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One of the biggest justifications for HFT that I see is that it increases liquidity. However, did major markets ever really have a huge problem with lack of li

One of the biggest justifications for HFT that I see is that it increases liquidity. However, did major markets ever really have a huge problem with lack of liquidity, 20 or 30 years ago before HFT? I can't help but wonder if this level of liquidity is only really useful to HFT, if it is something that HFT is both the primary provider and beneficiary of, and if they're sort of using their existence to justify their existence, so to speak. Chris uses mom and pop trader examples to explain the concepts here, but the fact is that Algo trading now accounts for much of the volume on major exchanges, and HFT is probably a decent portion of that. I'd love to see Chris or any other HFT trader's take on that. He sort of does near the end, but would be interesting to see a more in depth discussion: >Although the latency competition provides little to no value to the end consumers, all HFTs must play the game. If they don’t, a faster HFT will beat them to market and their order flow will be reduced. This is a very real social cost of HFT - many very smart people spend a lot of time and effort reducing the latency of trading systems. I’m no fool, but when I worked as an HFT I often felt like one. The field contains a lot of very smart people, and the world would probably be better off if the stock market had a little more latency and those smart people were building products for the world. For example, after leaving HFT I built a useful consumer product. But with current market mechanics, the global optimum where trading is marginally slower and smart people build useful products is impossible to reach. The latency arms race has us stuck in a suboptimal Nash Equilibrium which is similar in character to signalling competitions (e.g., the education bubble).

tptacek 15y ago
Yes. The reason you didn't read about it is because the markets didn't really consider it a "problem" that they were fleecing people who needed to cross the spreads to make trades; it was just part of the business model.
harryh 15y ago
> However, did major markets ever really have a huge problem with lack of liquidity, 20 or 30 years ago before HFT? Yes. It used to be that humans were the market makers. Humans are (generally) a lot more expensive than computers so providing liquidity came at a higher cost. Bid/ask spreads used to be much higher. HFT it just an example of computers replacing humans at a lower cost. A phenomenon that can be observed in many industries.
- tptacek 15y ago
  Humans are also far less transparent than algorithmic market makers. Talk to professionals about the specialist system. It's (words chosen carefully) hard to take anyone seriously who pines for the good old days of 1970's and 1980's trade execution.
  - harryh 15y ago
    Yup, 100% agree.
  - teamonkey 15y ago
    > hard to take anyone seriously who pines for the good old days of 1970's and 1980's trade execution. I've just read through the entire thread and I don't think anyone has suggested that.
    - tptacek 15y ago
      "did major markets ever really have a huge problem with lack of liquidity, 20 or 30 years ago before HFT?"
      - SkyMarshal 15y ago
        I wasn't 'pining' for those days, I was barely even alive then. Just asking.
beagle3 15y ago
> However, did major markets ever really have a huge problem with lack of liquidity, 20 or 30 years ago before HFT? Well, officially some traders in US exchanges are privileged in both information and fees ("specialist" market makers) in exchange for guaranteeing liquidity. I was not following the markets 20 or 30 years ago, but those "specialists" always claimed that they were, in fact, helping the market rather than themselves (it was demonstrably false in the mid 2000s for almost all specialists; I don't know about the 80s). European exchanges in which no such privileged traders exist were able to pick up a lot of international and american trading volume in the last 10 years thanks to perceived anonymity and fairness. The german exchanges went as far as to slow down data streams to better connected users until they were able to offer the better connection across the board.
gaius 15y ago
I thought you wrote mom and prop trader which would be a great way to describe a small fund.
fr0sty 15y ago
> did major markets ever really have a huge problem with lack of liquidity, 20 or 30 years ago before HFT? Yes. huge problems. 20 years ago (1992) stocks were traded in 1/8ths or 1/4s (minimum spreads of (12.5 or 25 cents) often more than one tick wide. By the turn of the century stocks had all been decimalized (traded in pennies) but spreads were still wide. This article: page 25 of this paper[1] shows the average stock spread of S&P500 stocks being squished from 8cents in 1997 to less than 2cents in 2010. [1] www.kellogg.northwestern.edu/faculty/...d/murphy_kim_spread.pdf
- tptacek 15y ago
  When you read this comment, keep in the front of your mind that the "width of the spread" is marketspeak for "the fee paid by normal people who want to buy and sell long-term positions to have market professionals execute their trades for them". You want spreads as thin as possible.

tptacek 15y ago

Yes. The reason you didn't read about it is because the markets didn't really consider it a "problem" that they were fleecing people who needed to cross the spreads to make trades; it was just part of the business model.

harryh 15y ago

> However, did major markets ever really have a huge problem with lack of liquidity, 20 or 30 years ago before HFT? Yes. It used to be that humans were the market makers. Humans are (generally) a lot more expensive than computers so providing liquidity came at a higher cost. Bid/ask spreads used to be much higher. HFT it just an example of computers replacing humans at a lower cost. A phenomenon that can be observed in many industries.

tptacek 15y ago
Humans are also far less transparent than algorithmic market makers. Talk to professionals about the specialist system. It's (words chosen carefully) hard to take anyone seriously who pines for the good old days of 1970's and 1980's trade execution.
- harryh 15y ago
  Yup, 100% agree.
- teamonkey 15y ago
  > hard to take anyone seriously who pines for the good old days of 1970's and 1980's trade execution. I've just read through the entire thread and I don't think anyone has suggested that.
  - tptacek 15y ago
    "did major markets ever really have a huge problem with lack of liquidity, 20 or 30 years ago before HFT?"
    - SkyMarshal 15y ago
      I wasn't 'pining' for those days, I was barely even alive then. Just asking.

beagle3 15y ago

> However, did major markets ever really have a huge problem with lack of liquidity, 20 or 30 years ago before HFT? Well, officially some traders in US exchanges are privileged in both information and fees ("specialist" market makers) in exchange for guaranteeing liquidity. I was not following the markets 20 or 30 years ago, but those "specialists" always claimed that they were, in fact, helping the market rather than themselves (it was demonstrably false in the mid 2000s for almost all specialists; I don't know about the 80s). European exchanges in which no such privileged traders exist were able to pick up a lot of international and american trading volume in the last 10 years thanks to perceived anonymity and fairness. The german exchanges went as far as to slow down data streams to better connected users until they were able to offer the better connection across the board.

gaius 15y ago

I thought you wrote mom and prop trader which would be a great way to describe a small fund.

fr0sty 15y ago

> did major markets ever really have a huge problem with lack of liquidity, 20 or 30 years ago before HFT? Yes. huge problems. 20 years ago (1992) stocks were traded in 1/8ths or 1/4s (minimum spreads of (12.5 or 25 cents) often more than one tick wide. By the turn of the century stocks had all been decimalized (traded in pennies) but spreads were still wide. This article: page 25 of this paper[1] shows the average stock spread of S&P500 stocks being squished from 8cents in 1997 to less than 2cents in 2010. [1] www.kellogg.northwestern.edu/faculty/...d/murphy_kim_spread.pdf

tptacek 15y ago
When you read this comment, keep in the front of your mind that the "width of the spread" is marketspeak for "the fee paid by normal people who want to buy and sell long-term positions to have market professionals execute their trades for them". You want spreads as thin as possible.