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I don't think that SomeCallMeTim understands that 0.10/share is a lot of money ($100,000) when a mutual fund is trading 1 million shares over 10 days. Now muli

I don't think that SomeCallMeTim understands that 0.10/share is a lot of money ($100,000) when a mutual fund is trading 1 million shares over 10 days. Now mulitply that by 60 holdings which are turned over 100% per year and you can see why pensions would want those mutual funds to save $6,000,000/year in liquidity costs. (Obviously mutual funds don't just do program trades, they also negotiate directly with each other etc. but the example still stands).

pdovy 15y ago
Exactly. Even more direct benefit to retail investors - low liquidity costs mean that we can invest in mutual funds and especially ETFs that have extremely low fees. Those funds have to shuffle around their holdings as investors come and go, and they'd have to charge a lot more if they were paying $0.10 to cross the spread.
- wtvanhest 15y ago
  The ETF concept could be interesting to look at. I was reading Tryenor's book and I thought he mentioned how entering an ETF position still nets out below an index return because of the cost of liquidity. I wonder if ETFs would have ever grown as large as they had if HFT never existed (the time periods of the rise of ETF parallels to the rise of HFT.) Anybody have any insight here?
  - JumpCrisscross 15y ago
    The success of ETFs is probably significantly underwritten by the increased liquidity. As a rule of thumb liquidity makes markets less volatile and thus able to sustain more complex structures. ETFs control tracking error, how closely the ETF follows the index to which it is benchmarked, by letting authorised participants (APs) arbitrage the ETF against the underlying. For example, if you are a SPY AP, you can turn in a certain quantity, called the creation unit, of S&P 500 constituent stocks and "create" the correct number of ETF units. Alternatively, you could surrender a creation unit of SPYs and the ETF trust would "destroy" those ETF units and issue you the S&P 500 constituent stocks [1]. The risk for APs increases non-linearly vis-a-vis the liquidity of the underlying. This has been empirically witnessed as a "U-shaped relationship between fund premium and market liquidity, which suggests that more active trading does lead to lower mispricing but only after a certain level of liquidity is reached" [2]. [1] http://www.londonstockexchange.com/traders-and-brokers/security-types/etfs/education/how-etfs-work/how-etfs-work.htm http://www.londonstockexchange.com/traders-and-brokers/secur... [2] http://onlinelibrary.wiley.com/doi/10.1111/j.1468-0416.2008.00144.x/abstract;jsessionid=1E87344267C3527B187A656E565B88D9.d01t01?userIsAuthenticated=false&deniedAccessCustomisedMessage= http://onlinelibrary.wiley.com/doi/10.1111/j.1468-0416.2008....
nhaehnle 15y ago
Please explain why small improvements in the spread are relevant compared to intraday movements. If I were trading a million shares over 10 days, then I would be much more worried about trading them at the right time of day, rather than worrying about bid/ask spreads. Edit: I am assuming here that we are talking about trades that actually change my long-term position. That is, I am selling or buying those million shares for good because I am re-weighting my portfolio or something like that.
- wtvanhest 15y ago
  They are both relevant. In general a portfolio manager + investment analysts are worried about stock price movements but the trader for the fund is worried about liquidity spreads and about buying the shares for the lowest price while selling shares for the greatest price. While $6M in not large by percentage, there is no reason to want to give that up.
  - nhaehnle 15y ago
    While $6M in not large by percentage, there is no reason to want to give that up. On the other hand, imagine a world of only portfolio managers and no HFT. That is, trades happen only between portfolio managers with no middle man. Then yes, on one day you as a portfolio manager would have to give up $6M. But where do those $6M go? Logically, they must go to another portfolio manager. By symmetry of portfolio managers, it follows that on other days, you will be the one who gains $6M. That should net out to zero on average, at least assuming that all portfolio managers are equally sophisticated. On the other hand, the HFTs earn money, otherwise they wouldn't be in the business. Where does that money come from, if not from the portfolio managers? So it seems that as long as you're looking at a narrow micro perspective, the story makes sense. But once you add up everything to a macro perspective, the argument vanishes. This does not necessarily apply against algorithmic trading in general. Algorithmic trading may well serve to always have some orders in the order book even on low volume markets, since humans just cannot trade on as many markets simultaneously as a computer can. But the arms race to ever lower latencies just seems useless from the point of view of society.
SomeCallMeTim 15y ago
I get that $0.10/share is significant, or I wouldn't have bothered posting. Why be annoyed at a process that isn't costing anyone anything significant? I also know that HFTs are taking money out of the equation, not adding money into the equation. If they weren't, they wouldn't be doing it -- and if the only value they're adding is reducing the time that a trade takes place by minutes or seconds, then I still submit that the value added to the stock market isn't worth the ACTUAL dollar cost. The OP pointed at the example with Fry and Zoidberg. In that case, Leela either makes $0.05/share on the transaction (which otherwise would have gone to Fry and/or Zoidberg), or takes a hit of $0.50/share. In the latter case Fry (say that's you're mutual fund) makes $0.50/share more than they would have otherwise, but that money doesn't come out of thin air -- it's lost by Leela. But in order for HFTs to do well, they have to make more money than they lose, so for every case like the above where Fry does better than he would have otherwise there is more money lost by people who would have done better without the interference of HFTs. So for every $100,000 saved by a mutual fund, much more is being siphoned off by HFTs, for no real added value.
- wtvanhest 15y ago
  I also know that HFTs are taking money out of the equation, not adding money into the equation. If they weren't, they wouldn't be doing it This assumption is questionable. There are a vast number of market participants who do loose money. The best start up example is the bias toward reporting companies who just got funding and not reporting all the companies that hit the dead pool. We don't really have a good idea on the net of HFT strategies and it is just as safe to assume they net zero. Lets just say HFT firms did net to zero, would you still have the same argument?
  - sirclueless 15y ago
    That seems massively unrealistic to me. It's safe to assume that HFT makes its participants a lot of money, for example because we know that they tend to spend a lot of money on hardware.
    - wtvanhest 15y ago

pdovy 15y ago

Exactly. Even more direct benefit to retail investors - low liquidity costs mean that we can invest in mutual funds and especially ETFs that have extremely low fees. Those funds have to shuffle around their holdings as investors come and go, and they'd have to charge a lot more if they were paying $0.10 to cross the spread.

wtvanhest 15y ago
The ETF concept could be interesting to look at. I was reading Tryenor's book and I thought he mentioned how entering an ETF position still nets out below an index return because of the cost of liquidity. I wonder if ETFs would have ever grown as large as they had if HFT never existed (the time periods of the rise of ETF parallels to the rise of HFT.) Anybody have any insight here?
- JumpCrisscross 15y ago
  The success of ETFs is probably significantly underwritten by the increased liquidity. As a rule of thumb liquidity makes markets less volatile and thus able to sustain more complex structures. ETFs control tracking error, how closely the ETF follows the index to which it is benchmarked, by letting authorised participants (APs) arbitrage the ETF against the underlying. For example, if you are a SPY AP, you can turn in a certain quantity, called the creation unit, of S&P 500 constituent stocks and "create" the correct number of ETF units. Alternatively, you could surrender a creation unit of SPYs and the ETF trust would "destroy" those ETF units and issue you the S&P 500 constituent stocks [1]. The risk for APs increases non-linearly vis-a-vis the liquidity of the underlying. This has been empirically witnessed as a "U-shaped relationship between fund premium and market liquidity, which suggests that more active trading does lead to lower mispricing but only after a certain level of liquidity is reached" [2]. [1] http://www.londonstockexchange.com/traders-and-brokers/security-types/etfs/education/how-etfs-work/how-etfs-work.htm http://www.londonstockexchange.com/traders-and-brokers/secur... [2] http://onlinelibrary.wiley.com/doi/10.1111/j.1468-0416.2008.00144.x/abstract;jsessionid=1E87344267C3527B187A656E565B88D9.d01t01?userIsAuthenticated=false&deniedAccessCustomisedMessage= http://onlinelibrary.wiley.com/doi/10.1111/j.1468-0416.2008....

nhaehnle 15y ago

Please explain why small improvements in the spread are relevant compared to intraday movements. If I were trading a million shares over 10 days, then I would be much more worried about trading them at the right time of day, rather than worrying about bid/ask spreads. Edit: I am assuming here that we are talking about trades that actually change my long-term position. That is, I am selling or buying those million shares for good because I am re-weighting my portfolio or something like that.

wtvanhest 15y ago
They are both relevant. In general a portfolio manager + investment analysts are worried about stock price movements but the trader for the fund is worried about liquidity spreads and about buying the shares for the lowest price while selling shares for the greatest price. While $6M in not large by percentage, there is no reason to want to give that up.
- nhaehnle 15y ago
  While $6M in not large by percentage, there is no reason to want to give that up. On the other hand, imagine a world of only portfolio managers and no HFT. That is, trades happen only between portfolio managers with no middle man. Then yes, on one day you as a portfolio manager would have to give up $6M. But where do those $6M go? Logically, they must go to another portfolio manager. By symmetry of portfolio managers, it follows that on other days, you will be the one who gains $6M. That should net out to zero on average, at least assuming that all portfolio managers are equally sophisticated. On the other hand, the HFTs earn money, otherwise they wouldn't be in the business. Where does that money come from, if not from the portfolio managers? So it seems that as long as you're looking at a narrow micro perspective, the story makes sense. But once you add up everything to a macro perspective, the argument vanishes. This does not necessarily apply against algorithmic trading in general. Algorithmic trading may well serve to always have some orders in the order book even on low volume markets, since humans just cannot trade on as many markets simultaneously as a computer can. But the arms race to ever lower latencies just seems useless from the point of view of society.

SomeCallMeTim 15y ago

I get that $0.10/share is significant, or I wouldn't have bothered posting. Why be annoyed at a process that isn't costing anyone anything significant? I also know that HFTs are taking money out of the equation, not adding money into the equation. If they weren't, they wouldn't be doing it -- and if the only value they're adding is reducing the time that a trade takes place by minutes or seconds, then I still submit that the value added to the stock market isn't worth the ACTUAL dollar cost. The OP pointed at the example with Fry and Zoidberg. In that case, Leela either makes $0.05/share on the transaction (which otherwise would have gone to Fry and/or Zoidberg), or takes a hit of $0.50/share. In the latter case Fry (say that's you're mutual fund) makes $0.50/share more than they would have otherwise, but that money doesn't come out of thin air -- it's lost by Leela. But in order for HFTs to do well, they have to make more money than they lose, so for every case like the above where Fry does better than he would have otherwise there is more money lost by people who would have done better without the interference of HFTs. So for every $100,000 saved by a mutual fund, much more is being siphoned off by HFTs, for no real added value.

wtvanhest 15y ago
I also know that HFTs are taking money out of the equation, not adding money into the equation. If they weren't, they wouldn't be doing it This assumption is questionable. There are a vast number of market participants who do loose money. The best start up example is the bias toward reporting companies who just got funding and not reporting all the companies that hit the dead pool. We don't really have a good idea on the net of HFT strategies and it is just as safe to assume they net zero. Lets just say HFT firms did net to zero, would you still have the same argument?
- sirclueless 15y ago
  That seems massively unrealistic to me. It's safe to assume that HFT makes its participants a lot of money, for example because we know that they tend to spend a lot of money on hardware.
  - wtvanhest 15y ago