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How to not get ripped off by High Frequency Traders

62 points by keveman 13y ago

Mikeb85 13y ago
Dunno, I for one value the service HFTs provide. They're the reason that I, as a small investor, can unload 50,000 dollars worth of shares in a couple seconds. Have you ever traded a stock market with low liquidity? You can have a market sell order sitting all day... I'd rather pay the small HFT toll, I still make plenty anyhow.
- adamgravitis 13y ago
  HFTs aren't really helping your situation at all. Other forms of liquidity generators might be, but HFTs are exploiting microsecond-level arbitrage opportunities. I've never heard of a small investor with sub-second execution requirements. In fact, I'd be curious why you needed to execute 50,000 shares in a few seconds at all. From my perspective, I'd be thrilled if I could sell a few shares over several minutes as long as I were confident I was getting a good price.
  - kasey_junk 13y ago
    That is a completely inaccurate generalization about what HFTs do. There is a class of HFT that does latency/venue arbitration but it is a very small niche. The vast majority of HFT volume on the other hand is traditional market making. This HFT market making is much more efficient and fair than human market making was. It is driving down the bid/ask spread to the thinnest possible levels (at least the thinnest legal levels). This is the single biggest driver to you getting the best price. Being a retail investor right now is the best it has ever been and HFT systems are a large reason why.
  - Mikeb85 13y ago
    Getting quick execution is nice. It's part of getting a good price - the price I want at the time. Retail investors would normally go to the back of the line, do you think human brokers and market makers are fair? I execute fairly quick trading strategies, I hold a stock from a day to a week, being able to sell at the peak of an up day or unload shares when the market is just beginning to move against me, as opposed to minutes or hours later is everything. And as another poster said, most of what HFT is, is market making... (Even traditional MMs made their money on arbitrage)
meric 13y ago
You still lose with Limit Orders. Here is how. I also propose how to actually not get ripped off. The bid price is $100, the offer price is $101. You want to buy, but you don't want to cross the spread. You're worried the $101 isn't actually there - i.e. if you place an order to buy for $102, either the $101 order will get pulled by the HFT trader, or the HFT trader will buy the $101 order and sell it to you at $102. The article suggests placing a limit order without crossing the spread. i.e. Put a limit order at $100. So you put the limit order at $100. It sits there, and doesn't move. 10 minutes later, another company in the same industry announces below expected results due to market conditions. As this company is in the same industry, its stock price is negatively affected. Before you have time to cancel your $100 limit order, the HFT trader has already parsed the negative news and short sold the stock all the way down to $99.5, taking your order with it, you're recorded to have sold at $100. You lose either way. The continuous limit order market is where HFT has a lot more edge than you do. You can try to avoid placing market orders that cross the spread, as well as avoid placing limit orders that linger for too long and get taken advantage of. There's a call auction in the morning before the stock market opens every day. No market orders are allowed. Everyone places limit orders and everyone executes at one price. There is no spread to cross. As long as enough other investors participate in the same call auction, it'll be a lot more difficult for HFT traders to take advantage of your order. (Frequency doesn't even come into play since call auctions are discrete markets, not continuous - there is only 1 open price. This negates the HFT trader's speed advantage, since speed is rendered irrelevant) Just regurgitating stuff I've learnt with finance at university.
- umanwizard 13y ago
  Your example doesn't make sense to me. Why would you place an order to buy for $102 if there is an offer for $101 ?
  - jessaustin 13y ago
    Prices move, so traders add a bit of leeway if they want to be sure the trade will execute. The worry with HFT is that the price will move solely in order to screw over this particular trade, rather than as a reflection of overall market conditions.
gizmo 13y ago
A few points: 1) This doesn't address the front-running issue. (Where different exchanges receive the buy/sell order at a different times and HFT can abuse those microsecond differences) 2) It's a universal truth that people who are better informed are harder to rip off. So that's not very persuasive. You can't reasonably expect regular people to know in which situations they'll be paying a premium for a liquidity service they may not even want. 3) It's completely fair to ask ourselves as a society if HFT groups are making a contribution to society that warrants the money they make. And if transparency with regard to HFT trading strategies leads regular people and sophisticated investors to make different decisions, then that means that the lack of transparency worked in favor of HFT. Therefore, it's reasonable to assume much of the HFT profits are just an externality. The decline of HFT is in part because investors are getting wise to the shenanigans.
- Mikeb85 13y ago
  No, the decline of the HFT industry is because there's so many competitors they're racing to $0...
  - wglb 13y ago
    Keep in mind that many HFTs are market makers and have specific agreements with exchanges that pays them 0.005 cents per share traded, regardless. The other side of this is that they MUST stay in the market, no matter what. Thus, when trading volume went down over last few years, many HFT firms had less income. (And to answer another commenter in this thread, No, other investors are not "wise" to the ways of HFT, all traders save for the brokerage firms who used to collect $0.10 on each share traded (the spread before HFT) benefit.)
- kasey_junk 13y ago
  "1) This doesn't address the front-running issue. (Where different exchanges receive the buy/sell order at a different times and HFT can abuse those microsecond differences)" This is only an issue if your order is large enough to take out the entire liquidity of one of the exchanges. If that is the case, by definition you are not a retail investor, you are an institutional investor and part of the value add you are supposedly adding is your ability to operate in a complex market. "2) It's a universal truth that people who are better informed are harder to rip off. So that's not very persuasive. You can't reasonably expect regular people to know in which situations they'll be paying a premium for a liquidity service they may not even want." So informed market participants should subsidize ignorant ones? "3) It's completely fair to ask ourselves as a society if HFT groups are making a contribution to society that warrants the money they make. And if transparency with regard to HFT trading strategies leads regular people and sophisticated investors to make different decisions, then that means that the lack of transparency worked in favor of HFT. Therefore, it's reasonable to assume much of the HFT profits are just an externality. The decline of HFT is in part because investors are getting wise to the shenanigans." Agreed. We should also have that discussion around dark pool operators, hedge funds, and investment banks. While we are at it, lets talk about photo sharing websites and internet chat services as well.
gopher1 13y ago
If you're not a pension fund or other large investor, HFT's don't care about your orders.
krastanov 13y ago
Isn't the entire point, that the anti-HFT folks are trying to make, that if HFT is abolished then we will still have liquidity? As in "Liquidity is not created by HFT. HFT are just an intermediary between the actual providers of liquidity and the rest of the market". This is a sincere question, because I really do not understand how HFT "creates liquidity" when they are just buying low and selling high.
- vbuterin 13y ago
  They are nevertheless buying higher than everyone else and selling lower than everyone else. Otherwise their orders would never get filled.
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    - kasey_junk 13y ago
      No exchange in the US allows trading something at $26.107 that is in fact explicitly against the rules. HFTs do not see your buy order before it reaches the market and then buy them ahead of you to sell them back to you. Your understanding of the stock markets and HFT is inaccurate and you are spreading incorrect information.
      - Sniperfish 13y ago
        Retail orders are generally routed to markets using a SOR and do not overage 100% of the full order. There are latency differences between exchanges / ATS'. If you are very fast is possible to post passively on multiple venues and exploit those latency differences to assume if you see a small ping on market x there is more behind it. You can gain book position and the spread with this information, if you are fast.
kasey_junk 13y ago
As usual Chris does a good job of explaining in simple terms how the markets actually work. The one thing I would have liked to see in this article is a discussion of the pro's and con's of paying for liquidity vs execution risk. From my perspective it is almost always better to have sooner execution with a liquidity tax than an order floating in the market but I'm not sure how to quantify that as a retail stock purchaser.
rbc 13y ago
I personally use limit orders. I think there is an important distinction in deciding how much will be paid for a security. It makes you think about what the security is actually worth, separate from what the market order book is saying about the security at any particular time.
hawkharris 13y ago
I just started learning about high frequency trading. I was interested to learn about some of the lore surrounding the field. While digital algorithms are relatively new, trading algorithms, in a conceptual sense, have existed for at least hundreds of years. I don't usually throw around links to my own content, but I think this is relevant: http://codyromano.com/using-pigeons-as-algorithms/ http://codyromano.com/using-pigeons-as-algorithms/
001sky 13y ago
Author would benefit from a closer reading of the M. Lewis piece. It's well researched far from trivial. What's interesting about it is that it tells the story of how outsiders modeled the various ways to rip off <institutional> traders. They did this first and the empirically pattern-matched observed behaviour. They then did both physical and social market-micro-structure studies. Lets take a look at this section (From attached article): The fact of the matter is that HFT’s can’t rip you off. You are never under any obligation to do business with them. In spite of that, lots of sophisticated investors voluntarily pay HFTs every day. An important question for all the critics of HFT to grapple with is, “why do sophisticated investors voluntarily pay for something useless?” This comes right after the section on why people don't adopt obvious strategies (use limit orders, etc): Why doesn’t everyone do this? This is an obvious question to ask. The answer is, quite simply, execution risk. Execution risk is the risk that you place an order but your trade never actually happens. The Analysis Lewis outlines in his book shows that HFT is specificially engineered <to create execution risk>. It engineers artificial scarcity (the opposite of liquidity). Empirical study from Lewis's book: Finally [The Trader] complained so loudly that they sent the developers, the guys who came to RBC in the Carlin acquisition. “They told me it was because I was in New York and the markets were in New Jersey and my market data was slow,” Katsuyama says. “Then they said that it was all caused by the fact that there are thousands of people trading in the market. They’d say: ‘You aren’t the only one trying to do what you’re trying to do. There’s other events. There’s news.’ ” <If that was the case, he asked them, why did the market in any given stock dry up only when he was trying to trade in it?> [emphasis added] To make his point, he asked the developers to stand behind him and watch while he traded. “I’d say: ‘Watch closely. I am about to buy 100,000 shares of AMD. I am willing to pay $15 a share. There are currently 100,000 shares of AMD being offered at $15 a share — 10,000 on BATS, 35,000 on the New York Stock Exchange, 30,000 on Nasdaq and 25,000 on Direct Edge.’ You could see it all on the screens. We’d all sit there and stare at the screen, and I’d have my finger over the Enter button. I’d count out loud to five. . . . “ ‘One. . . . “ ‘Two. . . . See, nothing’s happened. “ ‘Three. . . . Offers are still there at 15. . . . “ ‘Four. . . . Still no movement. . . . “ ‘Five.’ Then I’d hit the Enter button, and — boom! — all hell would break loose. The offerings would all disappear, and the stock would pop higher.” This is why it's being investigated by the FBI, in addition the other issues (front running, NPI, etc). "There are many people in government who are very focused on this and who are concerned about it and who think it breaks the law," an FBI spokesman said. "There is a big concern that high-frequency traders are getting material nonpublic information ahead of others and trading on it."
logfromblammo 13y ago
I am not a finance expert. What would happen if you traded stocks using a continual series of discrete uniform price auctions? Each buyer enters a sealed bid consisting of the amount he wishes to buy, and at what price. Each seller enters a sealed offer consisting of the amount he wishes to sell, and at what price. When the auction interval ends, the secure settlement system orders the bids and offers, and calculates the common settlement price such that every bid higher than that price can be satisfied with the offers lower than that price. Every unit in the auction is traded at that one price. Unsatisfied bids and offers could be set up to roll over to subsequent intervals, or to expire. The settlement system takes a fee from all trades, as a fraction of the amount a buyer was willing to pay, but didn't need to, and a fraction of the amount a seller got in excess of what he wanted. The marginal buyer and seller, who were not pleasantly surprised by the interval's settlement price, pay nothing. There is no opportunity for front running. If you bid lower than a major institution, your orders will be filled after the institution's orders. You can't re-sell to it at a higher price because it already has what it wants. Trading speed is irrelevant. All that matters is that your orders are in before the settlement interval closes, which happens on a human scale. Why would such a system be unsuitable for our modern finance system?
- kasey_junk 13y ago
  What scale would you use? If we choose 15 minutes, then day traders who sit at a computer screen all day have an advantage over people who have to work. Ok then, how about once a day. Well then people without kids have an advantage as they have more time to research this stuff. Not to be overly sarcastic, but you can't pick a discrete time period that doesn't have trading speed as a component.
  - logfromblammo 13y ago
    If you set your orders and offers to roll over through multiple intervals, you don't need to babysit them. You are absolutely guaranteed to pay at most what you bid, and to receive at least your reserve price. You could leave them in the system for a thousand years and never be disappointed in your trade. I can set my bid at what I think a company is worth to me, and simply leave it there until the clearing price is lower. I would probably set the interval to one hour, with 24 auctions clearing per day, and each tradable item settling at a different position on the clock, so as to not overload my servers at any given time.
Sniperfish 13y ago
Nanex explains this stuff better than I will so I'm just going to link to their research (tl;dr summary of [1] below). I will accept not all HFT participants are obligated to follow any or all of these behaviours, but they are argued in defence of all HFT activity which is patently not true. 1. They Provide liquidity, false. Or at least works on a definition of liquidity that is not what would generally be used by other market participants (institutional or retail) - specifically see pinging or using orders to determine interest [2] 2. Tighten spreads, false. Attributable in the largest part to reg NMS not directly to HFT. Spread volatility has increased. 3. Lower costs, false. Cheap trading available via discount brokers before HFTs and additional costs to other market participants operating in HFT innundated environments are ignored. 4. Studies showing positive of HFT cherry pick and are of inconsequential detail, no conclusions should be drawn without deeper analysis of the data 5. Nannex guys just have an axe to grind repudiation Plus ignores any other negative side effects of super-high speed trading such as stock specific flash crashes, data overload, and locked / crossed markets. Appreciate some of those can also be attributed to the proliferation of protected markets post Reg NMS. [1] http://www.nanex.net/aqck2/4594.html http://www.nanex.net/aqck2/4594.html [2] http://www.nanex.net/aqck2/4592.html http://www.nanex.net/aqck2/4592.html (appearing to violate SEA 9.a.1.A)
panzagl 13y ago
There is a lot of 'unless you're selling 100000 shares in a hurry you shouldn't care', but if an HFT 'rips off' a pension fund I very much do care- even if I'm not personally affected I'm sure the added cost will be passed on to the state somehow.
liricooli 13y ago
For anyone interested in more information, I׳d recommend reading the comments in these two threads [0,1] from Marginal Revolution blog. Two HFT traders wrote thoroughly about HFT. I׳ve never read such an interesting and broad online discussion about HFT. I actually spent most of yesterday׳s afternoon reading these threads. [0] http://marginalrevolution.com/marginalrevolution/2014/04/matt-levine-on-michael-lewis-and-hft.html http://marginalrevolution.com/marginalrevolution/2014/04/mat... [1] http://marginalrevolution.com/marginalrevolution/2014/03/new-michael-lewis-book-on-finance-and-high-frequency-trading.html#comments http://marginalrevolution.com/marginalrevolution/2014/03/new...
elecengin 13y ago
Unfortunately, a traditional US retail investor does not have the flexibility described here. Lewis describes Electronic Market Makers (EMMs) and Payment For Order Flow (PFOF) - under these models, your order never actually reaches a market. It is routed directly to a market making firm (usually Citadel, Knight, Pershing, or Getco) that fills the order immediately if the price is marketable and then trades out of the position later. This indirection makes the whole discussion around your position in the order book somewhat moot. It is important to recognize that under Reg NMS the market making firm must fill you at the prevailing market price (the NBBO). While they technically could sweep the market to move the market price before filling, this almost never happens for a retail order since they are so small. For this reason, the whole discussion around HFT "front-running" isn't very topical to the retail investor buying individual stocks and it barely affects the cost of execution of funds ($0.43 per $10,000 notional value traded according to [1]) In summary, the people fanning this flame are not trying to protect retail investors... If they were, they would focus on the larger scams on the street (exhorbitant management fees for actively managed funds, for example) [1] http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1928510 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1928510
- thatthatis 13y ago
  It saddens me that people lump Market Making and HFT together. Over the past 100 years, the bid-ask spread has fairly steadily decreased due to technology and this fact in isolation is uniformly a good thing for retail investors. http://www.cxoadvisory.com/5737/big-ideas/trading-frictions-over-the-long-run/ http://www.cxoadvisory.com/5737/big-ideas/trading-frictions-... Other HFT methods are less clearly on net socially good.
fsk 13y ago
The premise of the post is false. If a large limit order is resting on the books, that's an implied option for the HFTs. If you place a large bid at $10.00, the HFTs will buy at $10.01. If the market starts going down, they sell to you before the price crashes more. If the price goes up, you never got your fill. Limit orders don't protect from HFTs exploiting you. What happens is you either don't get filled (price drops to $10.01 and goes back up), or the price drops to $9.99 or less.
PaulHoule 13y ago
I think people forget how much front running happened in the bad old days on the stock market floor, how the NYSE organized a cartel that kept trading prices high, and that the bid/ask spread is usually a lot less than it used to be. One thing people don't say much about HFT is that the HFT practitioners got the exchanges to add undocumented order types that let them, in some cases, take advantage of people who do limit orders as the author of this post describes. The best description of this is at http://www.amazon.com/The-Problem-HFT-Collected-Frequency/dp/1481978357 http://www.amazon.com/The-Problem-HFT-Collected-Frequency/dp... Often when I trade stocks I like to set a limit order at a price that might be a percent or so better than the market rate. Since the price fluctuates, odds are pretty good that I'll get my fill. Now if it is just the normal Brownian motion, it's a good thing that I get my fill, but if the stock is getting hammered by an external event that is driving it way down I might have hit the limit for the wrong reason and be unhappy I got the fill. In situations like that, HFT traders have an advantage with their special order types. I think the normal retail investor who buys and holds for a while is not hurt terribly by HFT and flash crashes(unless the market is depressed because of the fear of HFT) but you can definitely get burned if you use stop orders. If a price goes down quickly, that can trigger your stop order, causing you to sell at a bad time.
whyme 13y ago
It's sad that I as a retail investor need to spend my valuable time focusing on how not to get screwed by the exchanges that have introduced a side business which does not serve the functioning of the market and instead corrupts it.
- harryh 13y ago
  You don't actually need to focus on this. As a retail investor your going to get filled at NBBO (National Best Bid and Offer). The people writing things that make you think otherwise are selling irrational fear. It's no different than how local news makes people think that crime in the US is at an all time high by reporting on it all the time when, in fact, crime has been dropping for decades. Don't buy what the fear-mongers are selling.
dbrower 13y ago
Can someone explain why any of these is a bad idea? (a) completed transaction tax; (b) regulatory fee on offers/cancellations; (c) insertion of random delays into offers/cancellations; All could increase friction and reduce the speculative/arbitrage opportunities, while having little effect on those wanting to trade to hold for periods exceeding seconds. There is a belief that the churn of HFTs/Arbs is enhancing liquidity for "real" investors. There ought to be reasonable questions what amount of churn is useful, adequate, and whether some frothy levels should be constrained in some way. Is there any way to decide when things are excessivly liquid, in ways that lead to undesirable effects?
- kasey_junk 13y ago
  Any tax you propose will reduce the amount of the taxed thing and introduce unintended consequences. So we have to ask why do you want less transactions or orders? It won't reduce HFT activity for instance. It will just mean that HFT systems will only make more profitable trades. That means higher bid/ask spreads and higher risk limits leading to higher volatility. It also may have the unintended consequence of consolidating more volume into smaller firms. That doesn't seem to be in anyone's best interest. As for latency games the issue is not the overall latency it is fifo priority matching. Without changing that bouncing trading signals off of mars won't help.
  - dbrower 13y ago
    I think a reasonable question is why we consider /more/ transactions a good thing, if a large fraction of them are for holding periods in small number of seconds. I think I am questioning the fifo paradigm, which creates these arbitrage opportunities, especially when there are multiple fifo queues representing multiple markets. It is not clear to me that batching things in 1 sec increments, and randomizing the our ordering would be bad or unfair. I also don't see why a modest fee that would make short-hold transactions for tiny gains is a bad thing. Structuring the system to reward HFT latency advantages seems opposed to stability, if one believes that the market is for actual investments. HFT seems to be a second order phenomenon that games the system, and may have come to dwarf what could be called legitimate investment. At what point is there "enough" liquidity, and when is "too much"? I suspect the people who do HFT and other arb techniques think there is no such thing as too much, because they profit on the churn. Others see this as producing nothing of societal value, extracting real money from the system that could be used for other purposes.
tptacek 13y ago
These discussions would be improved if more of the participants understood the problem of transacting in large blocks of tradable instruments. The impression HN trading discussions create is that there is a universe in which block trades are frictionless or even remotely predictable. In fact, moving large blocks across the market isn't just an annoying detail of the markets; it's one of the basic fundamental problems of institutional trading, and a large part of the rationale for the existence of brokers. Transacting in blocks of stock is to professional trading what the CAP theorem is to distributed software development. One of the most famous and approachable books about market structure is Larry Harris' _Trading And Exchanges_. The book is like the TCP/IP Illustrated of money. It is supremely readable and written in a style that software developers in particular will find congenial. You can get a Kindle version of it right now. I feel extremely comfortable recommending it. It is a great read. The example of trying to move a large block of (fictitious) Smithsonian Industries is one of the opening, motivating examples the book uses to outline the challenges of trading. The inheritor of a huge chunk of Smithsonian Industries needs to sell 900,000 shares of thinly-traded stock. The example continues: Goldman's block brokers face the following predicament. If nobody knows that they have stock to sell, they will not be able to sell it. However, if too many people know that a large block of stack is hanging over the market, speculators will push the price down. The Goldman brokers thus must be selective when approaching potential buyers. The motivating example Lewis gives in his book is of a trader at a large investment bank who, based on their $2MM/year salary, is presumably being paid handsomely for the service of figuring out how to move blocks like that without having the market shift out from under them. In Harris' example, the Goldman traders research other owners of Smithsonian Industries and approaches them privately and individually in the hopes of placing much of the block privately at a small discount. In Lewis' example, the handsomely-paid trader sees a spot price in their blotter screen, expects to push a single button (no, really, that's how Lewis frames it) to sell at that price, and is outraged when the price moves. There's an interesting debate to be had about HFT and, particularly, the conflicts of interest between broker-dealers and exchanges and dark pools. But it's hard to have that discussion if you start from the belief that institutional trading is supposed to be easy. The opposite is true.

62 points by keveman 13y ago

Dunno, I for one value the service HFTs provide. They're the reason that I, as a small investor, can unload 50,000 dollars worth of shares in a couple seconds. Have you ever traded a stock market with low liquidity? You can have a market sell order sitting all day... I'd rather pay the small HFT toll, I still make plenty anyhow.

adamgravitis 13y ago
HFTs aren't really helping your situation at all. Other forms of liquidity generators might be, but HFTs are exploiting microsecond-level arbitrage opportunities. I've never heard of a small investor with sub-second execution requirements. In fact, I'd be curious why you needed to execute 50,000 shares in a few seconds at all. From my perspective, I'd be thrilled if I could sell a few shares over several minutes as long as I were confident I was getting a good price.
- kasey_junk 13y ago
  That is a completely inaccurate generalization about what HFTs do. There is a class of HFT that does latency/venue arbitration but it is a very small niche. The vast majority of HFT volume on the other hand is traditional market making. This HFT market making is much more efficient and fair than human market making was. It is driving down the bid/ask spread to the thinnest possible levels (at least the thinnest legal levels). This is the single biggest driver to you getting the best price. Being a retail investor right now is the best it has ever been and HFT systems are a large reason why.
- Mikeb85 13y ago
  Getting quick execution is nice. It's part of getting a good price - the price I want at the time. Retail investors would normally go to the back of the line, do you think human brokers and market makers are fair? I execute fairly quick trading strategies, I hold a stock from a day to a week, being able to sell at the peak of an up day or unload shares when the market is just beginning to move against me, as opposed to minutes or hours later is everything. And as another poster said, most of what HFT is, is market making... (Even traditional MMs made their money on arbitrage)

meric 13y ago

You still lose with Limit Orders. Here is how. I also propose how to actually not get ripped off. The bid price is $100, the offer price is $101. You want to buy, but you don't want to cross the spread. You're worried the $101 isn't actually there - i.e. if you place an order to buy for $102, either the $101 order will get pulled by the HFT trader, or the HFT trader will buy the $101 order and sell it to you at $102. The article suggests placing a limit order without crossing the spread. i.e. Put a limit order at $100. So you put the limit order at $100. It sits there, and doesn't move. 10 minutes later, another company in the same industry announces below expected results due to market conditions. As this company is in the same industry, its stock price is negatively affected. Before you have time to cancel your $100 limit order, the HFT trader has already parsed the negative news and short sold the stock all the way down to $99.5, taking your order with it, you're recorded to have sold at $100. You lose either way. The continuous limit order market is where HFT has a lot more edge than you do. You can try to avoid placing market orders that cross the spread, as well as avoid placing limit orders that linger for too long and get taken advantage of. There's a call auction in the morning before the stock market opens every day. No market orders are allowed. Everyone places limit orders and everyone executes at one price. There is no spread to cross. As long as enough other investors participate in the same call auction, it'll be a lot more difficult for HFT traders to take advantage of your order. (Frequency doesn't even come into play since call auctions are discrete markets, not continuous - there is only 1 open price. This negates the HFT trader's speed advantage, since speed is rendered irrelevant) Just regurgitating stuff I've learnt with finance at university.

umanwizard 13y ago
Your example doesn't make sense to me. Why would you place an order to buy for $102 if there is an offer for $101 ?
- jessaustin 13y ago
  Prices move, so traders add a bit of leeway if they want to be sure the trade will execute. The worry with HFT is that the price will move solely in order to screw over this particular trade, rather than as a reflection of overall market conditions.

gizmo 13y ago

A few points: 1) This doesn't address the front-running issue. (Where different exchanges receive the buy/sell order at a different times and HFT can abuse those microsecond differences) 2) It's a universal truth that people who are better informed are harder to rip off. So that's not very persuasive. You can't reasonably expect regular people to know in which situations they'll be paying a premium for a liquidity service they may not even want. 3) It's completely fair to ask ourselves as a society if HFT groups are making a contribution to society that warrants the money they make. And if transparency with regard to HFT trading strategies leads regular people and sophisticated investors to make different decisions, then that means that the lack of transparency worked in favor of HFT. Therefore, it's reasonable to assume much of the HFT profits are just an externality. The decline of HFT is in part because investors are getting wise to the shenanigans.

Mikeb85 13y ago
No, the decline of the HFT industry is because there's so many competitors they're racing to $0...
- wglb 13y ago
  Keep in mind that many HFTs are market makers and have specific agreements with exchanges that pays them 0.005 cents per share traded, regardless. The other side of this is that they MUST stay in the market, no matter what. Thus, when trading volume went down over last few years, many HFT firms had less income. (And to answer another commenter in this thread, No, other investors are not "wise" to the ways of HFT, all traders save for the brokerage firms who used to collect $0.10 on each share traded (the spread before HFT) benefit.)
kasey_junk 13y ago
"1) This doesn't address the front-running issue. (Where different exchanges receive the buy/sell order at a different times and HFT can abuse those microsecond differences)" This is only an issue if your order is large enough to take out the entire liquidity of one of the exchanges. If that is the case, by definition you are not a retail investor, you are an institutional investor and part of the value add you are supposedly adding is your ability to operate in a complex market. "2) It's a universal truth that people who are better informed are harder to rip off. So that's not very persuasive. You can't reasonably expect regular people to know in which situations they'll be paying a premium for a liquidity service they may not even want." So informed market participants should subsidize ignorant ones? "3) It's completely fair to ask ourselves as a society if HFT groups are making a contribution to society that warrants the money they make. And if transparency with regard to HFT trading strategies leads regular people and sophisticated investors to make different decisions, then that means that the lack of transparency worked in favor of HFT. Therefore, it's reasonable to assume much of the HFT profits are just an externality. The decline of HFT is in part because investors are getting wise to the shenanigans." Agreed. We should also have that discussion around dark pool operators, hedge funds, and investment banks. While we are at it, lets talk about photo sharing websites and internet chat services as well.

gopher1 13y ago

If you're not a pension fund or other large investor, HFT's don't care about your orders.

krastanov 13y ago

Isn't the entire point, that the anti-HFT folks are trying to make, that if HFT is abolished then we will still have liquidity? As in "Liquidity is not created by HFT. HFT are just an intermediary between the actual providers of liquidity and the rest of the market". This is a sincere question, because I really do not understand how HFT "creates liquidity" when they are just buying low and selling high.

vbuterin 13y ago
They are nevertheless buying higher than everyone else and selling lower than everyone else. Otherwise their orders would never get filled.
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  - kasey_junk 13y ago
    No exchange in the US allows trading something at $26.107 that is in fact explicitly against the rules. HFTs do not see your buy order before it reaches the market and then buy them ahead of you to sell them back to you. Your understanding of the stock markets and HFT is inaccurate and you are spreading incorrect information.
    - Sniperfish 13y ago
      Retail orders are generally routed to markets using a SOR and do not overage 100% of the full order. There are latency differences between exchanges / ATS'. If you are very fast is possible to post passively on multiple venues and exploit those latency differences to assume if you see a small ping on market x there is more behind it. You can gain book position and the spread with this information, if you are fast.

kasey_junk 13y ago

As usual Chris does a good job of explaining in simple terms how the markets actually work. The one thing I would have liked to see in this article is a discussion of the pro's and con's of paying for liquidity vs execution risk. From my perspective it is almost always better to have sooner execution with a liquidity tax than an order floating in the market but I'm not sure how to quantify that as a retail stock purchaser.

rbc 13y ago

I personally use limit orders. I think there is an important distinction in deciding how much will be paid for a security. It makes you think about what the security is actually worth, separate from what the market order book is saying about the security at any particular time.

hawkharris 13y ago

I just started learning about high frequency trading. I was interested to learn about some of the lore surrounding the field. While digital algorithms are relatively new, trading algorithms, in a conceptual sense, have existed for at least hundreds of years. I don't usually throw around links to my own content, but I think this is relevant: http://codyromano.com/using-pigeons-as-algorithms/ http://codyromano.com/using-pigeons-as-algorithms/

001sky 13y ago

Author would benefit from a closer reading of the M. Lewis piece. It's well researched far from trivial. What's interesting about it is that it tells the story of how outsiders modeled the various ways to rip off <institutional> traders. They did this first and the empirically pattern-matched observed behaviour. They then did both physical and social market-micro-structure studies. Lets take a look at this section (From attached article): The fact of the matter is that HFT’s can’t rip you off. You are never under any obligation to do business with them. In spite of that, lots of sophisticated investors voluntarily pay HFTs every day. An important question for all the critics of HFT to grapple with is, “why do sophisticated investors voluntarily pay for something useless?” This comes right after the section on why people don't adopt obvious strategies (use limit orders, etc): Why doesn’t everyone do this? This is an obvious question to ask. The answer is, quite simply, execution risk. Execution risk is the risk that you place an order but your trade never actually happens. The Analysis Lewis outlines in his book shows that HFT is specificially engineered <to create execution risk>. It engineers artificial scarcity (the opposite of liquidity). Empirical study from Lewis's book: Finally [The Trader] complained so loudly that they sent the developers, the guys who came to RBC in the Carlin acquisition. “They told me it was because I was in New York and the markets were in New Jersey and my market data was slow,” Katsuyama says. “Then they said that it was all caused by the fact that there are thousands of people trading in the market. They’d say: ‘You aren’t the only one trying to do what you’re trying to do. There’s other events. There’s news.’ ” <If that was the case, he asked them, why did the market in any given stock dry up only when he was trying to trade in it?> [emphasis added] To make his point, he asked the developers to stand behind him and watch while he traded. “I’d say: ‘Watch closely. I am about to buy 100,000 shares of AMD. I am willing to pay $15 a share. There are currently 100,000 shares of AMD being offered at $15 a share — 10,000 on BATS, 35,000 on the New York Stock Exchange, 30,000 on Nasdaq and 25,000 on Direct Edge.’ You could see it all on the screens. We’d all sit there and stare at the screen, and I’d have my finger over the Enter button. I’d count out loud to five. . . . “ ‘One. . . . “ ‘Two. . . . See, nothing’s happened. “ ‘Three. . . . Offers are still there at 15. . . . “ ‘Four. . . . Still no movement. . . . “ ‘Five.’ Then I’d hit the Enter button, and — boom! — all hell would break loose. The offerings would all disappear, and the stock would pop higher.” This is why it's being investigated by the FBI, in addition the other issues (front running, NPI, etc). "There are many people in government who are very focused on this and who are concerned about it and who think it breaks the law," an FBI spokesman said. "There is a big concern that high-frequency traders are getting material nonpublic information ahead of others and trading on it."

logfromblammo 13y ago

I am not a finance expert. What would happen if you traded stocks using a continual series of discrete uniform price auctions? Each buyer enters a sealed bid consisting of the amount he wishes to buy, and at what price. Each seller enters a sealed offer consisting of the amount he wishes to sell, and at what price. When the auction interval ends, the secure settlement system orders the bids and offers, and calculates the common settlement price such that every bid higher than that price can be satisfied with the offers lower than that price. Every unit in the auction is traded at that one price. Unsatisfied bids and offers could be set up to roll over to subsequent intervals, or to expire. The settlement system takes a fee from all trades, as a fraction of the amount a buyer was willing to pay, but didn't need to, and a fraction of the amount a seller got in excess of what he wanted. The marginal buyer and seller, who were not pleasantly surprised by the interval's settlement price, pay nothing. There is no opportunity for front running. If you bid lower than a major institution, your orders will be filled after the institution's orders. You can't re-sell to it at a higher price because it already has what it wants. Trading speed is irrelevant. All that matters is that your orders are in before the settlement interval closes, which happens on a human scale. Why would such a system be unsuitable for our modern finance system?

kasey_junk 13y ago
What scale would you use? If we choose 15 minutes, then day traders who sit at a computer screen all day have an advantage over people who have to work. Ok then, how about once a day. Well then people without kids have an advantage as they have more time to research this stuff. Not to be overly sarcastic, but you can't pick a discrete time period that doesn't have trading speed as a component.
- logfromblammo 13y ago
  If you set your orders and offers to roll over through multiple intervals, you don't need to babysit them. You are absolutely guaranteed to pay at most what you bid, and to receive at least your reserve price. You could leave them in the system for a thousand years and never be disappointed in your trade. I can set my bid at what I think a company is worth to me, and simply leave it there until the clearing price is lower. I would probably set the interval to one hour, with 24 auctions clearing per day, and each tradable item settling at a different position on the clock, so as to not overload my servers at any given time.

Sniperfish 13y ago

Nanex explains this stuff better than I will so I'm just going to link to their research (tl;dr summary of [1] below). I will accept not all HFT participants are obligated to follow any or all of these behaviours, but they are argued in defence of all HFT activity which is patently not true. 1. They Provide liquidity, false. Or at least works on a definition of liquidity that is not what would generally be used by other market participants (institutional or retail) - specifically see pinging or using orders to determine interest [2] 2. Tighten spreads, false. Attributable in the largest part to reg NMS not directly to HFT. Spread volatility has increased. 3. Lower costs, false. Cheap trading available via discount brokers before HFTs and additional costs to other market participants operating in HFT innundated environments are ignored. 4. Studies showing positive of HFT cherry pick and are of inconsequential detail, no conclusions should be drawn without deeper analysis of the data 5. Nannex guys just have an axe to grind repudiation Plus ignores any other negative side effects of super-high speed trading such as stock specific flash crashes, data overload, and locked / crossed markets. Appreciate some of those can also be attributed to the proliferation of protected markets post Reg NMS. [1] http://www.nanex.net/aqck2/4594.html http://www.nanex.net/aqck2/4594.html [2] http://www.nanex.net/aqck2/4592.html http://www.nanex.net/aqck2/4592.html (appearing to violate SEA 9.a.1.A)

panzagl 13y ago

There is a lot of 'unless you're selling 100000 shares in a hurry you shouldn't care', but if an HFT 'rips off' a pension fund I very much do care- even if I'm not personally affected I'm sure the added cost will be passed on to the state somehow.

liricooli 13y ago

For anyone interested in more information, I׳d recommend reading the comments in these two threads [0,1] from Marginal Revolution blog. Two HFT traders wrote thoroughly about HFT. I׳ve never read such an interesting and broad online discussion about HFT. I actually spent most of yesterday׳s afternoon reading these threads. [0] http://marginalrevolution.com/marginalrevolution/2014/04/matt-levine-on-michael-lewis-and-hft.html http://marginalrevolution.com/marginalrevolution/2014/04/mat... [1] http://marginalrevolution.com/marginalrevolution/2014/03/new-michael-lewis-book-on-finance-and-high-frequency-trading.html#comments http://marginalrevolution.com/marginalrevolution/2014/03/new...

elecengin 13y ago

Unfortunately, a traditional US retail investor does not have the flexibility described here. Lewis describes Electronic Market Makers (EMMs) and Payment For Order Flow (PFOF) - under these models, your order never actually reaches a market. It is routed directly to a market making firm (usually Citadel, Knight, Pershing, or Getco) that fills the order immediately if the price is marketable and then trades out of the position later. This indirection makes the whole discussion around your position in the order book somewhat moot. It is important to recognize that under Reg NMS the market making firm must fill you at the prevailing market price (the NBBO). While they technically could sweep the market to move the market price before filling, this almost never happens for a retail order since they are so small. For this reason, the whole discussion around HFT "front-running" isn't very topical to the retail investor buying individual stocks and it barely affects the cost of execution of funds ($0.43 per $10,000 notional value traded according to [1]) In summary, the people fanning this flame are not trying to protect retail investors... If they were, they would focus on the larger scams on the street (exhorbitant management fees for actively managed funds, for example) [1] http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1928510 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1928510

thatthatis 13y ago
It saddens me that people lump Market Making and HFT together. Over the past 100 years, the bid-ask spread has fairly steadily decreased due to technology and this fact in isolation is uniformly a good thing for retail investors. http://www.cxoadvisory.com/5737/big-ideas/trading-frictions-over-the-long-run/ http://www.cxoadvisory.com/5737/big-ideas/trading-frictions-... Other HFT methods are less clearly on net socially good.

fsk 13y ago

The premise of the post is false. If a large limit order is resting on the books, that's an implied option for the HFTs. If you place a large bid at $10.00, the HFTs will buy at $10.01. If the market starts going down, they sell to you before the price crashes more. If the price goes up, you never got your fill. Limit orders don't protect from HFTs exploiting you. What happens is you either don't get filled (price drops to $10.01 and goes back up), or the price drops to $9.99 or less.

PaulHoule 13y ago

I think people forget how much front running happened in the bad old days on the stock market floor, how the NYSE organized a cartel that kept trading prices high, and that the bid/ask spread is usually a lot less than it used to be. One thing people don't say much about HFT is that the HFT practitioners got the exchanges to add undocumented order types that let them, in some cases, take advantage of people who do limit orders as the author of this post describes. The best description of this is at http://www.amazon.com/The-Problem-HFT-Collected-Frequency/dp/1481978357 http://www.amazon.com/The-Problem-HFT-Collected-Frequency/dp... Often when I trade stocks I like to set a limit order at a price that might be a percent or so better than the market rate. Since the price fluctuates, odds are pretty good that I'll get my fill. Now if it is just the normal Brownian motion, it's a good thing that I get my fill, but if the stock is getting hammered by an external event that is driving it way down I might have hit the limit for the wrong reason and be unhappy I got the fill. In situations like that, HFT traders have an advantage with their special order types. I think the normal retail investor who buys and holds for a while is not hurt terribly by HFT and flash crashes(unless the market is depressed because of the fear of HFT) but you can definitely get burned if you use stop orders. If a price goes down quickly, that can trigger your stop order, causing you to sell at a bad time.

whyme 13y ago

It's sad that I as a retail investor need to spend my valuable time focusing on how not to get screwed by the exchanges that have introduced a side business which does not serve the functioning of the market and instead corrupts it.

harryh 13y ago
You don't actually need to focus on this. As a retail investor your going to get filled at NBBO (National Best Bid and Offer). The people writing things that make you think otherwise are selling irrational fear. It's no different than how local news makes people think that crime in the US is at an all time high by reporting on it all the time when, in fact, crime has been dropping for decades. Don't buy what the fear-mongers are selling.

dbrower 13y ago

Can someone explain why any of these is a bad idea? (a) completed transaction tax; (b) regulatory fee on offers/cancellations; (c) insertion of random delays into offers/cancellations; All could increase friction and reduce the speculative/arbitrage opportunities, while having little effect on those wanting to trade to hold for periods exceeding seconds. There is a belief that the churn of HFTs/Arbs is enhancing liquidity for "real" investors. There ought to be reasonable questions what amount of churn is useful, adequate, and whether some frothy levels should be constrained in some way. Is there any way to decide when things are excessivly liquid, in ways that lead to undesirable effects?

kasey_junk 13y ago
Any tax you propose will reduce the amount of the taxed thing and introduce unintended consequences. So we have to ask why do you want less transactions or orders? It won't reduce HFT activity for instance. It will just mean that HFT systems will only make more profitable trades. That means higher bid/ask spreads and higher risk limits leading to higher volatility. It also may have the unintended consequence of consolidating more volume into smaller firms. That doesn't seem to be in anyone's best interest. As for latency games the issue is not the overall latency it is fifo priority matching. Without changing that bouncing trading signals off of mars won't help.
- dbrower 13y ago
  I think a reasonable question is why we consider /more/ transactions a good thing, if a large fraction of them are for holding periods in small number of seconds. I think I am questioning the fifo paradigm, which creates these arbitrage opportunities, especially when there are multiple fifo queues representing multiple markets. It is not clear to me that batching things in 1 sec increments, and randomizing the our ordering would be bad or unfair. I also don't see why a modest fee that would make short-hold transactions for tiny gains is a bad thing. Structuring the system to reward HFT latency advantages seems opposed to stability, if one believes that the market is for actual investments. HFT seems to be a second order phenomenon that games the system, and may have come to dwarf what could be called legitimate investment. At what point is there "enough" liquidity, and when is "too much"? I suspect the people who do HFT and other arb techniques think there is no such thing as too much, because they profit on the churn. Others see this as producing nothing of societal value, extracting real money from the system that could be used for other purposes.

tptacek 13y ago

These discussions would be improved if more of the participants understood the problem of transacting in large blocks of tradable instruments. The impression HN trading discussions create is that there is a universe in which block trades are frictionless or even remotely predictable. In fact, moving large blocks across the market isn't just an annoying detail of the markets; it's one of the basic fundamental problems of institutional trading, and a large part of the rationale for the existence of brokers. Transacting in blocks of stock is to professional trading what the CAP theorem is to distributed software development. One of the most famous and approachable books about market structure is Larry Harris' _Trading And Exchanges_. The book is like the TCP/IP Illustrated of money. It is supremely readable and written in a style that software developers in particular will find congenial. You can get a Kindle version of it right now. I feel extremely comfortable recommending it. It is a great read. The example of trying to move a large block of (fictitious) Smithsonian Industries is one of the opening, motivating examples the book uses to outline the challenges of trading. The inheritor of a huge chunk of Smithsonian Industries needs to sell 900,000 shares of thinly-traded stock. The example continues: Goldman's block brokers face the following predicament. If nobody knows that they have stock to sell, they will not be able to sell it. However, if too many people know that a large block of stack is hanging over the market, speculators will push the price down. The Goldman brokers thus must be selective when approaching potential buyers. The motivating example Lewis gives in his book is of a trader at a large investment bank who, based on their $2MM/year salary, is presumably being paid handsomely for the service of figuring out how to move blocks like that without having the market shift out from under them. In Harris' example, the Goldman traders research other owners of Smithsonian Industries and approaches them privately and individually in the hopes of placing much of the block privately at a small discount. In Lewis' example, the handsomely-paid trader sees a spot price in their blotter screen, expects to push a single button (no, really, that's how Lewis frames it) to sell at that price, and is outraged when the price moves. There's an interesting debate to be had about HFT and, particularly, the conflicts of interest between broker-dealers and exchanges and dark pools. But it's hard to have that discussion if you start from the belief that institutional trading is supposed to be easy. The opposite is true.