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Can someone explain how HFT would "provide liquidity", which seems to always be the pro-HFT response? To use an analogy, if I want to buy a house and someone is

Can someone explain how HFT would "provide liquidity", which seems to always be the pro-HFT response? To use an analogy, if I want to buy a house and someone is selling a house, how does a third-party buying the house first and selling it to me a slightly higher price provide liquidity?

patmcc 13y ago
If a third-party is always willing to buy houses (or sell houses it owns), then you don't have the awkward case where I want to buy your house today but you really really wanted to sell it a month ago.
Mikeb85 13y ago
Because they'd be buying and selling when there isn't a buyer or seller. Imagine if you could have the house off your hands, at market price, in a day instead of listing it for months. That's b what liquidity does for you. Almost all HFT is market making, there's plenty of information about what that means...
- pkinsky 13y ago
  I thought the whole point of HFT was to wait for a buyer to signal interest in buying X, and then buy X before that buyer and sell it to him at a slightly higher price. If this is true, then in your scenario you would still have your house listed for months, but a high frequency trader would buy it just slightly before it would be brought without any high frequency traders in the loop.
  - kasey_junk 13y ago
    You'd think that is true from all the hoopla wouldn't you. But that simple assumption is exactly what large buy side investors want you to think and it is false* *There are some highly predatory algorithms that try to do this. The problem is that if you are fast enough to do this routinely, you are sophisticated enough to do legitimate market making and make more money.
  - harryh 13y ago
    Your understanding of the point of HFT is incorrect. Unfortunately your understanding is a fairly widespread misunderstanding and Michael Lewis book only serves to make things worse. Maybe start here to better understand things: http://www.bloombergview.com/articles/2014-03-31/michael-lewis-doesn-t-like-high-frequency-traders http://www.bloombergview.com/articles/2014-03-31/michael-lew...
  - Mikeb85 13y ago
    The idea is to buy when there's a seller, then sell when there are buyers. This can mean holding on to shares for seconds or minutes. Yes they seek to make money on arbitrage and predict which way the stock goes based on existing bids and asks, but they are definitely creating liquidity by filling the gaps.
aet 13y ago
k, I'll bite. Lets say you want to sell your house in 1935. Luckily, there is a buyer, but he won't be ready until 1946 when he gets back from fighting WW2. Luckily, there is a real estate investor who is willing to step in an buy from you and sell to him. He'll hold the property from 1935 to 1946. During that time he takes the risk that housing prices may go down. He also has to pay operating costs in the form of his office and assistant. This is essentially what HFTs do. They intermediate markets.They have cost and risks. Some of them take advantage of special knowledge of market organization. They know the hot neighborhood. The real question is: Are market intermediaries being compensated fairly for the risk they take? i.e. do HFTs make too much money for the risk and expense they incur while intermediating markets.
- erichocean 13y ago
  I get all that, but does that really apply when the time interval is sub-second? It's hard to imagine the discounted value of the trade changing in a sub-second interval, whereas it obviously does selling 11 years later. In other words, sure, definitionally it's liquidity, but since the trade would have gone through a sub-second later anyway, it's not meaningful liquidity: the liquidity was already there on a reasonable timespan (again, sub-second) for the seller. Thus, nothing has been gained. What am I missing here? Do sellers really need additional sub-second liquidity beyond what the market would provide without HFT?
  - aet 13y ago
    I think it is just the nature of the market mechanism i.e. the rules of the game. Since markets are continuous there is going to be competition. Tick sizes means that participants have to compete on speed rather than price. It seems to me that competition and continuous markets are maybe the best way to keep prices aligned across markets. And, just maybe, the best way to keep costs low for retail traders.
  - hft_throwaway 13y ago
    If you think you don't benefit from someone else providing a quote, place a limit order of your own and update it throughout the day. Buying the market-maker's quote is basically giving them your trading problem. It's specialization like anything else. You get to do what you're best at. He gets to figure out the cheapest way to exit/hedge the position. Also very few HFTs have sub-second average holding periods. There aren't many instances where the market trades both sides so quickly. Probably average in the 10s of seconds at least if not longer.
reverend_gonzo 13y ago
Saying Alice wants to sell a house, but she needs to sell the house now, and is willing to take slightly less money to get it sold. That's when the HFT comes in says, "Okay we'll buy your house for slightly less than market value, since we're taking the risk that we can resell it." That's Alice crossing the bid-ask spread, and paying for liquidity. Suppose Alice doesn't want to pay for liquidity. She can just as well say, I'm going to wait for a buyer willing to pay the ask price. She doesn't trade with an HFT and instead takes the risk that a buyer never shows up or that the market moves against her. This is equivalent to an add-liquidity-only order. She won't be crossing the spread, and she therefore she won't pay the bid-ask spread. It's the same thing if you're buying. If you don't want to pay for liquidity you don't have to. You state your price, say you'll only add liquidity, and when a seller comes along who's willing to give it to you at that price, you'll be matched.
- AnthonyMouse 13y ago
  Let's unpack that a little. For most publicly traded stocks, there are always going to be willing buyers and willing sellers, for the right price. Those prices, respectively, are the bid and ask prices. So for example, if you want to trade shares of some stock, the bid might be $100.00 and the ask might be $100.10, i.e. someone will buy from you at $100.00 and someone will sell to you at $100.10. Obviously if the buyers and sellers hold fast then no trades get made: The buyers are offering less than the sellers are willing to accept. If you want to make a trade then someone has to cross the spread -- either the buyer has to pay $100.10 or the seller has to accept $100.00. This leaves room for speculators: When a seller decides they want to trade right now and they cross the spread, the speculator can buy the shares and then hold them until a buyer comes who is willing to cross the spread, and then the speculator profits by buying at the bid price and selling at the ask price. The speculator is taking the risk that in the meantime the price of the stock may go down and they'll lose money, and that risk is what earns the profit. But HFT isn't that. HFT is having fast computers sitting in Chicago and New York, so that when a buyer crosses the spread in Chicago at the same time as a seller crosses the spread in New York, the HFTer can arbitrage the transactions with the foreknowledge that both trades will clear immediately. The HFTer is not taking a risk proportional to the profit but rather is profiting from trading with superior information. Moreover, the HFTer is only holding the shares for milliseconds. How does that provide any useful amount of liquidity? Why can't we arrange the exchanges so that if a buyer and seller both cross the spread at approximately the same time, they split the difference and no third party takes anything?
harryh 13y ago
Market makers provide liquidity because a lot of the time when you want to buy a house no one is actually selling one. Rather than waiting around for someone else to show up to sell you a house the market maker is always there with one to sell.
deleted 13y ago
[deleted]
KVFinn 13y ago
>Can someone explain how HFT would "provide liquidity", which seems to always be the pro-HFT response? You should narrow your question to how the latency arms race provides liquidity, and if it would be different it latency was capped at some amount.
snowwrestler 13y ago
Let's use an example that everyone is already familiar with. Everyone knows you can get more for a used car if you sell it yourself instead of trading it in. Yet millions of people trade in their cars. Why? Because it's easier and faster. The difference in price they get from the dealer vs Craigslist is the price they are paying for liquidity in the transaction.
mcguire 13y ago
You have to understand that the definition of "providing liquidity" is to always supply a buyer for a security, with the minor qualification that the buyer so provided should be able to immediately turn the security around for a profit. HFT's are very good at providing liquidity (and obviously so), under that definition.

patmcc 13y ago

If a third-party is always willing to buy houses (or sell houses it owns), then you don't have the awkward case where I want to buy your house today but you really really wanted to sell it a month ago.

Mikeb85 13y ago

Because they'd be buying and selling when there isn't a buyer or seller. Imagine if you could have the house off your hands, at market price, in a day instead of listing it for months. That's b what liquidity does for you. Almost all HFT is market making, there's plenty of information about what that means...

pkinsky 13y ago
I thought the whole point of HFT was to wait for a buyer to signal interest in buying X, and then buy X before that buyer and sell it to him at a slightly higher price. If this is true, then in your scenario you would still have your house listed for months, but a high frequency trader would buy it just slightly before it would be brought without any high frequency traders in the loop.
- kasey_junk 13y ago
  You'd think that is true from all the hoopla wouldn't you. But that simple assumption is exactly what large buy side investors want you to think and it is false* *There are some highly predatory algorithms that try to do this. The problem is that if you are fast enough to do this routinely, you are sophisticated enough to do legitimate market making and make more money.
- harryh 13y ago
  Your understanding of the point of HFT is incorrect. Unfortunately your understanding is a fairly widespread misunderstanding and Michael Lewis book only serves to make things worse. Maybe start here to better understand things: http://www.bloombergview.com/articles/2014-03-31/michael-lewis-doesn-t-like-high-frequency-traders http://www.bloombergview.com/articles/2014-03-31/michael-lew...
- Mikeb85 13y ago
  The idea is to buy when there's a seller, then sell when there are buyers. This can mean holding on to shares for seconds or minutes. Yes they seek to make money on arbitrage and predict which way the stock goes based on existing bids and asks, but they are definitely creating liquidity by filling the gaps.

aet 13y ago

k, I'll bite. Lets say you want to sell your house in 1935. Luckily, there is a buyer, but he won't be ready until 1946 when he gets back from fighting WW2. Luckily, there is a real estate investor who is willing to step in an buy from you and sell to him. He'll hold the property from 1935 to 1946. During that time he takes the risk that housing prices may go down. He also has to pay operating costs in the form of his office and assistant. This is essentially what HFTs do. They intermediate markets.They have cost and risks. Some of them take advantage of special knowledge of market organization. They know the hot neighborhood. The real question is: Are market intermediaries being compensated fairly for the risk they take? i.e. do HFTs make too much money for the risk and expense they incur while intermediating markets.

erichocean 13y ago
I get all that, but does that really apply when the time interval is sub-second? It's hard to imagine the discounted value of the trade changing in a sub-second interval, whereas it obviously does selling 11 years later. In other words, sure, definitionally it's liquidity, but since the trade would have gone through a sub-second later anyway, it's not meaningful liquidity: the liquidity was already there on a reasonable timespan (again, sub-second) for the seller. Thus, nothing has been gained. What am I missing here? Do sellers really need additional sub-second liquidity beyond what the market would provide without HFT?
- aet 13y ago
  I think it is just the nature of the market mechanism i.e. the rules of the game. Since markets are continuous there is going to be competition. Tick sizes means that participants have to compete on speed rather than price. It seems to me that competition and continuous markets are maybe the best way to keep prices aligned across markets. And, just maybe, the best way to keep costs low for retail traders.
- hft_throwaway 13y ago
  If you think you don't benefit from someone else providing a quote, place a limit order of your own and update it throughout the day. Buying the market-maker's quote is basically giving them your trading problem. It's specialization like anything else. You get to do what you're best at. He gets to figure out the cheapest way to exit/hedge the position. Also very few HFTs have sub-second average holding periods. There aren't many instances where the market trades both sides so quickly. Probably average in the 10s of seconds at least if not longer.

reverend_gonzo 13y ago

Saying Alice wants to sell a house, but she needs to sell the house now, and is willing to take slightly less money to get it sold. That's when the HFT comes in says, "Okay we'll buy your house for slightly less than market value, since we're taking the risk that we can resell it." That's Alice crossing the bid-ask spread, and paying for liquidity. Suppose Alice doesn't want to pay for liquidity. She can just as well say, I'm going to wait for a buyer willing to pay the ask price. She doesn't trade with an HFT and instead takes the risk that a buyer never shows up or that the market moves against her. This is equivalent to an add-liquidity-only order. She won't be crossing the spread, and she therefore she won't pay the bid-ask spread. It's the same thing if you're buying. If you don't want to pay for liquidity you don't have to. You state your price, say you'll only add liquidity, and when a seller comes along who's willing to give it to you at that price, you'll be matched.

AnthonyMouse 13y ago
Let's unpack that a little. For most publicly traded stocks, there are always going to be willing buyers and willing sellers, for the right price. Those prices, respectively, are the bid and ask prices. So for example, if you want to trade shares of some stock, the bid might be $100.00 and the ask might be $100.10, i.e. someone will buy from you at $100.00 and someone will sell to you at $100.10. Obviously if the buyers and sellers hold fast then no trades get made: The buyers are offering less than the sellers are willing to accept. If you want to make a trade then someone has to cross the spread -- either the buyer has to pay $100.10 or the seller has to accept $100.00. This leaves room for speculators: When a seller decides they want to trade right now and they cross the spread, the speculator can buy the shares and then hold them until a buyer comes who is willing to cross the spread, and then the speculator profits by buying at the bid price and selling at the ask price. The speculator is taking the risk that in the meantime the price of the stock may go down and they'll lose money, and that risk is what earns the profit. But HFT isn't that. HFT is having fast computers sitting in Chicago and New York, so that when a buyer crosses the spread in Chicago at the same time as a seller crosses the spread in New York, the HFTer can arbitrage the transactions with the foreknowledge that both trades will clear immediately. The HFTer is not taking a risk proportional to the profit but rather is profiting from trading with superior information. Moreover, the HFTer is only holding the shares for milliseconds. How does that provide any useful amount of liquidity? Why can't we arrange the exchanges so that if a buyer and seller both cross the spread at approximately the same time, they split the difference and no third party takes anything?

harryh 13y ago

Market makers provide liquidity because a lot of the time when you want to buy a house no one is actually selling one. Rather than waiting around for someone else to show up to sell you a house the market maker is always there with one to sell.

deleted 13y ago

[deleted]

KVFinn 13y ago

>Can someone explain how HFT would "provide liquidity", which seems to always be the pro-HFT response? You should narrow your question to how the latency arms race provides liquidity, and if it would be different it latency was capped at some amount.

snowwrestler 13y ago

Let's use an example that everyone is already familiar with. Everyone knows you can get more for a used car if you sell it yourself instead of trading it in. Yet millions of people trade in their cars. Why? Because it's easier and faster. The difference in price they get from the dealer vs Craigslist is the price they are paying for liquidity in the transaction.

mcguire 13y ago

You have to understand that the definition of "providing liquidity" is to always supply a buyer for a security, with the minor qualification that the buyer so provided should be able to immediately turn the security around for a profit. HFT's are very good at providing liquidity (and obviously so), under that definition.