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A Fervent Defense of Front-running HFTs

107 points by spindritf 13y ago

elecengin 13y ago
This is great - it hits major topics that should be part of this debate. It's long, and it's a bit complicated... but so is the issue. Some things you should be thinking about after reading this: * What exactly constitutes front running? Does trading based on public data (albeit in expensive feeds) constitute front running? * Large trades are almost all traded through algos. Are those algos better than proprietary "market making" algos? Why? * What is adverse selection? How do dark pools contribute? Who benefits and who suffers? Read more articles like this. Be suspicious of "simplified" discussions.
- exelius 13y ago
  I have some questions based on yours: * What constitutes public data? * How likely are the types of front-running HFT algos that are discussed in this article to be the old, traditional players? * What are the ethical (lol) rules against front-running your own customers if you're a market-maker? How could your customers even find out? What happens when the proprietary information is that a customer has just placed a large trade, and you drive up the price before it even hits the market? How is this fundamentally different than the commission these firms already charge?
  - reverend_gonzo 13y ago
    What are the ethical (lol) rules against front-running your own customers if you're a market-maker? How could your customers even find out? What happens when the proprietary information is that a customer has just placed a large trade, and you drive up the price before it even hits the market? How is this fundamentally different than the commission these firms already charge? Market makers are generally proprietary firms that trade their own money, and don't have customers. Brokerages (ie: Scottrade) have customers and it illegal for them to front run their customers.
    - exelius 13y ago
      I'm not thinking retail brokerages -- I'm thinking investment banks like Goldman. Often the big i-banks have both prop trading operations and the ability to fill large orders for institutional clients (e.g. a pension fund looking to buy $1 billion of Apple stock).
      - reverend_gonzo 13y ago
        For them, they have a fiduciary duty to their clients to act in their customers' best interest. So, if their clients asks to purchase, for example 100,000 shares of AAPL, it would be illegal for them to first drive up the price.
  - elecengin 13y ago
    Good questions. * Along with order routing, market data is heavily legislated under RegNMS as well. Both the creation of the SIP feeds (the slower consolidated data) and the rules around exchange proprietary feeds are legislated there. As part of the Fair Access Rule, exchanges cannot favor a certain participant with preferential pricing. Therefore, even if proprietary exchange data products are expensive, they are equally expensive to all participants. I consider that fair. An argument could be made that the price of the feeds is exclusionary. I do not buy this - there are many types of data available in the market that come at a high price. The next question (if you assume that the price makes it effectively non-public) is if there are effective substitutes. I think for non-professional traders (moving less than, say, $10mm notional per month) the SIP and similar feeds is acceptable (just as many retail traders accept 15min delayed market data as acceptable). For more serious traders, there may not be an acceptable substitute, but given their usage the higher costs are more justified. * Ethical rules around front running of orders is covered in the Manning Rule. In short, it prevents placing a firm's trading interests in front of a client. The details can be found at FINRA: http://finra.complinet.com/en/display/display.html?rbid=2403&element_id=9989 http://finra.complinet.com/en/display/display.html?rbid=2403...
davidw 13y ago
I've been following (sort of) the back and forth on this and find it quite interesting. Here's a question though: what happens when the "whale" is really something like an index fund that, ultimately, is composed mostly of retail investors? Aren't they getting ripped off in that case? This isn't a rhetorical question, I'm curious to know how it plays out.
- exelius 13y ago
  Yes. But you get ripped off less in an index fund since in general, they are also run by algos within other algos that just rebalance to match whatever they're tracking. The idea if you're an investment firm is that index funds can hide risky investments: they're often large and they're often not highly leveraged. In reality, index funds are the safest way for individuals to make money in the market because you're placing a bet on the economy as a whole.
- harryh 13y ago
  Here's the CIO of Vanguard (who run some of the biggest index funds in the world) saying that HFTs cut costs: http://www.cnbc.com/id/49434073 http://www.cnbc.com/id/49434073
- daveed 13y ago
  I think it really depends on what you mean by ripped off. I think that institutional investors looking to place multi-million dollar moves shouldn't be able to just place an order and cry foul when it's not completely filled on all the exchanges either. From another point of view, that's the slippage you get from an improper order placement strategy.
- crdoconnor 13y ago
  >Here's a question though: what happens when the "whale" is really something like an index fund that, ultimately, is composed mostly of retail investors? Aren't they getting ripped off in that case? Damn right they're getting ripped off. The defense in the OP is essentially "yes, that can happen but it's very rare". Which is about as believable as it sounds.
wavesounds 13y ago
I'm not buying it. Healthy markets are markets where everyone has access to the same information. HFT by definition means some traders have more access to information than others. This is fundamentally unfair and bad for markets and the economy. I don't see how HFT is any different then insider trading and everyone agrees that should be illegal.
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- giergirey 13y ago
  Where do you draw the line? Some retail investors still rely on reading stock quotes in the financial section of their daily newspaper - should we force everyone to only change prices once a day?
- reverend_gonzo 13y ago
  HFT does not have more information. They have access to the same public information as everybody else, but they have invested in better technology and are therefore able to parse and utilize that information more efficiently. Insider trading, by its definition, is insiders trading on non-public information, that outsiders simply do not have access to for any amount of money.
  - Pxtl 13y ago
    If I tell you that I know privately a piece of news about company XYZ that's about to become public tomorrow, and then you use that knowledge to trade based on how you know its shares will change, that's insider trading. If I tell you that I know privately a piece of news about company XYZ that's about to be come public in 0.25 seconds and your machine is fast-enough to parse and react to this information before that deadline, that seems pretty close to insider-trading, it's just the "insider" is the exchange itself.
jellicle 13y ago
TL;DR: Stucchio thinks that front-running people is fine in circumstances where it's not prohibited by law. It's legal, therefore morally right, is his argument. Other people (including very many securities regulators) think that the problem here is that the law is missing a prohibition.
- exelius 13y ago
  You'll find this attitude (it's legal, therefore it's morally right) is very prevalent in the investment finance industry. It's as if these guys lack a moral compass of their own...
  - kasey_junk 13y ago
    That sort of smear may or may not be true, but it isn't what is happening in this case. What is happening in this case is that 2 groups (large liquidity purchasers and liquidity providers) have a natural antagonistic relationship with each other. Purchaser always want to lower the price and providers want to raise it. This is good for the markets operation. But there is a PR/Power imbalance currently in the market. The large purchasers have tons of money had influence. They are using it to smear the sellers of the product they want. The sellers happen to be an easy group to smear (they are highly technical, secretive, and operate in a world that no one seems to understand). If anything is immoral in all this is that they are actively trying to obfiscate what is happening in the markets and thereby spreading fear.
    - crdoconnor 13y ago
      > The sellers happen to be an easy group to smear (they are highly technical, secretive, and operate in a world that no one seems to understand). Once you understand what it is that they are doing, it's pretty clear that it's wrong. Unfortunately, they like to muddy the issue. Hell, the OP does that every time it comes up on HN by asking people to explain what their problem with it is using obtuse industry jargon (e.g. "which part of FIX/OUCH enables front running?").
chollida1 13y ago
I think this article does a good job of illustrating why its so hard to have an open dialog on this subject. Start with asking "What is front running."? The market's definition would not include what HFT do. But bring this up to someone without knowledge of the public markets and their first reaction is to say, hey this is front running, it must be wrong. "Front Running" has a specific definition and it only relates to a broker and their own clients. You trading before me because you are faster is not front running. You understanding my flow is not front running. You can then ask "What is public information". The fact that everyone can see any tape they pay money to see so there doesn't seem to be any one acting on "insider knowledge." Now tell people that HFT's will use their fast machines to change their orders due to a change on one exchanges tape before the main NBBO tape is updated and some people will claim that this is obviously wrong. The other argument I've seen made here is that trading on "insider knowledge is obviously wrong." Well it isn't obviously wrong and the entire commodities market assumes that anyone can trade legally on insider knowledge. Imagine you are the biggest producer of oranges. You know that you are going to have a bad crop so you but some orange futures so you can meet your demands. This is insider information you've traded on and its the way the market is intended to work.
jalopy 13y ago
TL;DR: Defending HFT’s argues for rewarding market participants who simply jump in front of the line b/c they see other people doing it, at the expense of participants who have worked hard to decided which line to get into. Here's a more fundamental question to ask: What kind of behavior do you want to reward in the stock market? If you view the stock market as a bunch of numbers that wiggle around, where "information" is conveyed by the actions of other people participating in the market (ie, what they’re buying and selling), then the HFT's play a legitimate role in spreading that information around. If you view the market as a place to buy and sell businesses (equivalently - shares of businesses), where capital is allocated to businesses commensurate with the value they provide to society, HFT's are parasites on the effort of others. There are participants in the market that spent an enormous amount of time, diligence and thought into deciding allocating capital to businesses according to the value they ascribe to the businesses. For these participants, the signal they send by putting out their orders is currently taken advantage of by other participants who spend enormous time, effort and money into trying to “tap into” the result of the efforts put forward by the first group and rush to another exchange to buy up that company before anyone else gets there. So: Do we really want to reward all of the effort spent building faster machines, communication links, and algorithms to jump right in front of someone in line? Or do we want to reward those people who are actually determining which businesses have intrinsic value and which do not? It's easy to hate Einhorn or Ackman b/c they're rich. What's important to keep in mind is that they are custodians of and act on behalf of thousands, probably even millions of other people to improve their financial situation. Pensions, endowments, sovereign wealth funds, etc make up the bulk of the funds that Einhorn, Ackman and others invest. The fact that they're rich an indication of their legitimate hard work at researching and allocating capital and enhancing the financial well-being of their clients. (Note: yes, there are always bad apples that get rich by illicit (read: insider) means, but that is an exceedingly small amount of participants and over time they usually get caught). Warren Buffett has often said that a perfectly good stock market would be one which is open only one day a year, where participants put up orders based on the value they actually ascribe to a business. If those orders cross, then trades occur - all in one day. Makes you wonder what would happen to society in that market. Would people would be able to find a way to channel all the frenetic activity currently employed in chasing prices and watching others’ actions into a more productive endeavor?
bakhy 13y ago
reading about the stock market is always kinda disgusting to me. "If a speculator believes AAPL is undervalued, he buys a bunch of shares of AAPL. This drives up the price until AAPL is no longer undervalued - then the speculator can sell his AAPL and reap the profits." -- the part after the dash shocked me :) seems like the entire purpose of the market is speculation? does anyone actually invest in companies any more? :D i did like reading this, informative. gave me a nice other perspective on HFT. however: (a) Goldman Sachs does not have it's own HFT outfit? they are the "helpless victims" here? sounds a little unbelievable. (b) why is it exactly socially beneficial that some HFT company performs this "robin hood" act (lol)? particularly if it exposes us all to the risk of market volatility due to mindless algorithms performing enormous, senseless trade volumes with each other? all in all, i'd vote for that very small tax on trades, just to get rid of this as-yet-unseen level of speculation.
- bakhy 13y ago
  p.s. how does moderation on this site work? i have been downvoted, and i wonder - is this an act of some admin moderating, or do users with sufficient karma get a downvote button and one of them simply dislikes my comment?..
  - Codhisattva 13y ago
    Sometimes downvote means "I disagree". Since you proposed a transaction tax, most likely a libertarian apologist pounced on you.
    - bakhy 13y ago
      ah, ok. i guess that's their right ;)
  - probably_wrong 13y ago
    > ..., or do users with sufficient karma get a downvote button (...)? Yes, they do. I always forget the threshold, but there is one. Check the 4th point in the FAQ: http://ycombinator.com/newsfaq.html http://ycombinator.com/newsfaq.html
politician 13y ago
If HFTs liberate access to price information, then does that make them the "open-source software" equivalent of our current economic operating system? That is, in the same sense that OSS delivers bundles of information about how to do various computational tasks efficiently via source code, HFTs deliver bundles of information about how to value companies efficiently via the ticker tape. In the same way that the source code reveals the genius of the programmer's understanding, the excellance of an HFT is revealed by the report of the ticker tape.
JumpCrisscross 13y ago
Why isn't HFT front-running? Let me attempt an explanation without relying on legalistic constructs. Customers pay brokers a commission to execute their orders. This involves a customer trusting a broker with their confidential order information. Until an order goes to the exchanges, only the customer and broker know about it. The order is material non-public information. Brokers have a fiduciary obligation to look out for their customers' interests. This applies even when the customer's interests conflict with the broker's. For example, suppose a broker holds Tesla stock. A knowledgeable customer calls the broker, seeking to sell 2 million shares. This would depress Tesla's stock price. Front-running would involve the broker selling his shares first, and then the customer's. This violates the broker's fiduciary obligation. That is why it is fraudulent and thus illegal–an explicit trust relationship would be ruptured. Across the trading floor from the brokers are us market makers. We trade our own capital. We also have no customers and thus no fiduciary obligations. Our income comes from the bid-ask spread (and liquidity-provider rebates from exchanges). For example, here is how a phone call might go: COUNTERPARTY: "2 million Tesla?" MARKET MAKER: "209 at 210." COUNTERPARTY: "Buy 2 million Tesla for 209." The counterparty is looking to buy or sell 2 million shares of Tesla stock. They do not specify which in advance. The market maker says they will buy at $209 or sell at $210. The customer then confirms that they want to buy, and will buy at $210. An order, when properly executed, does not betray its owner's intentions. This applies as much in the meat space as in HFT. For example, here is how one would not place an order: COUNTERPARTY: "I am looking to sell 2 million shares of Tesla stock at whatever price you'll give me. My wife just left me for a Brazillian stripper and I'm halfway through my handle of morning vodka." This guy won't get 209 at 210. He might not even get 200. This isn't the market maker front-running a customer. It's a liquidity provider protecting his book and bottom line. This adversarial relationship is efficient - it keeps markets from getting too clubby. There are valid critiques against HFT. (My pet is that HFT has no obligation to continue providing liquidity in adverse market conditions. This means they can pull out when the seas get rough, i.e. precisely when liquidity is needed. Traditional market makers cannot do that.) "Front-running" is not one of them.
- nissimk 13y ago
  Yeah, and isn't it true that the traders managing those large orders never enter them through traditional means anyhow? They either submit them to "dark pools" where the huge blocks can trade with other large participants without impacting the market as much, or they enter them as algo orders with their broker and they are split up into many smaller orders throughout the day with the goal of transacting at the average daily price.
bertil 13y ago
As I understand it, the main issue with HFT are two fold: * some cases of insider trading at under-a-microsecond rhythm, that sound like faster-than-light favoritism but are actually covered by existing legislation (you just need to update judges and the SEC on basic technological feasibility); * dangerous unmanned behaviour -- flash-crashes. Front-running has always been presented as controversial at best, i.e. taking cents from people who could spare dollars; more often illustrative of finance’s excess (spending the GDP of a large country to establish even faster lines between cities already well connected, not that makes any more sense than blaming Formula 1 racing for going above the legal limit). I understand his passion, and the “I’m a geek and I work for a small company facing Goldman” inferiority complex must be crushing -- he writes himself ‘A fervent defense’. However, that seems to be missing the key issues most people have with such technology left unmonitored.
foobarqux 13y ago
I think there is a lot of nuance being left out in these types of defences which are misleading. For example, > Note that the market maker at no point had the ability to change any order in response to Big Joe. But they sort of can, specifically the canonical example in Lewis' book is that HFT market makers change their standing order on other markets faster than it takes the orders of buy/sellers taking liquidity to hit that venue. That behavior isn't what a reasonable person would expect by default. There is no mention of things like flash orders (which no longer exist in US equities?), hide-not-slide, payment for order flow, maker/taker, etc, all of which are potentially problematic and deserve discussion. In short these defences are nearly as simplistic as the attacks they attempt to counter.
- kasey_junk 13y ago
  Agreed. But the difference is that the people defending them are not trying through public perception, or regulation to change the current system. If they are not asking for change, why should they be held to a higher standard than the attackers. For all of the potentially problematic items mentioned, there is an equally problematic issue on the liquidity taker side. Invisible order books, iceberg orders, preferred router agreements, and large block rebates are all "features" that the markets provide to give advantages to the large institutional investor that harm the rest of the market but they aren't mentioned in the Lewis book, and are never referenced by folks trying to defend "the little guy".
- yummyfajitas 13y ago
  Big Joe is a retail trader trying to move 1-2 lots. His order can be entirely filled at a single exchange. Changing standing orders on other markets is only an issue for big players trying to move many lots. You are correct that the financial markets are complex and I can't possible cover every topic. Even if I had the stamina I don't have the knowledge.
salmonellaeater 13y ago
> If we had no price discrimination, perhaps because of a regulation requiring market makers to leave their quotes out in the market for 60 seconds, then ... [t]he net result is that Big Joe would pay more to trade and Little Billie would pay less. The debate about HFT is largely about who gets to benefit from new information. Suppose someone does a lot of research and discovers that a firm is undervalued. Should they get to profit from the information, at the expense of current stockholders? Or is it better for stockholders to quickly figure out that their holdings are worth more? HFT helps the stockholders in this case, because it moves the price faster to its eventual higher equilibrium before the researcher can buy up many shares at the (low) current price. The researcher may have expended a lot of time and effort to get this information, and with the existence of HFT their work may not be sustainable. Contrast this with someone who accidentally discovers public information that could be profitable, or someone who engages in insider trading. In both these cases it's hard to argue that we as a society should create rules that let them profit at others' expense. In other spheres of life (software patents, copyrights), the law over-protects dubious discoveries and creations. Is information related to stock pricing different? Are we under-protecting it, such that we should let someone with new information collect more profit than they can today?
thatthatis 13y ago
> Predatory traders detect information and split the profits with the counterparties (taking a cut in the process) No. No they do not. They detect the information, and extract part of the value without improving the situation of the seller. The seller was going to get filled at $21 in either case, the only difference is that the front-runner bought and resold those shares to the "whale" buyer. This intellectual backflip is premised upon two mutually exclusive things happening: 1) the predator trades on information that there is demand coming and 2) in the counterfactual for the seller, that demand may never have come. But because the front-runner is cutting the line, they only place trades once the demand is in the order book. As a work of acrobatics, this is impressive. As an intellectual work, it is saddening.
- yummyfajitas 13y ago
  But because the front-runner is cutting the line, they only place trades once the demand is in the order book. There is no "cutting the line". If the demand were already in the order book the trade would have occurred. Please go read the tutorial before commenting further - you demonstrably do not understand how a matching engine works.
  - thatthatis 13y ago
    I re read your article, and it appears I took information from your headline and assumed it into your examples. I think you're talking about plain vanilla market making and speculation. Nothing in there is what I would consider predatory or HFT or front running. These things exist, per my best reading of the wsj, and you said you were defending HFT but as best I can tell merely defended computerized market making and speculation.
    - dllthomas 13y ago
      The thing that is being called "front running" here involves multiple exchanges. There is no cutting in any single line. There is more then one line, and you can be in multiple simultaneously. In some cases, traders may go through one line and then complain that HFT traders went and got in the other line. In order to call that "cutting in line" and be well founded, you need to come up with some framework for how that "line" works - it does not fall trivially out of the actual lines in the two exchanges.
MaggieL 13y ago
I'd be more impressed by a "fervent defense of HFT" from somebody who isn't in the business.
- yummyfajitas 13y ago
  Do you disagree with my arguments or are you appealing to the genetic fallacy? Not that it matters - I left HFT a long time ago.
crdoconnor 13y ago
>Predatory traders break this information advantage. Instead of Goldman, David Einhorn or other informed traders gaining the full benefit of their information, predatory traders detect that information and split the profits with the counterparties (taking a cut in the process). Predatory traders improve market efficiency by turning information about market demand into price movements. They are simply criticized because the price movement happens before the whale actually wanted it to. This is the exact same defense used against insider trading and front running in general. There is nothing special about HFT in this respect, other than the fact that it is currently still legal. Edit: downvoting without responding. classy.

107 points by spindritf 13y ago

This is great - it hits major topics that should be part of this debate. It's long, and it's a bit complicated... but so is the issue. Some things you should be thinking about after reading this: * What exactly constitutes front running? Does trading based on public data (albeit in expensive feeds) constitute front running? * Large trades are almost all traded through algos. Are those algos better than proprietary "market making" algos? Why? * What is adverse selection? How do dark pools contribute? Who benefits and who suffers? Read more articles like this. Be suspicious of "simplified" discussions.

exelius 13y ago
I have some questions based on yours: * What constitutes public data? * How likely are the types of front-running HFT algos that are discussed in this article to be the old, traditional players? * What are the ethical (lol) rules against front-running your own customers if you're a market-maker? How could your customers even find out? What happens when the proprietary information is that a customer has just placed a large trade, and you drive up the price before it even hits the market? How is this fundamentally different than the commission these firms already charge?
- reverend_gonzo 13y ago
  What are the ethical (lol) rules against front-running your own customers if you're a market-maker? How could your customers even find out? What happens when the proprietary information is that a customer has just placed a large trade, and you drive up the price before it even hits the market? How is this fundamentally different than the commission these firms already charge? Market makers are generally proprietary firms that trade their own money, and don't have customers. Brokerages (ie: Scottrade) have customers and it illegal for them to front run their customers.
  - exelius 13y ago
    I'm not thinking retail brokerages -- I'm thinking investment banks like Goldman. Often the big i-banks have both prop trading operations and the ability to fill large orders for institutional clients (e.g. a pension fund looking to buy $1 billion of Apple stock).
    - reverend_gonzo 13y ago
      For them, they have a fiduciary duty to their clients to act in their customers' best interest. So, if their clients asks to purchase, for example 100,000 shares of AAPL, it would be illegal for them to first drive up the price.
- elecengin 13y ago
  Good questions. * Along with order routing, market data is heavily legislated under RegNMS as well. Both the creation of the SIP feeds (the slower consolidated data) and the rules around exchange proprietary feeds are legislated there. As part of the Fair Access Rule, exchanges cannot favor a certain participant with preferential pricing. Therefore, even if proprietary exchange data products are expensive, they are equally expensive to all participants. I consider that fair. An argument could be made that the price of the feeds is exclusionary. I do not buy this - there are many types of data available in the market that come at a high price. The next question (if you assume that the price makes it effectively non-public) is if there are effective substitutes. I think for non-professional traders (moving less than, say, $10mm notional per month) the SIP and similar feeds is acceptable (just as many retail traders accept 15min delayed market data as acceptable). For more serious traders, there may not be an acceptable substitute, but given their usage the higher costs are more justified. * Ethical rules around front running of orders is covered in the Manning Rule. In short, it prevents placing a firm's trading interests in front of a client. The details can be found at FINRA: http://finra.complinet.com/en/display/display.html?rbid=2403&element_id=9989 http://finra.complinet.com/en/display/display.html?rbid=2403...

davidw 13y ago

I've been following (sort of) the back and forth on this and find it quite interesting. Here's a question though: what happens when the "whale" is really something like an index fund that, ultimately, is composed mostly of retail investors? Aren't they getting ripped off in that case? This isn't a rhetorical question, I'm curious to know how it plays out.

exelius 13y ago
Yes. But you get ripped off less in an index fund since in general, they are also run by algos within other algos that just rebalance to match whatever they're tracking. The idea if you're an investment firm is that index funds can hide risky investments: they're often large and they're often not highly leveraged. In reality, index funds are the safest way for individuals to make money in the market because you're placing a bet on the economy as a whole.
harryh 13y ago
Here's the CIO of Vanguard (who run some of the biggest index funds in the world) saying that HFTs cut costs: http://www.cnbc.com/id/49434073 http://www.cnbc.com/id/49434073
daveed 13y ago
I think it really depends on what you mean by ripped off. I think that institutional investors looking to place multi-million dollar moves shouldn't be able to just place an order and cry foul when it's not completely filled on all the exchanges either. From another point of view, that's the slippage you get from an improper order placement strategy.
crdoconnor 13y ago
>Here's a question though: what happens when the "whale" is really something like an index fund that, ultimately, is composed mostly of retail investors? Aren't they getting ripped off in that case? Damn right they're getting ripped off. The defense in the OP is essentially "yes, that can happen but it's very rare". Which is about as believable as it sounds.

wavesounds 13y ago

I'm not buying it. Healthy markets are markets where everyone has access to the same information. HFT by definition means some traders have more access to information than others. This is fundamentally unfair and bad for markets and the economy. I don't see how HFT is any different then insider trading and everyone agrees that should be illegal.

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giergirey 13y ago
Where do you draw the line? Some retail investors still rely on reading stock quotes in the financial section of their daily newspaper - should we force everyone to only change prices once a day?
reverend_gonzo 13y ago
HFT does not have more information. They have access to the same public information as everybody else, but they have invested in better technology and are therefore able to parse and utilize that information more efficiently. Insider trading, by its definition, is insiders trading on non-public information, that outsiders simply do not have access to for any amount of money.
- Pxtl 13y ago
  If I tell you that I know privately a piece of news about company XYZ that's about to become public tomorrow, and then you use that knowledge to trade based on how you know its shares will change, that's insider trading. If I tell you that I know privately a piece of news about company XYZ that's about to be come public in 0.25 seconds and your machine is fast-enough to parse and react to this information before that deadline, that seems pretty close to insider-trading, it's just the "insider" is the exchange itself.

jellicle 13y ago

TL;DR: Stucchio thinks that front-running people is fine in circumstances where it's not prohibited by law. It's legal, therefore morally right, is his argument. Other people (including very many securities regulators) think that the problem here is that the law is missing a prohibition.

exelius 13y ago
You'll find this attitude (it's legal, therefore it's morally right) is very prevalent in the investment finance industry. It's as if these guys lack a moral compass of their own...
- kasey_junk 13y ago
  That sort of smear may or may not be true, but it isn't what is happening in this case. What is happening in this case is that 2 groups (large liquidity purchasers and liquidity providers) have a natural antagonistic relationship with each other. Purchaser always want to lower the price and providers want to raise it. This is good for the markets operation. But there is a PR/Power imbalance currently in the market. The large purchasers have tons of money had influence. They are using it to smear the sellers of the product they want. The sellers happen to be an easy group to smear (they are highly technical, secretive, and operate in a world that no one seems to understand). If anything is immoral in all this is that they are actively trying to obfiscate what is happening in the markets and thereby spreading fear.
  - crdoconnor 13y ago
    > The sellers happen to be an easy group to smear (they are highly technical, secretive, and operate in a world that no one seems to understand). Once you understand what it is that they are doing, it's pretty clear that it's wrong. Unfortunately, they like to muddy the issue. Hell, the OP does that every time it comes up on HN by asking people to explain what their problem with it is using obtuse industry jargon (e.g. "which part of FIX/OUCH enables front running?").

chollida1 13y ago

I think this article does a good job of illustrating why its so hard to have an open dialog on this subject. Start with asking "What is front running."? The market's definition would not include what HFT do. But bring this up to someone without knowledge of the public markets and their first reaction is to say, hey this is front running, it must be wrong. "Front Running" has a specific definition and it only relates to a broker and their own clients. You trading before me because you are faster is not front running. You understanding my flow is not front running. You can then ask "What is public information". The fact that everyone can see any tape they pay money to see so there doesn't seem to be any one acting on "insider knowledge." Now tell people that HFT's will use their fast machines to change their orders due to a change on one exchanges tape before the main NBBO tape is updated and some people will claim that this is obviously wrong. The other argument I've seen made here is that trading on "insider knowledge is obviously wrong." Well it isn't obviously wrong and the entire commodities market assumes that anyone can trade legally on insider knowledge. Imagine you are the biggest producer of oranges. You know that you are going to have a bad crop so you but some orange futures so you can meet your demands. This is insider information you've traded on and its the way the market is intended to work.

jalopy 13y ago

TL;DR: Defending HFT’s argues for rewarding market participants who simply jump in front of the line b/c they see other people doing it, at the expense of participants who have worked hard to decided which line to get into. Here's a more fundamental question to ask: What kind of behavior do you want to reward in the stock market? If you view the stock market as a bunch of numbers that wiggle around, where "information" is conveyed by the actions of other people participating in the market (ie, what they’re buying and selling), then the HFT's play a legitimate role in spreading that information around. If you view the market as a place to buy and sell businesses (equivalently - shares of businesses), where capital is allocated to businesses commensurate with the value they provide to society, HFT's are parasites on the effort of others. There are participants in the market that spent an enormous amount of time, diligence and thought into deciding allocating capital to businesses according to the value they ascribe to the businesses. For these participants, the signal they send by putting out their orders is currently taken advantage of by other participants who spend enormous time, effort and money into trying to “tap into” the result of the efforts put forward by the first group and rush to another exchange to buy up that company before anyone else gets there. So: Do we really want to reward all of the effort spent building faster machines, communication links, and algorithms to jump right in front of someone in line? Or do we want to reward those people who are actually determining which businesses have intrinsic value and which do not? It's easy to hate Einhorn or Ackman b/c they're rich. What's important to keep in mind is that they are custodians of and act on behalf of thousands, probably even millions of other people to improve their financial situation. Pensions, endowments, sovereign wealth funds, etc make up the bulk of the funds that Einhorn, Ackman and others invest. The fact that they're rich an indication of their legitimate hard work at researching and allocating capital and enhancing the financial well-being of their clients. (Note: yes, there are always bad apples that get rich by illicit (read: insider) means, but that is an exceedingly small amount of participants and over time they usually get caught). Warren Buffett has often said that a perfectly good stock market would be one which is open only one day a year, where participants put up orders based on the value they actually ascribe to a business. If those orders cross, then trades occur - all in one day. Makes you wonder what would happen to society in that market. Would people would be able to find a way to channel all the frenetic activity currently employed in chasing prices and watching others’ actions into a more productive endeavor?

bakhy 13y ago

reading about the stock market is always kinda disgusting to me. "If a speculator believes AAPL is undervalued, he buys a bunch of shares of AAPL. This drives up the price until AAPL is no longer undervalued - then the speculator can sell his AAPL and reap the profits." -- the part after the dash shocked me :) seems like the entire purpose of the market is speculation? does anyone actually invest in companies any more? :D i did like reading this, informative. gave me a nice other perspective on HFT. however: (a) Goldman Sachs does not have it's own HFT outfit? they are the "helpless victims" here? sounds a little unbelievable. (b) why is it exactly socially beneficial that some HFT company performs this "robin hood" act (lol)? particularly if it exposes us all to the risk of market volatility due to mindless algorithms performing enormous, senseless trade volumes with each other? all in all, i'd vote for that very small tax on trades, just to get rid of this as-yet-unseen level of speculation.

bakhy 13y ago
p.s. how does moderation on this site work? i have been downvoted, and i wonder - is this an act of some admin moderating, or do users with sufficient karma get a downvote button and one of them simply dislikes my comment?..
- Codhisattva 13y ago
  Sometimes downvote means "I disagree". Since you proposed a transaction tax, most likely a libertarian apologist pounced on you.
  - bakhy 13y ago
    ah, ok. i guess that's their right ;)
- probably_wrong 13y ago
  > ..., or do users with sufficient karma get a downvote button (...)? Yes, they do. I always forget the threshold, but there is one. Check the 4th point in the FAQ: http://ycombinator.com/newsfaq.html http://ycombinator.com/newsfaq.html

politician 13y ago

If HFTs liberate access to price information, then does that make them the "open-source software" equivalent of our current economic operating system? That is, in the same sense that OSS delivers bundles of information about how to do various computational tasks efficiently via source code, HFTs deliver bundles of information about how to value companies efficiently via the ticker tape. In the same way that the source code reveals the genius of the programmer's understanding, the excellance of an HFT is revealed by the report of the ticker tape.

JumpCrisscross 13y ago

Why isn't HFT front-running? Let me attempt an explanation without relying on legalistic constructs. Customers pay brokers a commission to execute their orders. This involves a customer trusting a broker with their confidential order information. Until an order goes to the exchanges, only the customer and broker know about it. The order is material non-public information. Brokers have a fiduciary obligation to look out for their customers' interests. This applies even when the customer's interests conflict with the broker's. For example, suppose a broker holds Tesla stock. A knowledgeable customer calls the broker, seeking to sell 2 million shares. This would depress Tesla's stock price. Front-running would involve the broker selling his shares first, and then the customer's. This violates the broker's fiduciary obligation. That is why it is fraudulent and thus illegal–an explicit trust relationship would be ruptured. Across the trading floor from the brokers are us market makers. We trade our own capital. We also have no customers and thus no fiduciary obligations. Our income comes from the bid-ask spread (and liquidity-provider rebates from exchanges). For example, here is how a phone call might go: COUNTERPARTY: "2 million Tesla?" MARKET MAKER: "209 at 210." COUNTERPARTY: "Buy 2 million Tesla for 209." The counterparty is looking to buy or sell 2 million shares of Tesla stock. They do not specify which in advance. The market maker says they will buy at $209 or sell at $210. The customer then confirms that they want to buy, and will buy at $210. An order, when properly executed, does not betray its owner's intentions. This applies as much in the meat space as in HFT. For example, here is how one would not place an order: COUNTERPARTY: "I am looking to sell 2 million shares of Tesla stock at whatever price you'll give me. My wife just left me for a Brazillian stripper and I'm halfway through my handle of morning vodka." This guy won't get 209 at 210. He might not even get 200. This isn't the market maker front-running a customer. It's a liquidity provider protecting his book and bottom line. This adversarial relationship is efficient - it keeps markets from getting too clubby. There are valid critiques against HFT. (My pet is that HFT has no obligation to continue providing liquidity in adverse market conditions. This means they can pull out when the seas get rough, i.e. precisely when liquidity is needed. Traditional market makers cannot do that.) "Front-running" is not one of them.

nissimk 13y ago
Yeah, and isn't it true that the traders managing those large orders never enter them through traditional means anyhow? They either submit them to "dark pools" where the huge blocks can trade with other large participants without impacting the market as much, or they enter them as algo orders with their broker and they are split up into many smaller orders throughout the day with the goal of transacting at the average daily price.

bertil 13y ago

As I understand it, the main issue with HFT are two fold: * some cases of insider trading at under-a-microsecond rhythm, that sound like faster-than-light favoritism but are actually covered by existing legislation (you just need to update judges and the SEC on basic technological feasibility); * dangerous unmanned behaviour -- flash-crashes. Front-running has always been presented as controversial at best, i.e. taking cents from people who could spare dollars; more often illustrative of finance’s excess (spending the GDP of a large country to establish even faster lines between cities already well connected, not that makes any more sense than blaming Formula 1 racing for going above the legal limit). I understand his passion, and the “I’m a geek and I work for a small company facing Goldman” inferiority complex must be crushing -- he writes himself ‘A fervent defense’. However, that seems to be missing the key issues most people have with such technology left unmonitored.

foobarqux 13y ago

I think there is a lot of nuance being left out in these types of defences which are misleading. For example, > Note that the market maker at no point had the ability to change any order in response to Big Joe. But they sort of can, specifically the canonical example in Lewis' book is that HFT market makers change their standing order on other markets faster than it takes the orders of buy/sellers taking liquidity to hit that venue. That behavior isn't what a reasonable person would expect by default. There is no mention of things like flash orders (which no longer exist in US equities?), hide-not-slide, payment for order flow, maker/taker, etc, all of which are potentially problematic and deserve discussion. In short these defences are nearly as simplistic as the attacks they attempt to counter.

kasey_junk 13y ago
Agreed. But the difference is that the people defending them are not trying through public perception, or regulation to change the current system. If they are not asking for change, why should they be held to a higher standard than the attackers. For all of the potentially problematic items mentioned, there is an equally problematic issue on the liquidity taker side. Invisible order books, iceberg orders, preferred router agreements, and large block rebates are all "features" that the markets provide to give advantages to the large institutional investor that harm the rest of the market but they aren't mentioned in the Lewis book, and are never referenced by folks trying to defend "the little guy".
yummyfajitas 13y ago
Big Joe is a retail trader trying to move 1-2 lots. His order can be entirely filled at a single exchange. Changing standing orders on other markets is only an issue for big players trying to move many lots. You are correct that the financial markets are complex and I can't possible cover every topic. Even if I had the stamina I don't have the knowledge.

salmonellaeater 13y ago

> If we had no price discrimination, perhaps because of a regulation requiring market makers to leave their quotes out in the market for 60 seconds, then ... [t]he net result is that Big Joe would pay more to trade and Little Billie would pay less. The debate about HFT is largely about who gets to benefit from new information. Suppose someone does a lot of research and discovers that a firm is undervalued. Should they get to profit from the information, at the expense of current stockholders? Or is it better for stockholders to quickly figure out that their holdings are worth more? HFT helps the stockholders in this case, because it moves the price faster to its eventual higher equilibrium before the researcher can buy up many shares at the (low) current price. The researcher may have expended a lot of time and effort to get this information, and with the existence of HFT their work may not be sustainable. Contrast this with someone who accidentally discovers public information that could be profitable, or someone who engages in insider trading. In both these cases it's hard to argue that we as a society should create rules that let them profit at others' expense. In other spheres of life (software patents, copyrights), the law over-protects dubious discoveries and creations. Is information related to stock pricing different? Are we under-protecting it, such that we should let someone with new information collect more profit than they can today?

thatthatis 13y ago

> Predatory traders detect information and split the profits with the counterparties (taking a cut in the process) No. No they do not. They detect the information, and extract part of the value without improving the situation of the seller. The seller was going to get filled at $21 in either case, the only difference is that the front-runner bought and resold those shares to the "whale" buyer. This intellectual backflip is premised upon two mutually exclusive things happening: 1) the predator trades on information that there is demand coming and 2) in the counterfactual for the seller, that demand may never have come. But because the front-runner is cutting the line, they only place trades once the demand is in the order book. As a work of acrobatics, this is impressive. As an intellectual work, it is saddening.

yummyfajitas 13y ago
But because the front-runner is cutting the line, they only place trades once the demand is in the order book. There is no "cutting the line". If the demand were already in the order book the trade would have occurred. Please go read the tutorial before commenting further - you demonstrably do not understand how a matching engine works.
- thatthatis 13y ago
  I re read your article, and it appears I took information from your headline and assumed it into your examples. I think you're talking about plain vanilla market making and speculation. Nothing in there is what I would consider predatory or HFT or front running. These things exist, per my best reading of the wsj, and you said you were defending HFT but as best I can tell merely defended computerized market making and speculation.
  - dllthomas 13y ago
    The thing that is being called "front running" here involves multiple exchanges. There is no cutting in any single line. There is more then one line, and you can be in multiple simultaneously. In some cases, traders may go through one line and then complain that HFT traders went and got in the other line. In order to call that "cutting in line" and be well founded, you need to come up with some framework for how that "line" works - it does not fall trivially out of the actual lines in the two exchanges.

MaggieL 13y ago

I'd be more impressed by a "fervent defense of HFT" from somebody who isn't in the business.

yummyfajitas 13y ago
Do you disagree with my arguments or are you appealing to the genetic fallacy? Not that it matters - I left HFT a long time ago.

crdoconnor 13y ago

>Predatory traders break this information advantage. Instead of Goldman, David Einhorn or other informed traders gaining the full benefit of their information, predatory traders detect that information and split the profits with the counterparties (taking a cut in the process). Predatory traders improve market efficiency by turning information about market demand into price movements. They are simply criticized because the price movement happens before the whale actually wanted it to. This is the exact same defense used against insider trading and front running in general. There is nothing special about HFT in this respect, other than the fact that it is currently still legal. Edit: downvoting without responding. classy.