9 ms·

How the Robots Lost: High-Frequency Trading's Rise and Fall

131 points by nohuck13 13y ago

yummyfajitas 13y ago
tl;dr; Competition between HFTs has reduced margins on market making to near zero. Wonderful news for consumers of liquidity, bad news for sellers of it.
- eksith 13y ago
  More than that though, the robots only win when they're fighting panicked human traders who try to maximize and fire blind (or at least a few seconds slower). Speaking of intelligent programs, they failed to achieve equilibrium with their natural environment, as Agent Smith would say. The takeaway: HFT also lacks the two things it needs the most: trading volume and price volatility. Compared with the deep, choppy waters of 2009 and 2010, the stock market is now a shallow, placid pool.
  - nissimk 13y ago
    Yes, that's the integral section of the article, but what it's really saying is that at least one component of this is the current cycle low in volatility and volume. This is a classic wall st shakeout when the best capitalized firms that make it through the down part of the cycle come back much stronger when their market returns because their competition closed up shop. They haven't scared everybody away, they're just suffering a market downturn in volatility and volume right now. The robots win when people trade more and when prices move around more. When those conditions return, the robot party will be back on.
- ott2 13y ago
  The second main point: with declining volatility, there is less space for HFT strategies to profit. What I didn't see in the article was an explicit discussion of transaction costs. Transaction tax would increase those costs, but was part of the decline because transaction costs have already gone up?
- crusso 13y ago
  That and this sad kicking in the groin of a system that's working through technology issues as it should: Democrats in Congress would go further. Iowa Senator Tom Harkin and Oregon Representative Peter DeFazio want a .03 percent tax on nearly every trade in nearly every market in the U.S Politicians just have to get in and start pecking for some extra revenue and attempt to give the illusion that they're going to help.
  - ihsw 13y ago
    Interestingly Sweden tried a 0.5% tax in 1984: > During the first week of the tax, the volume of bond trading fell by 85%, even though the tax rate on five-year bonds was only 0.003%. The volume of futures trading fell by 98% and the options trading market disappeared. Needless to say, 'tax avoidance' became the norm (especially since it was exceedingly easy to circumvent) and it was later repealed in 1991. [1] http://en.wikipedia.org/wiki/Swedish_financial_transaction_tax http://en.wikipedia.org/wiki/Swedish_financial_transaction_t...
    - crististm 13y ago
      law of unintended consequences
  - whazzmaster 13y ago
    In today's deficit boogeyman environment I can't say that extra revenue isn't a consideration, but really the tax was to attempt to stem a runaway financial system that has become the blood-sucking vampire squid[1] that's taking more and more of the wealth while providing little of value to the country. [1] http://www.guardian.co.uk/business/andrew-clark-on-america/2009/jul/14/goldmansachs-banks http://www.guardian.co.uk/business/andrew-clark-on-america/2...
    - crusso 13y ago
      Like the article points out, the inefficiencies of the market are being removed exactly because of these so called "vampire squid". Maybe we should call them "cleaner shrimp" instead, since they're performing a useful function? Don't get me wrong, I tried my hand at some day trading a couple of years back and the HFTs helped to make it hard going. That was the problem with the business model I wanted to pursue at the time, though, not with the market itself.
- clavalle 13y ago
  Yep. They are currently scrambling into every market on the planet to try and eke out profits there but the pace is accelerated. Before too long I think we will see HFTs merging until there are only a handful of players globally. IOW, HFT is transitioning into a commodity.
macavity23 13y ago
Nice anecdote about Knight Capital: "When the market opened on Aug. 1, a new piece of trading software that Knight had just installed went haywire and started aggressively buying shares... By the end of Aug. 2, Knight had spent $440 million unwinding its trades" I'd love to know more about that particular launch. A hole in somebody's test suite!
- themckman 13y ago
  I think the story goes that something not ready for production made it into production. I obviously can't say anything about their test suite, but it sounds more like a mismanaged merge/deployment process.
  - nissimk 13y ago
    There are some interesting links here: http://spectrum.ieee.org/riskfactor/computing/it/new-insights-into-knight-capital-trading-snafu http://spectrum.ieee.org/riskfactor/computing/it/new-insight... I had initially heard that the test program was released to production causing the system to take the wrong side of every trade, but I don't think it was ever confirmed.
- joezydeco 13y ago
  Nanex has lots of fun data on the Knight incident: "We believe Knight accidentally released the test software they used to verify that their new market making software functioned properly, into NYSE's live system." http://www.nanex.net/aqck2/3525.html http://www.nanex.net/aqck2/3525.html "We can fully appreciate the nightmare their team must have experienced that morning." And a whole boatload of amazing charts and data here: http://www.nanex.net/aqck2/3522.html http://www.nanex.net/aqck2/3522.html
  - themckman 13y ago
    Nanex is a company that intrigues me immensely. I follow Scott (their founder, I think) on twitter and I wish I understood even a small percentage of what they produce on a daily basis. The stock market in general is something I wish I understood more of. Can anyone recommend some reading material?
ott2 13y ago
Another key point: "the SEC is sharing information with the FBI to probe manipulative trading practices by some HFT firms" and now has the infrastructure to detect anomalies.
glitchdout 13y ago
I get why the need to always be one step ahead pushed trading firms to automation. Still, for some reason, this makes me incredibly sad. Maybe it's because I don't fully understand how the world and the economy work. Why does it have to be this way?
- woodchuck64 13y ago
  It's the co-evolution of parasite and host. These firms are like tape worms, siphoning off nutrients in the hopes the host won't notice. But the host is continually evolving new mechanisms that make it difficult for the parasite to survive. The economy is growing, changing and becoming more efficient, thanks to the internet. If history is any indication, easy-money traders are headed for extinction.
- minimax 13y ago
  We use technology to improve efficiencies in every industry in the world, but when we use technology in the capital markets people freak out. I don't get it.
  - Nursie 13y ago
    Huge volumes of money, a perception of it being gambling and playing with numbers rather than productive work, the possibility of screwing over basically the whole of society when it goes wrong, privileged positions for the entrenched traders (people that outsmart the algo-traders get arrested, massive costs to get the millisecond co-lo advantage on HFT etc), total divorce of algo/HFT from the idea of actual investment in companies based on what they do... There are some reasons that people are suspicious of the entire world of finance. HFT and algorithmic trading really exemplify all of the issues some people have with the money markets in the first place.
nohuck13 13y ago
So, there's a correlation between HFT and volatility. Yup. Causation is hard though. "Trading volumes in U.S. equities are around 6 billion shares a day, roughly where they were in 2006. Volatility, a measure of the extent to which a share’s price jumps around, is about half what it was a few years ago. By seeking out price disparities across assets and exchanges, speed traders ensure that when things do get out of whack, they’re quickly brought back into harmony." There's been academic research that HFT market making dampens intraday volatility [1] There have also been findings in the other direction [2]. I suspect to the extent you're talking about market making, the first version is true, but you almost never see it in articles like this. Maybe it makes for poor sensationalism. [1] http://www.wsuc3m.com/HFT_and_Volatility_Final%20Brogaard.pdf http://www.wsuc3m.com/HFT_and_Volatility_Final%20Brogaard.pd... [2] http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1691679 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1691679
Mikeb85 13y ago
HFT basically involves an arbitrage. The more competition there is, the less profits are made. It's simply a case of the market becoming more efficient, so the arbitrage opportunity is gone. Meanwhile, consumers of market makers (ie. normal investors) benefit from being able to make any trade in a split second, for very little cost. In the end, it still requires a human element.
programminggeek 13y ago
I'm sure it's been done, but I know there is a place for longer term automated trading as well. Computers have an advantage over the super short term, but even on the short, mid, long term, there is money to be made in finding holes based on human behavior over time, which still drives a big chunk of the market.
chiph 13y ago
Iowa Senator Tom Harkin and Oregon Representative Peter DeFazio want a .03 percent tax on nearly every trade in nearly every market in the U.S. The camel's nose is heading towards the tent.
- omni 13y ago
  Explanation of this metaphor for people like me who had never heard it before: http://en.wikipedia.org/wiki/Camel%27s_nose http://en.wikipedia.org/wiki/Camel%27s_nose edit: fixed link, whoops
  - kgermino 13y ago
    http://en.wikipedia.org/wiki/Camel%27s_nose http://en.wikipedia.org/wiki/Camel%27s_nose
- deleted 13y ago
  [deleted]
radikalus 13y ago
HFT Profit = f(Noise/Signal) - g(Tech Costs)
X4 13y ago
The implicit claim is that your trading engine won't beat established trading engines and because of volume. Both can be falsified, by inventing a better trading engine and getting foreign capital into it. Yes the margin for profit isn't that high anymore, but trading engines+trading markets are one card in the stack one can fight with. There is no holistic solution to making maximum profit, except succeeding when others fail. That's why innovators are always rare goods, because capital herds dry it out.
T-hawk 13y ago
"According to Rosenblatt, in 2009 the entire HFT industry made around $5 billion trading stocks." Where does this money come from? The industry doesn't actually create any wealth. There must be a greater fool who lost this $5 billion to the HFT industry. But who is that? Who became $5 billion poorer to make the HFT guys that $5 billion richer? Is the article just counting the total profit of HFT winners and ignoring the HFT losers? This is not rhetorical, I really want to understand this.
- intrazoo 13y ago
  The industry doesn't actually create any wealth => in theory, does not "investing" sorta "create" wealth? This might be the answer, otherwise I, too, am stumped.
- herge 13y ago
  The finance industry creates wealth by making financial transactions and investment instruments cheaper and more efficient. Same way as a rail company or Amazon creates wealth not by 'building things', but by moving things from point A to point B cheaper, more easily and for less risk.
  - T-hawk 13y ago
    But there's still a loser there: the older transportation or retail providers who can no longer sustain their high profit margins. The Pennsylvania Railroad took in profits that used to belong to Erie Canal shippers. Amazon got rich by collecting money that used to go to Barnes & Noble at brick-and-mortar retail. So from where did the profits or money come that make up the HFTs' profit? From the other responses, it sounds like the real answer is salami slices from lots of other market participants. A large mutual fund buyer pays a slightly worse price because the HFT jumped in ahead of them to arbitrage between the selling market maker and this buyer. So the HFT's profit comes out of the mutual fund's capital. The loss would show up as tracking error for an index fund, for example.
    - peterjancelis 13y ago
Lagged2Death 13y ago
One of HFT’s objectives has always been to make the market more efficient. Speed traders have done such an excellent job of wringing waste out of buying and selling stocks that they’re having a hard time making money themselves. One of its objectives? Those philanthropic high-frequency traders just wanted to make the market more efficient for everyone? Sure they did. Sure they did.
- hcal 13y ago
  I think they mean "more efficient" like the cotton gin made the cotton industry more efficient. By reducing the labor involved in processing cotton, the companies that used cotton gins could eek more profit from every acre of production. HFT doesn't "wring the waste" of inefficiency back into the market, but into the hands of the HF trader. HFT does benefit normal market traders, but I'm not sure to what extent.
- cynicalkane 13y ago
  You can say that about any industry that turns a profit. Those philanthropic $MEMBERS_OF_MONEY_MAKING_INDUSTRY just wanted to make $THING_INDUSTRY_DOES better for everyone? Sure they did. Sure they did. Making money is not a character flaw. Otherwise, many prominent members of this board would be horrible people.
  - cma 13y ago
    Your caveat doesn't apply if they aren't helping markets be more efficient. HFT is basically a latency arms race ripoff scam. Whoever pays more for faster lines and closer access to the datacenter takes the cake. Thousands of PHDs are working on this instead of real stuff. Say this is the makeup of market participants: all of them are normal merchants buying fruit for their shops but 2 are latency arbitragers. Shipments of fruit don't always come in because sometimes the sail boat crashes into something. The latency arbitragers hire high speed skiffs to go scout for the ship before it arrives. If one of them sees that a shipment of oranges are missing, he rushs back to game the unsuspecting others in the market: orange prices are going to go up so he buys them on the cheap. Because nothing gets better with two competing arbitragers. They simply compete with each other on hiring out more skiffs and paying for elaborate faster ones. Or signaling by latern along a chain of ships. None of this helps the market; all other participants lose out. With competition between the two arbitragers they end up wasting most of the money buying faster ships. Ships that could be used for.. rescuing crashed orange ships? Many other things as well. The worst government bureaucracy couldn't be more wasteful. Markets aren't efficient even in theory if there is an information asymmetry. I hope you can see the analogy between my example and things like: * deploying more and more servers to literally turn our energy into waste heat (they could be simulating protein fold or something) * paying trading exchanges extra for in-house servers (this is just a complete scam) * Digging hundreds of miles of new fiber line to save 2ms of latency over the existing line (with no plausible consumer benefit because the old lines had plenty of dark fiber and the new line is monopolized by whomever pays the most) * Setting up microwave (lantern?) relay towers to get from New York to Chicago a millisecond faster * Making markets more likely to have a major crash by forcing developers to use C++ to eek out a couple milliseconds over safer alternatives You can make a little bit better case for electronic market making.
peterjancelis 13y ago
Awesome. Capitalism working as intended. There was an inefficiency in the market, people exploited it and low barriers to entry now make the profits disappear. Our stocks are now better priced as a result.
- javert 13y ago
  Yeah. I see this article as an amazing validation of HFT to all the naysayers.
benjamincburns 13y ago
http://www.businessweek.com/printer/articles/122900-how-the-robots-lost-high-frequency-tradings-rise-and-fall http://www.businessweek.com/printer/articles/122900-how-the-... - one page version.

131 points by nohuck13 13y ago

tl;dr; Competition between HFTs has reduced margins on market making to near zero. Wonderful news for consumers of liquidity, bad news for sellers of it.

eksith 13y ago
More than that though, the robots only win when they're fighting panicked human traders who try to maximize and fire blind (or at least a few seconds slower). Speaking of intelligent programs, they failed to achieve equilibrium with their natural environment, as Agent Smith would say. The takeaway: HFT also lacks the two things it needs the most: trading volume and price volatility. Compared with the deep, choppy waters of 2009 and 2010, the stock market is now a shallow, placid pool.
- nissimk 13y ago
  Yes, that's the integral section of the article, but what it's really saying is that at least one component of this is the current cycle low in volatility and volume. This is a classic wall st shakeout when the best capitalized firms that make it through the down part of the cycle come back much stronger when their market returns because their competition closed up shop. They haven't scared everybody away, they're just suffering a market downturn in volatility and volume right now. The robots win when people trade more and when prices move around more. When those conditions return, the robot party will be back on.
ott2 13y ago
The second main point: with declining volatility, there is less space for HFT strategies to profit. What I didn't see in the article was an explicit discussion of transaction costs. Transaction tax would increase those costs, but was part of the decline because transaction costs have already gone up?
crusso 13y ago
That and this sad kicking in the groin of a system that's working through technology issues as it should: Democrats in Congress would go further. Iowa Senator Tom Harkin and Oregon Representative Peter DeFazio want a .03 percent tax on nearly every trade in nearly every market in the U.S Politicians just have to get in and start pecking for some extra revenue and attempt to give the illusion that they're going to help.
- ihsw 13y ago
  Interestingly Sweden tried a 0.5% tax in 1984: > During the first week of the tax, the volume of bond trading fell by 85%, even though the tax rate on five-year bonds was only 0.003%. The volume of futures trading fell by 98% and the options trading market disappeared. Needless to say, 'tax avoidance' became the norm (especially since it was exceedingly easy to circumvent) and it was later repealed in 1991. [1] http://en.wikipedia.org/wiki/Swedish_financial_transaction_tax http://en.wikipedia.org/wiki/Swedish_financial_transaction_t...
  - crististm 13y ago
    law of unintended consequences
- whazzmaster 13y ago
  In today's deficit boogeyman environment I can't say that extra revenue isn't a consideration, but really the tax was to attempt to stem a runaway financial system that has become the blood-sucking vampire squid[1] that's taking more and more of the wealth while providing little of value to the country. [1] http://www.guardian.co.uk/business/andrew-clark-on-america/2009/jul/14/goldmansachs-banks http://www.guardian.co.uk/business/andrew-clark-on-america/2...
  - crusso 13y ago
    Like the article points out, the inefficiencies of the market are being removed exactly because of these so called "vampire squid". Maybe we should call them "cleaner shrimp" instead, since they're performing a useful function? Don't get me wrong, I tried my hand at some day trading a couple of years back and the HFTs helped to make it hard going. That was the problem with the business model I wanted to pursue at the time, though, not with the market itself.
clavalle 13y ago
Yep. They are currently scrambling into every market on the planet to try and eke out profits there but the pace is accelerated. Before too long I think we will see HFTs merging until there are only a handful of players globally. IOW, HFT is transitioning into a commodity.

macavity23 13y ago

Nice anecdote about Knight Capital: "When the market opened on Aug. 1, a new piece of trading software that Knight had just installed went haywire and started aggressively buying shares... By the end of Aug. 2, Knight had spent $440 million unwinding its trades" I'd love to know more about that particular launch. A hole in somebody's test suite!

themckman 13y ago
I think the story goes that something not ready for production made it into production. I obviously can't say anything about their test suite, but it sounds more like a mismanaged merge/deployment process.
- nissimk 13y ago
  There are some interesting links here: http://spectrum.ieee.org/riskfactor/computing/it/new-insights-into-knight-capital-trading-snafu http://spectrum.ieee.org/riskfactor/computing/it/new-insight... I had initially heard that the test program was released to production causing the system to take the wrong side of every trade, but I don't think it was ever confirmed.
joezydeco 13y ago
Nanex has lots of fun data on the Knight incident: "We believe Knight accidentally released the test software they used to verify that their new market making software functioned properly, into NYSE's live system." http://www.nanex.net/aqck2/3525.html http://www.nanex.net/aqck2/3525.html "We can fully appreciate the nightmare their team must have experienced that morning." And a whole boatload of amazing charts and data here: http://www.nanex.net/aqck2/3522.html http://www.nanex.net/aqck2/3522.html
- themckman 13y ago
  Nanex is a company that intrigues me immensely. I follow Scott (their founder, I think) on twitter and I wish I understood even a small percentage of what they produce on a daily basis. The stock market in general is something I wish I understood more of. Can anyone recommend some reading material?

ott2 13y ago

Another key point: "the SEC is sharing information with the FBI to probe manipulative trading practices by some HFT firms" and now has the infrastructure to detect anomalies.

glitchdout 13y ago

I get why the need to always be one step ahead pushed trading firms to automation. Still, for some reason, this makes me incredibly sad. Maybe it's because I don't fully understand how the world and the economy work. Why does it have to be this way?

woodchuck64 13y ago
It's the co-evolution of parasite and host. These firms are like tape worms, siphoning off nutrients in the hopes the host won't notice. But the host is continually evolving new mechanisms that make it difficult for the parasite to survive. The economy is growing, changing and becoming more efficient, thanks to the internet. If history is any indication, easy-money traders are headed for extinction.
minimax 13y ago
We use technology to improve efficiencies in every industry in the world, but when we use technology in the capital markets people freak out. I don't get it.
- Nursie 13y ago
  Huge volumes of money, a perception of it being gambling and playing with numbers rather than productive work, the possibility of screwing over basically the whole of society when it goes wrong, privileged positions for the entrenched traders (people that outsmart the algo-traders get arrested, massive costs to get the millisecond co-lo advantage on HFT etc), total divorce of algo/HFT from the idea of actual investment in companies based on what they do... There are some reasons that people are suspicious of the entire world of finance. HFT and algorithmic trading really exemplify all of the issues some people have with the money markets in the first place.

nohuck13 13y ago

So, there's a correlation between HFT and volatility. Yup. Causation is hard though. "Trading volumes in U.S. equities are around 6 billion shares a day, roughly where they were in 2006. Volatility, a measure of the extent to which a share’s price jumps around, is about half what it was a few years ago. By seeking out price disparities across assets and exchanges, speed traders ensure that when things do get out of whack, they’re quickly brought back into harmony." There's been academic research that HFT market making dampens intraday volatility [1] There have also been findings in the other direction [2]. I suspect to the extent you're talking about market making, the first version is true, but you almost never see it in articles like this. Maybe it makes for poor sensationalism. [1] http://www.wsuc3m.com/HFT_and_Volatility_Final%20Brogaard.pdf http://www.wsuc3m.com/HFT_and_Volatility_Final%20Brogaard.pd... [2] http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1691679 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1691679

Mikeb85 13y ago

HFT basically involves an arbitrage. The more competition there is, the less profits are made. It's simply a case of the market becoming more efficient, so the arbitrage opportunity is gone. Meanwhile, consumers of market makers (ie. normal investors) benefit from being able to make any trade in a split second, for very little cost. In the end, it still requires a human element.

programminggeek 13y ago

I'm sure it's been done, but I know there is a place for longer term automated trading as well. Computers have an advantage over the super short term, but even on the short, mid, long term, there is money to be made in finding holes based on human behavior over time, which still drives a big chunk of the market.

chiph 13y ago

Iowa Senator Tom Harkin and Oregon Representative Peter DeFazio want a .03 percent tax on nearly every trade in nearly every market in the U.S. The camel's nose is heading towards the tent.

omni 13y ago
Explanation of this metaphor for people like me who had never heard it before: http://en.wikipedia.org/wiki/Camel%27s_nose http://en.wikipedia.org/wiki/Camel%27s_nose edit: fixed link, whoops
- kgermino 13y ago
  http://en.wikipedia.org/wiki/Camel%27s_nose http://en.wikipedia.org/wiki/Camel%27s_nose
deleted 13y ago
[deleted]

radikalus 13y ago

HFT Profit = f(Noise/Signal) - g(Tech Costs)

X4 13y ago

The implicit claim is that your trading engine won't beat established trading engines and because of volume. Both can be falsified, by inventing a better trading engine and getting foreign capital into it. Yes the margin for profit isn't that high anymore, but trading engines+trading markets are one card in the stack one can fight with. There is no holistic solution to making maximum profit, except succeeding when others fail. That's why innovators are always rare goods, because capital herds dry it out.

T-hawk 13y ago

"According to Rosenblatt, in 2009 the entire HFT industry made around $5 billion trading stocks." Where does this money come from? The industry doesn't actually create any wealth. There must be a greater fool who lost this $5 billion to the HFT industry. But who is that? Who became $5 billion poorer to make the HFT guys that $5 billion richer? Is the article just counting the total profit of HFT winners and ignoring the HFT losers? This is not rhetorical, I really want to understand this.

intrazoo 13y ago
The industry doesn't actually create any wealth => in theory, does not "investing" sorta "create" wealth? This might be the answer, otherwise I, too, am stumped.
herge 13y ago
The finance industry creates wealth by making financial transactions and investment instruments cheaper and more efficient. Same way as a rail company or Amazon creates wealth not by 'building things', but by moving things from point A to point B cheaper, more easily and for less risk.
- T-hawk 13y ago
  But there's still a loser there: the older transportation or retail providers who can no longer sustain their high profit margins. The Pennsylvania Railroad took in profits that used to belong to Erie Canal shippers. Amazon got rich by collecting money that used to go to Barnes & Noble at brick-and-mortar retail. So from where did the profits or money come that make up the HFTs' profit? From the other responses, it sounds like the real answer is salami slices from lots of other market participants. A large mutual fund buyer pays a slightly worse price because the HFT jumped in ahead of them to arbitrage between the selling market maker and this buyer. So the HFT's profit comes out of the mutual fund's capital. The loss would show up as tracking error for an index fund, for example.
  - peterjancelis 13y ago

Lagged2Death 13y ago

One of HFT’s objectives has always been to make the market more efficient. Speed traders have done such an excellent job of wringing waste out of buying and selling stocks that they’re having a hard time making money themselves. One of its objectives? Those philanthropic high-frequency traders just wanted to make the market more efficient for everyone? Sure they did. Sure they did.

hcal 13y ago
I think they mean "more efficient" like the cotton gin made the cotton industry more efficient. By reducing the labor involved in processing cotton, the companies that used cotton gins could eek more profit from every acre of production. HFT doesn't "wring the waste" of inefficiency back into the market, but into the hands of the HF trader. HFT does benefit normal market traders, but I'm not sure to what extent.
cynicalkane 13y ago
You can say that about any industry that turns a profit. Those philanthropic $MEMBERS_OF_MONEY_MAKING_INDUSTRY just wanted to make $THING_INDUSTRY_DOES better for everyone? Sure they did. Sure they did. Making money is not a character flaw. Otherwise, many prominent members of this board would be horrible people.
- cma 13y ago
  Your caveat doesn't apply if they aren't helping markets be more efficient. HFT is basically a latency arms race ripoff scam. Whoever pays more for faster lines and closer access to the datacenter takes the cake. Thousands of PHDs are working on this instead of real stuff. Say this is the makeup of market participants: all of them are normal merchants buying fruit for their shops but 2 are latency arbitragers. Shipments of fruit don't always come in because sometimes the sail boat crashes into something. The latency arbitragers hire high speed skiffs to go scout for the ship before it arrives. If one of them sees that a shipment of oranges are missing, he rushs back to game the unsuspecting others in the market: orange prices are going to go up so he buys them on the cheap. Because nothing gets better with two competing arbitragers. They simply compete with each other on hiring out more skiffs and paying for elaborate faster ones. Or signaling by latern along a chain of ships. None of this helps the market; all other participants lose out. With competition between the two arbitragers they end up wasting most of the money buying faster ships. Ships that could be used for.. rescuing crashed orange ships? Many other things as well. The worst government bureaucracy couldn't be more wasteful. Markets aren't efficient even in theory if there is an information asymmetry. I hope you can see the analogy between my example and things like: * deploying more and more servers to literally turn our energy into waste heat (they could be simulating protein fold or something) * paying trading exchanges extra for in-house servers (this is just a complete scam) * Digging hundreds of miles of new fiber line to save 2ms of latency over the existing line (with no plausible consumer benefit because the old lines had plenty of dark fiber and the new line is monopolized by whomever pays the most) * Setting up microwave (lantern?) relay towers to get from New York to Chicago a millisecond faster * Making markets more likely to have a major crash by forcing developers to use C++ to eek out a couple milliseconds over safer alternatives You can make a little bit better case for electronic market making.

peterjancelis 13y ago

Awesome. Capitalism working as intended. There was an inefficiency in the market, people exploited it and low barriers to entry now make the profits disappear. Our stocks are now better priced as a result.

javert 13y ago
Yeah. I see this article as an amazing validation of HFT to all the naysayers.

benjamincburns 13y ago

http://www.businessweek.com/printer/articles/122900-how-the-robots-lost-high-frequency-tradings-rise-and-fall http://www.businessweek.com/printer/articles/122900-how-the-... - one page version.