7 ms·

"As far as narrowing spreads, that’s absolutely true, but in absolute terms what does it translate into? For the individual investor it might save them a quarte

"As far as narrowing spreads, that’s absolutely true, but in absolute terms what does it translate into? For the individual investor it might save them a quarter a month." In a properly designed, information age stock market there should not be a spread. All stocks should trade via a programmed, black box auction that runs on an interval. The HFT practice of creating phony orders that are immediately canceled, just to gain visibility into the current bids and asks, would be eliminated. No seeing other people's bids, and then front running them, no canceling orders. You put in a limit order for the value of the stock, and the stock goes to the highest bidder. All the extra pennies and quarters go to the shareholder, nothing to the HFT algorithms (unless they provide actually value such as market making or smoothing irrational volatility). It's the most efficient design for stock market trading possible.

freshhawk 14y ago
> It's the most efficient design for stock market trading possible Precisely why it doesn't work that way.
- bokonist 14y ago
  In theory, if this system were to be adopted, the Stock Exchange Operator could charge a small tariff so that some of the money that now goes to HFT's goes to the stock exchange, with the rest going to the shareholders. So in theory, adopting this more optimal system would be financially beneficially to both the corporations and the Stock Exchange (and in theory, those two are the only two players who's agreement is needed to change the system). So I wonder why the optimal, auction based system does not get adopted - is there some reason for the status quo other than the normal inertia and stupidity of large institutions?
  - freshhawk 14y ago
    > In theory Not a good theory. All the players in this game believe they are above average among players in this game. They all want the system to be exploitable because they all believe they will exploit it better than their peers. At the very least better than the investors (the real suckers here). You are falling into the game theory economics trap. People are highly irrational actors who don't even act in their own self interest most of the time, nevermind some form of optimal rational behavior.
    - bokonist 14y ago
      You are falling into the behavioral economics trap. In general, the big movers and shakers in financial markets act in quite economically rational ways. There is a natural selection process at work where the people who are good at using their brain to accumulate money, accumulate money, and thus have more impact in the market. If you look at many cases where wealthy market players appear to be acting irrationally, what you'll often see is they are acting in a personally rational manner, but are operating in a context with very perverse incentives. So I am curious if anyone in the HN commentariat knows the specific perverse incentives involved that prevent this more optimal system from happening. ( Joe Retail investor can be quite irrational. But I'm wondering why the Stock Exchanges and big corporations accept the status quo with regards to HFT.)
      - Bootvis 14y ago
        I guess that is because it is in their interest to maintain the status quo. They probably don't believe HFT is evil or is the lesser evil.
      - freshhawk 14y ago
        "In general, the big movers and shakers in financial markets act in quite economically rational ways" They are certainly more intelligent, knowledgeable and invest more rationally but I've seen nothing to make me believe that they lack or compensate for the types of positivity biases that makes everyone think they are above average and can beat their peers. We weren't talking about the contexts of the investment choices they make (where I mostly agree with you) but about changing to a system where the winners can't exploit the system to extract far more money than the value they put in. If they are A-type human beings they have a positivity bias if they have a human brain. You don't need perverse incentives to keep a system that over-rewards winners if everyone thinks they are, or soon will be, the winners. That said, I would also be interested in knowing about any perverse incentives here, I just don't think they are necessary.
rudiger 14y ago
Interesting! Where can I find out more about this more efficient market exchange design?
hogu 14y ago
How would this be better than what we have now? Right now stocks already go to the highest bidder - if there is a seller willing to sell at that price. how would you run an auction if there are 40 firms trying to sell the same stock? The ad market is well suited towards auctions because you have one seller for many buyers, but in finance you have a symmetric relationship between buyers and sellers.
- bokonist 14y ago
  Google "HFT frontrunning". The issue is that HFT algorithms can use their superior speed and the ability to cancel orders to essentially figure out what institutional buyers are bidding, and then front run the market to buy up shares in front of them. This would be prevented in my system by the black box auction and trading on an interval.
  - sseveran 14y ago
    There are many opportunities for institutional investors to trade in exactly the manner you suggest. NASDAQ runs the opening and closing cross as well as other intra-day crosses. Other platforms allow private crosses, dark pools allow crossing not in public and today 1/3 of all shares are crossed internally on brokerage platforms. Institutional investors have many opportunities to trade in the dark. There is a price to be paid for instantly accessing liquidity in the market, and it is much cheaper than it used to be.
deleted 14y ago
[deleted]
jeffem 14y ago
What experience do you have in financial markets that you believe you've come up with "the most efficient design for stock market trading possible"?
btilly 14y ago
What do you do in thinly traded markets, like some out of the market options?
- bokonist 14y ago
  You might have different auction interval times based on the volume of the particular market or stock. An AAPL auction happens every minute, but some low volume securities might trade once an hour or even once a day.
zhoutong 14y ago
This is not efficient. If you use interval bidding, there will frequently be gaps in market prices. Remember that at any instant, the order book (bids and asks) represents only a small portion of market sentiment (real demand and supply). The market prices move smoothly when people are able to react to order changes and price spikes. If it's a black box, it's very easy to manipulate the market in a massive scale. For example, AAPL is $600 now. Under your system, $600 is the price that generated the highest volume in previous bidding event. (There will be sellers placing orders under $600, and buyers over $600 - they'll all be settled at $600 and the exchange obviously wants to maximize this overlap, hence the price). If a large institutional investor wants to manipulate the price, he can place huge buy and sell orders at $700. And very likely in the next bidding event the price of AAPL will move to close to $700, because that will be the price that maximizes the overlap. This is almost impossible in current market system, because you have to continuously buy from all the sellers who are willing to sell at $700 to get the price. Meanwhile, traders (especially day traders) will add to the order book to take advantage of this irrational move. In a black box, irrational moves can't be detected and corrected by other market participants. So you can't really get the idea of the actual matching price in a black box system. When you place a buy order, if there's overlap with any sell orders, it should be matched and executed instantly. Otherwise it will stay in the book to wait for sell orders. The market equilibrium is reached when the spread is minimal and no trade occurs. (Yes, this is in theory.) However, in your "efficient" system, there's no market equilibrium, because buyers and sellers are discouraged from making their real demand and supply invisible. The exchange has the incentive to maximize trade volume, so the only way to result in zero volume is no overlapping orders in the entire interval, even when the buyers are sellers have no knowledge of any orders. This only happens when people have no confidence or interest to trade at all. Again, it makes market vulnerable to be manipulated. In China, stock exchanges partially adopted your idea. In Shanghai Securities Exchange, the first 10 minutes (9.15am to 9.25am) of the day is set to be non-continuous bidding period. In Shenzhen Securities Exchange, the first 10 mins and last 3 mins are the same. This was introduced to reduce market manipulation because the order book is empty at the beginning of the day. However, after the period, trade starts continuously and all remainder orders in the bidding event will automatically enter the order book. This way, the price movement of the whole day is smooth with minimal spikes, while the opening and closing prices reflect market sentiment more accurately. Generally, the more the visible orders, the more smoothed the price. Interval bidding discourages order placement because the next price is absolutely unpredictable. It can be adopted in extremely illiquid market situations though.

freshhawk 14y ago

> It's the most efficient design for stock market trading possible Precisely why it doesn't work that way.

bokonist 14y ago
In theory, if this system were to be adopted, the Stock Exchange Operator could charge a small tariff so that some of the money that now goes to HFT's goes to the stock exchange, with the rest going to the shareholders. So in theory, adopting this more optimal system would be financially beneficially to both the corporations and the Stock Exchange (and in theory, those two are the only two players who's agreement is needed to change the system). So I wonder why the optimal, auction based system does not get adopted - is there some reason for the status quo other than the normal inertia and stupidity of large institutions?
- freshhawk 14y ago
  > In theory Not a good theory. All the players in this game believe they are above average among players in this game. They all want the system to be exploitable because they all believe they will exploit it better than their peers. At the very least better than the investors (the real suckers here). You are falling into the game theory economics trap. People are highly irrational actors who don't even act in their own self interest most of the time, nevermind some form of optimal rational behavior.
  - bokonist 14y ago
    You are falling into the behavioral economics trap. In general, the big movers and shakers in financial markets act in quite economically rational ways. There is a natural selection process at work where the people who are good at using their brain to accumulate money, accumulate money, and thus have more impact in the market. If you look at many cases where wealthy market players appear to be acting irrationally, what you'll often see is they are acting in a personally rational manner, but are operating in a context with very perverse incentives. So I am curious if anyone in the HN commentariat knows the specific perverse incentives involved that prevent this more optimal system from happening. ( Joe Retail investor can be quite irrational. But I'm wondering why the Stock Exchanges and big corporations accept the status quo with regards to HFT.)
    - Bootvis 14y ago
      I guess that is because it is in their interest to maintain the status quo. They probably don't believe HFT is evil or is the lesser evil.
    - freshhawk 14y ago
      "In general, the big movers and shakers in financial markets act in quite economically rational ways" They are certainly more intelligent, knowledgeable and invest more rationally but I've seen nothing to make me believe that they lack or compensate for the types of positivity biases that makes everyone think they are above average and can beat their peers. We weren't talking about the contexts of the investment choices they make (where I mostly agree with you) but about changing to a system where the winners can't exploit the system to extract far more money than the value they put in. If they are A-type human beings they have a positivity bias if they have a human brain. You don't need perverse incentives to keep a system that over-rewards winners if everyone thinks they are, or soon will be, the winners. That said, I would also be interested in knowing about any perverse incentives here, I just don't think they are necessary.

rudiger 14y ago

Interesting! Where can I find out more about this more efficient market exchange design?

hogu 14y ago

How would this be better than what we have now? Right now stocks already go to the highest bidder - if there is a seller willing to sell at that price. how would you run an auction if there are 40 firms trying to sell the same stock? The ad market is well suited towards auctions because you have one seller for many buyers, but in finance you have a symmetric relationship between buyers and sellers.

bokonist 14y ago
Google "HFT frontrunning". The issue is that HFT algorithms can use their superior speed and the ability to cancel orders to essentially figure out what institutional buyers are bidding, and then front run the market to buy up shares in front of them. This would be prevented in my system by the black box auction and trading on an interval.
- sseveran 14y ago
  There are many opportunities for institutional investors to trade in exactly the manner you suggest. NASDAQ runs the opening and closing cross as well as other intra-day crosses. Other platforms allow private crosses, dark pools allow crossing not in public and today 1/3 of all shares are crossed internally on brokerage platforms. Institutional investors have many opportunities to trade in the dark. There is a price to be paid for instantly accessing liquidity in the market, and it is much cheaper than it used to be.

deleted 14y ago

[deleted]

jeffem 14y ago

What experience do you have in financial markets that you believe you've come up with "the most efficient design for stock market trading possible"?

btilly 14y ago

What do you do in thinly traded markets, like some out of the market options?

bokonist 14y ago
You might have different auction interval times based on the volume of the particular market or stock. An AAPL auction happens every minute, but some low volume securities might trade once an hour or even once a day.

zhoutong 14y ago

This is not efficient. If you use interval bidding, there will frequently be gaps in market prices. Remember that at any instant, the order book (bids and asks) represents only a small portion of market sentiment (real demand and supply). The market prices move smoothly when people are able to react to order changes and price spikes. If it's a black box, it's very easy to manipulate the market in a massive scale. For example, AAPL is $600 now. Under your system, $600 is the price that generated the highest volume in previous bidding event. (There will be sellers placing orders under $600, and buyers over $600 - they'll all be settled at $600 and the exchange obviously wants to maximize this overlap, hence the price). If a large institutional investor wants to manipulate the price, he can place huge buy and sell orders at $700. And very likely in the next bidding event the price of AAPL will move to close to $700, because that will be the price that maximizes the overlap. This is almost impossible in current market system, because you have to continuously buy from all the sellers who are willing to sell at $700 to get the price. Meanwhile, traders (especially day traders) will add to the order book to take advantage of this irrational move. In a black box, irrational moves can't be detected and corrected by other market participants. So you can't really get the idea of the actual matching price in a black box system. When you place a buy order, if there's overlap with any sell orders, it should be matched and executed instantly. Otherwise it will stay in the book to wait for sell orders. The market equilibrium is reached when the spread is minimal and no trade occurs. (Yes, this is in theory.) However, in your "efficient" system, there's no market equilibrium, because buyers and sellers are discouraged from making their real demand and supply invisible. The exchange has the incentive to maximize trade volume, so the only way to result in zero volume is no overlapping orders in the entire interval, even when the buyers are sellers have no knowledge of any orders. This only happens when people have no confidence or interest to trade at all. Again, it makes market vulnerable to be manipulated. In China, stock exchanges partially adopted your idea. In Shanghai Securities Exchange, the first 10 minutes (9.15am to 9.25am) of the day is set to be non-continuous bidding period. In Shenzhen Securities Exchange, the first 10 mins and last 3 mins are the same. This was introduced to reduce market manipulation because the order book is empty at the beginning of the day. However, after the period, trade starts continuously and all remainder orders in the bidding event will automatically enter the order book. This way, the price movement of the whole day is smooth with minimal spikes, while the opening and closing prices reflect market sentiment more accurately. Generally, the more the visible orders, the more smoothed the price. Interval bidding discourages order placement because the next price is absolutely unpredictable. It can be adopted in extremely illiquid market situations though.