4 ms·

I've never really understood the stock market. Is this basically how it works? A person can make or sell things, but that person is limited in the scope of the

I've never really understood the stock market. Is this basically how it works? A person can make or sell things, but that person is limited in the scope of their business by their available capital. Thus, they can increase their capital by either securing a business loan or by making their company "public." Securing a business loan is risky, because they will still have to pay back the loan regardless of whether or not their company makes any money. Going public carries additional risks, but at least they aren't on the hook if the business fails - and there's an added benefit of the potential for enormous gains in capital which can further increase their business potential. So, the person "goes public" which is extremely complex and time consuming, but let's say they are able to convince 100 people that they should each buy a "share" of the company. This means that the more money that the company earns in profit, that a little bit of that profit is "owned" by each person who owns a share. Right? (I am legitimately asking here, because as I said I really don't understand much of the way it works.) So, now we have stock exchanges. These are places that people can buy, sell, or trade stocks of different companies for cash or other assets? I own one share of Company A and that share is worth $51 right now. Later in the day, however, we see that company A has earned a little bit more money than we thought it was going to, and so now my stock is worth $53. And I originally purchased the stock for $47, so I can potentially sell that stock for a $6 profit, or I can hang on to it and hope that it goes a little higher. However, humans can only act so quickly, and day-traders and short-sellers act on stocks in the span of minutes or hours. So if I purchase 10,000 shares of Company B at 10:00 for $5 each, and then sell those same 10,000 shares back at 10:04 for $5.02 each, then I have made a small profit. And large firms do this hundreds of times each day, with dozens of companies, and likely tens of thousands of stocks. Right? So, HFT does the same thing. Except, instead of making a purchase-sell decision every few minutes, they do it every few microseconds. And the returns per transaction are something like... .0000034 per share (this is a guess), but over tens of thousands of shares, and millions of times a day. Right? This, however, is where my understanding breaks down completely. HFT obviously benefits a company that can wield it. If my hedge fund can hire the programmers, run the servers, and buy the licenses to the data then I stand to make huge profits for a minimal investment when my HFT "algobots (lol)" do their thing. But I don't understand how this benefits the rest of the market? I'm guessing that most of these HFT bots are not being run by small-time investors, and in fact that the trades made by small-time investors will be heavily influenced by the HFT trades that are made in-between the time the guy using E-Trades can point on the "Buy!" button and the time he can click on it. And as a consumer who does not participate in the stock market (in that I do not have an investment portfolio, I realize that the stock market influences me regardless of whether or not I put money into it), I really don't get how HFT helps me. What it looks like to me, is that players who have the most money, and who have the best technology will have a benefit over players who lack those resources. And so while there's no evidence (that I'm aware of) that these HFT-using companies are committing any malfeasance, it looks like the natural side-effect is that the market becomes more one-sided. I would liken this to a professional athlete using steroids (let's pretend that steroids aren't illegal). Steroid use may stem from the player simply wanting to maximize their ability to use their body, and so they enhance their muscles and work hard to be able to control them. This player isn't actively trying to cheat, he is simply using technology to overcome a natural hurdle (let's also assume that this same player has, through hard work, literally pushed their body to the limit of what it can naturally achieve). However, a similar player who has also pushed their body to the limit is either unable or unwilling to use steroids, and thus they are unable to compete against the other due to the slight technical advantage. Is this a true analogy?

shabble 13y ago
I'm not entirely clear on the exact process either, but I think your initial summary has it mostly correct. There are additional complexities in Share Dividends (you receive a fraction of the companies profits proportional to your number of shares owned, which incentivises not-selling, to a point) The basic issue that HFT (and markets in general) seek to solve is liquidity - the ability to buy & sell when you want, rather than having to wait while a deal is worked out. Consider the differences in process when buying/selling a commodity such as gold, vs buying a particular house. There's a good overview of the mechanics & benefits of [HF]T in the 'A High Frequency Trader's Apology'[0] series, written by HN member yummyfajitas. [0] http://www.chrisstucchio.com/blog/2012/hft_apology.html http://www.chrisstucchio.com/blog/2012/hft_apology.html
- Lazare 13y ago
  That's an excellent series of posts. Thanks for the link!
Lazare 13y ago
Kinda. A few points to help clarify things: All funds that go into the business will either be debt or equity. Debt gets a guaranteed rate of return, and needs to be paid back. It gets first claim if you go under, but gets no "bonus" if you do well. Equity is an ownership stake; last in line if you go under, but with a claim on all future profits if you do well. The most obvious type of equity stake is your own, but you might say to a friend hey, go halves with me on buying a new lathe, and I'll split the profits from the furniture I make 50/50. That's another example of an equity stake, as old as the hills. All a stock market is, is your friend saying "look, I've got the note saying I have a right to 50% of the profits of Zac's furniture business, but I'm broke right now; anyone wanna give me $50 for it?". And because in practice this sort of thing is fraught with risk, this is incredibly regulated, but that's all a stock market is; people trading the right to some uncertain future profits. (Well...kinda. There's also the question of control. Some shares give you a say in how a company is run; some don't. That's rarely a factor though.) Notionally, incidentally, the value of a company's stock is the discounted sum of all future cash flows. If you owe 100% of Amazon, obviously you have the right to 100% of all future profit they make. If you owe 0.0001% of Amazon, you have the right to 0.0001% of all future profit they make. That's the core driver of stock prices; the market's ever-changing estimation of a companies future. As for HFT...no, you won't make huge profits. The entire HFT industry, globally, makes chicken feed, but they make for VERY entertaining news stories, so you read about them a ton. Anyhow, as to "why HFT is good", the answer is basically that we all benefit when markets work better, and one way markets can work better is if they are deep and liquid. In simple terms, that means that if you want to buy or sell something, there's always someone there offering to take the other side of the trade for more-or-less the market rate. Conversely, housing is a very shallow, very illiquid market. If you want to sell your $400k house, it might takes weeks or months, and you may find yourself happily paying significant fees to the broker, and maybe even selling it at a discount, just to get the damn thing to sell. If you want to sell your share of Apple stock, it will take microseconds, and you'll get very close to the market rate (ie, low commission/low spread). And while HFT doesn't have a huge impact, to the extent it has an impact, it is to make the market deeper, more liquid, and more efficient. HFT benefits the HFT traders, but it also, and this is really, really, important to grasp benefits every person who trades with the HFT traders. The losers are the "low frequency traders" who would have bought your Apple share from you a little slower and for a little less money, but lost out. But again, this effect is minimal. The drive for HFT is the race for pennies in an increasingly efficient and competitive market. Small time investors, honestly, aren't the victims here. (Unless they're doing the day-trading, "I can pick stocks because I read a book on trend analysis" thing, in which case...they're absolutely screwed, but no more so now than before HFT. The stock market is not a game.) And no, I wouldn't say the market is becoming "more one-sided"; that presupposes there being two sides. There aren't; there are seven billion sides. HFT does not profit at the expense of pension funds or entrepreneurs; it profits at the expense of everyone else who wanted to profit from them. And I think the sports analogy is especially inapt. We want markets to work as efficiently as possible. We want sports to provide a spectacle. These things are not similar.

shabble 13y ago

I'm not entirely clear on the exact process either, but I think your initial summary has it mostly correct. There are additional complexities in Share Dividends (you receive a fraction of the companies profits proportional to your number of shares owned, which incentivises not-selling, to a point) The basic issue that HFT (and markets in general) seek to solve is liquidity - the ability to buy & sell when you want, rather than having to wait while a deal is worked out. Consider the differences in process when buying/selling a commodity such as gold, vs buying a particular house. There's a good overview of the mechanics & benefits of [HF]T in the 'A High Frequency Trader's Apology'[0] series, written by HN member yummyfajitas. [0] http://www.chrisstucchio.com/blog/2012/hft_apology.html http://www.chrisstucchio.com/blog/2012/hft_apology.html

Lazare 13y ago
That's an excellent series of posts. Thanks for the link!

Lazare 13y ago

Kinda. A few points to help clarify things: All funds that go into the business will either be debt or equity. Debt gets a guaranteed rate of return, and needs to be paid back. It gets first claim if you go under, but gets no "bonus" if you do well. Equity is an ownership stake; last in line if you go under, but with a claim on all future profits if you do well. The most obvious type of equity stake is your own, but you might say to a friend hey, go halves with me on buying a new lathe, and I'll split the profits from the furniture I make 50/50. That's another example of an equity stake, as old as the hills. All a stock market is, is your friend saying "look, I've got the note saying I have a right to 50% of the profits of Zac's furniture business, but I'm broke right now; anyone wanna give me $50 for it?". And because in practice this sort of thing is fraught with risk, this is incredibly regulated, but that's all a stock market is; people trading the right to some uncertain future profits. (Well...kinda. There's also the question of control. Some shares give you a say in how a company is run; some don't. That's rarely a factor though.) Notionally, incidentally, the value of a company's stock is the discounted sum of all future cash flows. If you owe 100% of Amazon, obviously you have the right to 100% of all future profit they make. If you owe 0.0001% of Amazon, you have the right to 0.0001% of all future profit they make. That's the core driver of stock prices; the market's ever-changing estimation of a companies future. As for HFT...no, you won't make huge profits. The entire HFT industry, globally, makes chicken feed, but they make for VERY entertaining news stories, so you read about them a ton. Anyhow, as to "why HFT is good", the answer is basically that we all benefit when markets work better, and one way markets can work better is if they are deep and liquid. In simple terms, that means that if you want to buy or sell something, there's always someone there offering to take the other side of the trade for more-or-less the market rate. Conversely, housing is a very shallow, very illiquid market. If you want to sell your $400k house, it might takes weeks or months, and you may find yourself happily paying significant fees to the broker, and maybe even selling it at a discount, just to get the damn thing to sell. If you want to sell your share of Apple stock, it will take microseconds, and you'll get very close to the market rate (ie, low commission/low spread). And while HFT doesn't have a huge impact, to the extent it has an impact, it is to make the market deeper, more liquid, and more efficient. HFT benefits the HFT traders, but it also, and this is really, really, important to grasp benefits every person who trades with the HFT traders. The losers are the "low frequency traders" who would have bought your Apple share from you a little slower and for a little less money, but lost out. But again, this effect is minimal. The drive for HFT is the race for pennies in an increasingly efficient and competitive market. Small time investors, honestly, aren't the victims here. (Unless they're doing the day-trading, "I can pick stocks because I read a book on trend analysis" thing, in which case...they're absolutely screwed, but no more so now than before HFT. The stock market is not a game.) And no, I wouldn't say the market is becoming "more one-sided"; that presupposes there being two sides. There aren't; there are seven billion sides. HFT does not profit at the expense of pension funds or entrepreneurs; it profits at the expense of everyone else who wanted to profit from them. And I think the sports analogy is especially inapt. We want markets to work as efficiently as possible. We want sports to provide a spectacle. These things are not similar.