suppose that the bid/ask is $10.00/10.05. Suppose that I am willing to buy at $10.20. In today's market I will immediately make the trade at $10.05. In my suggested market there is another fact to consider, the price. Suppose that it is $10.03. Then I become an outstanding buy order, and for as long as I am outstanding, the price will drift up. If the price reaches $10.05 without finding a seller, then I will trade at $10.05 with the HFT folks. But if a seller who is willing to sell at $9.90 comes along before that happens, we will trade with each other at the current price and leave the HFT folks out of the loop. My suspicion is that, if this were implemented, a large fraction of trades would actually execute in the middle ground between what the HFT traders are willing to offer as a bid/ask. Therefore this would be even better for actual speculators than the current system. HFT players would still be in that market, but they would not be as important. In short the difference with my system is that trades may have a small delay before they execute, but should execute at the same or better price for me than the existing market mechanism.
    - yummyfajitas 15y ago
      I definitely misunderstood what you proposed. Your idea is definitely interesting. It certainly slows down price discovery, though probably not enough to matter. I'd need to think more carefully about whether it's a good idea or not, but it's definitely the best suggested tweak to market mechanics I've heard in this thread (or the last one).
unabridged 15y ago
I still think discretizing the exchange (bucketing all orders every N milliseconds) is the best way to go, no one in that thread was able to show why it would be worse than our current method. All we lose is the ability for entities to change prices during the round, and we level the playing field for traders who cannot afford colocation with the exchange.

growse 15y ago

How else would you do it? At random? Why would that be better?

jcampbell1 15y ago
Possibly. It would stop the arms race that adds little value to the economy. The same arms race happened in the pits, except it was height, not latency. It seems a bit ridiculous that a taller trader would make more money that a smarter one, and that a faster algorithm makes more money than a smarter one.
- kiba 15y ago
  Intelligence is also a function of speed. All else being equal, a faster solver will win over the slow one. A faster learner will accumulate much more knowledge in less time. In warfare, it pays to react faster than your opponents. You don't have time to think slowly about how you're going to shoot. You'll just have to shoot accurately and utilize tactics that you already know.
  - yummyfajitas 15y ago
    Much like warfare, the race to trade is a zero sum game. Either Leela or Bender is going to provide liquidity, but no one (besides Leela and Bender) cares which one does. There is no compelling social reason why we should reward smarts in this case.
  - jcampbell1 15y ago
    Should all the spoils of market making go to the fastest trader, or should the trader who is willing to offer the most volume be rewarded? The goal is liquidity, and it is not obvious which answer is best. Don't dismiss the tradeoff. At any rate, the current system is much better than rewarding the tallest guy with the ugliest jacket.
- deleted 15y ago
  [deleted]
- 15y ago

chrisaycock 15y ago

Not all exchanges have time priority. NASDAQ PSX and most of the derivatives exchanges use a pro-rata allocation based on how large the quote size is. Also, NYSE gives "parity" to their floor brokers and designated market makers, effectively letting them jump the queue over other liquidity providers. See this discussion on the Quant Finance Stack Exchange: http://quant.stackexchange.com/q/2278/35 http://quant.stackexchange.com/q/2278/35

andrewla 15y ago

Not all exchanges do time-based priority. For example, the Philadelphia Stock Exchange (PSX) operated by NASDAQ uses a pro-rata allocation based on order size at a given price level. See rule 3307, "Book Processing", at http://nasdaqomxphlx.cchwallstreet.com/NASDAQOMXPHLXTools/PlatformViewer.asp?selectednode=chp_1_3&manual=%2Fnasdaqomxphlx%2Fphlx%2Fphlx-rulesbrd%2F http://nasdaqomxphlx.cchwallstreet.com/NASDAQOMXPHLXTools/Pl....

yread 15y ago

I wonder if http://en.wikipedia.org/wiki/Dutch_auction http://en.wikipedia.org/wiki/Dutch_auction could be useful