6 ms·

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

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?
- fr0sty 13y ago
  > 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. Can you explain this in more detail? How does the HFT know that someone is crossing the spread? How is the HFT able to transact with two market-crossing orders after the fact? What financial instrument is being traded in Chicago and NY?
  - AnthonyMouse 13y ago
    > How does the HFT know that someone is crossing the spread? So suppose the bid for some particular stock is $100.00 and the ask is $100.10 in both Chicago and New York. They could be different between the two exchanges, but the prices between exchanges will generally be the same or very close to each other at any given time because any significant divergence is an arbitrage opportunity. Now somebody wants to buy some shares of that stock in Chicago, so they cross the spread and put in a bid for $100.10. They immediately buy all the shares in Chicago that are available at $100.10. Now the ask in Chicago will go up because all the shares available for $100.10 in Chicago have been purchased, so now the bid in Chicago is $100.10 and the ask is, say, $100.20. At the same time, in New York, somebody wants to sell some shares of the same stock. So they cross the spread and make shares available for the bid price in New York, which is $100.00. That seller sells to everyone in New York who is willing to pay $100.00, so now the ask in New York is $100.00 and the bid is, say, $99.90. Both the buyer in Chicago and the seller in New York are still willing to buy and sell more shares at $100.10 and $100.00 respectively, i.e. the new bid in Chicago is higher than the new ask in New York. The HFTer sees the new prices before most other traders because their computers are faster and closer to the exchanges. As soon as the buyer at $100.10 learns there is a seller at $100.00 or vice versa, they would get together and trade all the shares they want to trade at some price in that range. But the HFTer learns the pricing information first and, before the buyer and seller find out about each other, the HFTer buys the seller's shares in New York at $100.00 and immediately resells them to the buyer in Chicago at $100.10.
    - fr0sty 13y ago

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?

fr0sty 13y ago
> 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. Can you explain this in more detail? How does the HFT know that someone is crossing the spread? How is the HFT able to transact with two market-crossing orders after the fact? What financial instrument is being traded in Chicago and NY?
- AnthonyMouse 13y ago
  > How does the HFT know that someone is crossing the spread? So suppose the bid for some particular stock is $100.00 and the ask is $100.10 in both Chicago and New York. They could be different between the two exchanges, but the prices between exchanges will generally be the same or very close to each other at any given time because any significant divergence is an arbitrage opportunity. Now somebody wants to buy some shares of that stock in Chicago, so they cross the spread and put in a bid for $100.10. They immediately buy all the shares in Chicago that are available at $100.10. Now the ask in Chicago will go up because all the shares available for $100.10 in Chicago have been purchased, so now the bid in Chicago is $100.10 and the ask is, say, $100.20. At the same time, in New York, somebody wants to sell some shares of the same stock. So they cross the spread and make shares available for the bid price in New York, which is $100.00. That seller sells to everyone in New York who is willing to pay $100.00, so now the ask in New York is $100.00 and the bid is, say, $99.90. Both the buyer in Chicago and the seller in New York are still willing to buy and sell more shares at $100.10 and $100.00 respectively, i.e. the new bid in Chicago is higher than the new ask in New York. The HFTer sees the new prices before most other traders because their computers are faster and closer to the exchanges. As soon as the buyer at $100.10 learns there is a seller at $100.00 or vice versa, they would get together and trade all the shares they want to trade at some price in that range. But the HFTer learns the pricing information first and, before the buyer and seller find out about each other, the HFTer buys the seller's shares in New York at $100.00 and immediately resells them to the buyer in Chicago at $100.10.
  - fr0sty 13y ago