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HFT provides liquidity, and extracts a price for providing that value. HFT seems like stealing only because they are using advanced technology methods to make

HFT provides liquidity, and extracts a price for providing that value. HFT seems like stealing only because they are using advanced technology methods to make money, whereas in the 1980s and before market makers routinely manipulated the spread and pocketed likely a similar percent of trading profits. At least the online brokerages and pioneers of HFT broke down the antiquated 1/8 stock price ticks and lowered the spread and per share transaction costs.

001sky 12y ago
Ugh. The memes. HFT is not "liquidity". The purpose of the "speed" is to elicit information.
- tptacek 12y ago
  This comment isn't even wrong.
  - 001sky 12y ago
    Thanks for the clarification. /S
- chimeracoder 12y ago
  > The purpose of the "speed" is to elicit information. Not quite. HFT uses information that you probably don't have, and acts on that information using software and hardware that you probably don't have[0]. You can obtain that information and that software/hardware - it's just expensive (high barrier to entry)[1]. As explained above, HFT exists because portions of the market are not perfectly competitive in the economic sense[2], but that's always been the case (and arguably was more so before the advent of computerized HFT). [0] It's not so much that you don't have the information - it's that the latency is too high for most players. [1] At least some portion of these costs are very real - the cost of maintaining low-latency connections between exchanges, colocating hardware, etc. [2] https://en.wikipedia.org/wiki/Perfect_competition https://en.wikipedia.org/wiki/Perfect_competition
  - toledotown 12y ago
    The HFT traders are most certainly getting information from the speed. They are submitting flash orders of a low quantity to gauge the demand of a stock, the if a buy order is detected, they buy all of the stock from the other exchanges.
- idohft 12y ago
  Where does this assertion come from? If you take a look at the market book, then you might see that yes, most market-makers (liquidity) in the equity markets are high-frequency orders.
- ChuckMcM 12y ago
  Language is such a tricky thing. 'Speed' is the time it takes to act on information, hence the 'high frequency' in the name to distinguish it from 'regular frequency' but it isn't the purpose. The fact that these traders exist, and their only motivation is to buy or sell at a marginal gain, means that there are always buyers and sellers for a given commodity in the presence of an HFT firm, they do provide the 'other side' of the buy/sell transaction and thus by definition provide liquidity to the assets being traded. I read a copy of the Mentat prayer that had been written for traders somewhere but have lost track of it, that was something like 'by liquidity I give my transactions life, by speed I give them value, by value I make me wealthy' or something along those lines. It was much more clever than I could come up with, but modest google fu has not revealed its location.
  - deleted 12y ago
    [deleted]
lucisferre 12y ago
I'm not an expert here by any means but I think HFT seems like stealing to most of us because it is largely hidden from public view and from any serious scrutiny. The price it extracts is largely unknown and not well understood by those who are paying it. The biggest HFTs seems like a shadow government running the markets and extracting a hidden trade tax. As for the argument that the value they provide is "liquidity", that also seems dubious. I've seen that argument thrown around a few times now, but I'm not entirely convinced that HFTs, as they exist and work now, are achieving this goal fairly, nor that this is necessarily the best solution.
- tptacek 12y ago
  The odd-eighth spread pricing scandal was also something that was hidden from public view for decades, and it had a far more profound impact on the fairness of the markets!
  - lucisferre 12y ago
    How does one scandal being worse justify another? Unless you can say that the "price extracted" is fair and self regulating without any clear and transparent oversight, I think there is probably room for improvement and a benefit from increased scrutiny. However, as I said, my knowledge of the internal workings of the markets is still pretty limited.
    - tptacek 12y ago
      If you understand the scandal, you understand the answer to that question: automated trading, opaque as it is, strangled the spreads that human market makers had been capitalizing on.
- yummyfajitas 12y ago
  The price is completely transparent. It's the bid/ask spread.
- icambron 12y ago
  Do you think that pre-HFT trading practices are transparent and easily understood, and that they're under a proper amount of scrutiny? Are large banks trading at lower frequencies less shadow governmenty? I posit they are not, and I don't understand why the speed of the transactions would be dispositive. (I'm told by knowledgeable people that there are indeed some shady things that happen in HFT, such as quote stuffing, that ought to be fixed, which makes sense. But I don't think that brings us anywhere near "shadow government", nor does it seem like a damning problem for HFT as a concept.)
Ologn 12y ago
Yes. You get liquidity, meaning more investment is available for some companies - people who would have not invested now will invest. The spread is lower, benefiting buyers and sellers. Work is automated meaning market makers do not have to stand around on the NYSE or CBOE all day - people can sit in their offices, thinking up algorithms, backtesting them etc. (of course the quants doing this are not the same people who had been doing it usually). The old time finance guys have no idea what a back-propagating multilayer neural network is and how it's eating their lunch, and there is resentment and suspicions of foul play. I am more suspicious about the suspicion. You can pitch a tent and set up a hedge fund like Renassiance or DE Shaw without the blessing of an investment bank, and perhaps the banks resent this, despite the fact that they're doing HFT as well.
workermonkey 12y ago
The do not 'provide liquidity' -- the liquidity is already there. Suppose there is a stock selling at $100. You want to buy 100,000 shares, and there are people willing to sell. A HFT leaves some bait 100 share blocks for sale at that price. You buy those first, they use the advantage of speed to buy any other $100 shares available. They then sell you what you wanted to buy at $100.10. What value did they add to the market? Bringing buyers and sellers together? Nope. Provide capital to the market? (Which is why stocks supposedly exist...) Nope. They end every day owning nothing. Lewis's book also shows that many banks and brokers instead route some trades through their own internal 'markets' first, trying to find a match, instead of just trying to get the fairest price available. Everyone gets screwed. There was a HFT trader who boasted that they went years without ever having a losing day. The only way to do that is in a market that isn't fair, where not all parties have equal access to information.
- yummyfajitas 12y ago
  Your story indicates that you don't understand how a matching engine works. I wrote a tutorial on it a few years ago, you might find it helpful: http://www.chrisstucchio.com/blog/2012/hft_apology.html http://www.chrisstucchio.com/blog/2012/hft_apology.html http://www.chrisstucchio.com/blog/2012/hft_apology2.html http://www.chrisstucchio.com/blog/2012/hft_apology2.html http://www.chrisstucchio.com/blog/2012/hft_whats_broken.html http://www.chrisstucchio.com/blog/2012/hft_whats_broken.html
  - pdonis 12y ago
    There was a similar discussion on HN a while back that never reached a resolution (at least, not to me). See here: https://news.ycombinator.com/item?id=7546104 https://news.ycombinator.com/item?id=7546104 Can you respond to my post in that subthread?
    - idohft 12y ago
      I can't reply to that thread (maybe it's because it was too long ago), but you draw a difference between someone moving a large block (as described in yummyfajitas' post), and someone trading a small size (50 shares). So let's say that someone does want to trade 50 shares, in your example, and breaks up their order into 2 25-share orders. At the point at which a 25-share order is executed on the market, the sheer size of the trade is not very much. It's not likely to signify a market move. At that time, nobody has knowledge that there is a second 25-share order heading to the second market. It is possible that an HFT player sees the first execution and takes out the shares at the second market, but with such a small execution, they are pretty much guaranteed to lose money.
danbruc 12y ago
I have a hard time to imagine how that works out. After all they are not interested in buying any shares so they have to quickly sell everything they buy effectively canceling the buy. How does that provide liquidity?
- tptacek 12y ago
  Didn't you just describe the operating theory of every market maker ever?
  - danbruc 12y ago
    I guess so. The problem is I really can't get my head around how market makers are supposed to work. If my stock performs well it should be easy to sell it for a fair price in case I need the money because somebody else will happily take the opportunity to make some money. If the stock does not perform well I will feel more comfortable with a market maker offering to buy the stock but what is the incentive of the market maker to buy my stocks? Almost the same goes for the other way - why should a market maker sell a well performing stock to me? If on the other hand the stock does not perform well but I really want some I should be able to get some anyway because others will be happy to get rid of them. I am always tempted to call bullshit on stock market liquidity but then the term is all over the place and I am pretty sure that not everybody besides me is an idiot and so I guess I am just missing an important point.
    - tptacek 12y ago
      I wrote this a few months ago, trying to explain market makers; I lightly edited it to make it make sense on this thread. At any given point in time, the "true" (buy-side) investors are likely to be relatively far apart on prices. This is especially true in thinly-traded markets. For example: consider housing, which is the canonical example of an illiquid market. I know the value of my house (it's around $300k). Say I want to sell it. The more liquidity I need, the worse price I'm going to get. Anyone with any intuition for the housing market knows that if I have to sell my house tomorrow, I am going to get a god-awful price for it; the "tomorrow" price for my house is many tens of thousands of dollars off its true value. This creates huge problems for homeowners. The obvious standard advice for sellers is to wait patiently for the best price, counting on many weeks or months before a reasonable offer arrives. But I have to pay money every month I hold on to the house. If I need to move immediately, for instance for a job, or because my financial circumstances have changed, I might need the house to sell quickly, and because houses are illiquid I have to accept a crappy price. Or consider trends in the market: by forcing me to hold the house for months rather than days, I'm maximally exposed to swings in the market. So if Chicago housing prices crater while I'm trying to sell, the extra time it takes to unload the house takes that price swing out of my hide. (You can easily see how the same thing happens in reverse in "hot" markets like Palo Alto, with the buyer now assuming the role of the hapless Chicago seller). The exact same thing happens in the public markets; it's just not as intuitively obvious because we're working in smaller deltas of time and price. But the public markets have a huge advantage that the real estate market doesn't: market makers. Imagine if houses traded (were bought and sold) so frequently that a smart company could make good educated guesses about the current value of any given house. Imagine if that company would on any given day snap up a house offered for sale. That company wouldn't pay my asking price for my Chicago house, but it would pay something much closer to it than the "true" market would. After buying my house, the company would immediately offer my house for sale at any price greater than what it bought the house for. I wouldn't care, though: either I'd be thrilled for the opportunity to sell my house quickly and painlessly, or I just wouldn't accept their offer and instead do what I do now, which is to wait for the best offer. Assuming the housing market makers were smart, the money they'd get by forcing me to accept a lower bid would be "free money" they get simply by being smart about valuing houses and having capital available to deploy. We'd all be a little irritated at them for scalping distressed buyers and sellers. But something else will inevitably happen: other smart firms will smell the free money, and they will compete for it. To capture a share of the premiums, all they have to do is offer a slightly more favorable price, so that's what they'll do. Over time, the money the housing market makers will get less and less "free", and the price penalty for immediate liquidity will get lower and lower. In my fantasy real estate market, I now have the opportunity to avail myself of a reasonable "market" order, or to buy or sell on a "limit" price. I could do that if there were housing market makers, but in their absence I can't, because the price hit for selling tomorrow is too great; it might be a 25% discount on my asking price, or even something close to 50%. That's the cost of illiquidity, or, stated more directly, the value of liquidity. It's probably also worth saying that liquidity is a presumption of the public electronic markets. Because it's taken for granted, there are whole trading strategies (hedging, for instance) that depend on its presence. These trading strategies face execution risk: if they can't bail out of a position within a specific window of time, they incur losses for the trader.
UweSchmidt 12y ago
But who needs the liquidity anyway? Seems like a "real" investor would buy e.g. shares for the expected dividends/profit after carefully studying the books, or for strategic business related reasons. Both buyers neither need to buy this very split-second nor do they care about the smallest price deviations. Remove the liquidity (which comes at quite a steep price it seems), now what? There seems to be plenty of capital looking for investments. The immense effort spent on HFT could now be concentrated on a) finding things worth investing and finding better ways to do so b) create more things worth investing in
- chimeracoder 12y ago
  > Remove the liquidity (which comes at quite a steep price it seems), The price of liquidity is less than the inefficiency (loss) that comes from an illiquid market (people who mutually want to execute a trade but cannot). This is rather straightforward to demonstrate mathematically. Just because HFT extracts a premium (similar to a transaction fee) on the spread doesn't mean both parties (and the rest of the market) can't still benefit. > The immense effort spent on HFT could now be concentrated on a) finding things worth investing and finding better ways to do so b) create more things worth investing in This is analogous to the argument often levied by non-techies at the entire tech sector: "They could be developing software to cure cancer, so why are they creating more apps to send selfies to their friends?"
  - UweSchmidt 12y ago
    I fail to see how the "real" investors which I described above cannot execute a trade. Could your mathematical model describe some hypothetical situation? The "premium" could then be split between the both parties. The cake is larger (but maybe not split as evenly). The argument about webapps vs. curing cancer is also levied by techies right here on this site and might be valid, (yet weaker, since webapp-big data might eventually help with medical-big data?). Either way you have not made an argument for HFT with your last sentence.
    - gd1 12y ago
guiomie 12y ago
Read Flash Boys, lots of HFT firms are exploiting the system, and they aren't adding any liquidity. They are using their speed to discover who wants to buy at what prcice, then they buy stocks faster then the other participant, to then sell it higher to that participant.
- tptacek 12y ago
  Don't read Flash Boys. Read Dark Pools. Dark Pools is also critical of HFT, but doesn't have the baggage that Flash Boys does. If all you know about HFT comes from Lewis' book, you should be concerned about having the whole picture. In particular: you can come away from Lewis' book believing that the markets prior to electronic trading were reasonable fair, when the reality is the opposite: the trendline of fairness and transparency in the market is sharply positive, and the inflection point of that trendline is the advent of fast electronic trading.
fzltrp 12y ago
> HFT provides liquidity For those like me who don't understand, what does it mean? What are the benefits? What are the drawbacks?
- washedup 12y ago
  Liquidity directly relates to the number of participants (or quotes) in a market place. Let's think about a simple market, where the price of a good can go from 1 to 10 dollars. One person is looking to sell the good for $8, while another person is looking to buy at $2. The market currently has a bid-offer spread of $6. With only two participants in this market place, they will have to meet somewhere in the middle, or never trade. The seller will lose value because he has to sell at a lower price, while the buyer will lose money by paying more. However, if there were more participants in the market place, all with different ideas about how valuable the good is, the buyer is more likely to get their $2 price while the seller is more likely to get their $8 price. For example, if a new seller joins the market at a price of $6, the person looking to buy can now do so at a cheaper price. Basically, with more participants, the bid-offer spread will begin to close, and trading will occur at more prices.
- danbruc 12y ago
  While I get the general idea of liquidity I really can't get my head around how it is supposed to work out in practice, especially in HFT. So let me make the question a bit more concrete. A very illiquid market, I want to buy for $9, somebody else wants to sell for $10, nothing else. And now? How does HFT help? How does a traditional market maker help? He buys for $10 and sells for $9 and then somehow recovers the loss? (Further down tptacek posted a great analogy. https://news.ycombinator.com/item?id=7853500 https://news.ycombinator.com/item?id=7853500)
  - maxerickson 12y ago
    The market maker might have open orders to buy at $9.25 and sell at $9.75. So you and the seller see better offers than if they didn't exist, even if those offers aren't good enough to get you to trade.
  - 12y ago
toledotown 12y ago
liquidity by propping up the market is not value.
SilasX 12y ago
One explanation I've heard for HFT's profitability (which I'm too lazy to source at the moment) is that it's also an artifact of the granularity of prices permitted by the exchange, just like the 1/8 limit. Instead of competing to save you a few more slivers of a cent per share, they compete to fill your order a few microseconds faster (at the next-highest price permitted). Seems most traders would prefer the money.
btilly 12y ago
Market makers had two jobs. Provide liquidity, and provide price stability. HFT does a better job than they did at providing liquidity, for a lower premium. However it does a worse job at providing price stability. Furthermore to me HFT looks like stealing because it is very inefficient relative to the need. If exchanges were to reorganize how they work slightly, we would get much better price stability, somewhat less liquidity, and have a much lower premium. The necessary change is simply this. Exchanges would have to set a price at which orders are to execute. Whenever there are excess orders in one direction or the other, that price would drift up or down, slowly, until the order executes. The result is that trades might take a minute to execute, but margins would be far less. Sure, a ton of finance people would jump up and down screaming bloody murder about how many of their complex trades would be affected. But my opinion is that that economic activity takes a lot of brains and resources, and doesn't significantly add to the purported purpose of finance - to make money available to companies engaged in useful production.
- chollida1 12y ago
  > The necessary change is simply this. Exchanges would have to set a price at which orders are to execute. Whenever there are excess orders in one direction or the other, that price would drift up or down, slowly, until the order executes. How would this even work? Understanding Market micro structure is literally my day job and I'm having trouble parsing your proposal. Consider the market where I want to buy at a limit of 9.90 and someone else wants to sell down to a limit of 10.00. What price would the exchange set? People have already said the maximum the market will buy for is 9.9 and the minimum the market will sell for is 10. if there is no overlap you just cant' trade no matter what the exchange does.
  - jedberg 12y ago
    > if there is no overlap you just cant' trade no matter what the exchange does. How does HFT change that?
    - tptacek 12y ago
      By literally creating the overlap.
unabridged 12y ago
But how much more liquidity would it provide versus frequent batch auctions where trades are grouped in 1 sec (or maybe 100 ms) intervals and matched? Batch auctions would entirely remove the benefits of the HFT arms race (and other gaming like flashing a price and cancelling instantly) Paper on frequent batch auctions: http://faculty.chicagobooth.edu/eric.budish/research/HFT-FrequentBatchAuctions.pdf http://faculty.chicagobooth.edu/eric.budish/research/HFT-Fre...
- jal278 12y ago
  Great quote from that paper: "There are some subtleties involved [...] since it takes light roughly 4 milliseconds to travel between Chicago (where ES trades) and New York (where SPY trades), [...] We would also like to suggest that the fact that special relativity plays a role in these calculations is support for frequent batch auctions." (emph added)
- kasey_junk 12y ago
  Batch auctions do not deal with the central problem which is tie-breakers. What happens if there are more participants on one side of a price level than the other? What mechanism do you use to determine ties? If it is FIFO then you still have a latency race.
  - unabridged 12y ago
    Order size is a good way to break ties, then I'd say random draw after that. And if ties are so frequent its time to add another digit to the price.
goodcanadian 12y ago
HFT provides liquidity . . . I always see this argument. Market makers provide liquidity, and yes, HFT often act as market makers. However, I am not at all convinced that the high frequency element adds anything useful to the equation. I don't care whether my trade executes in a microsecond or a second. In fact, I often leave limit orders open for DAYS in order to get the price I want. I am also not convinced that most HFT are truly acting as market makers. I think the most charitable thing that can be said about HFT is that it narrows the spread. In order to make it worth their while, the HF traders then have to make a lot more trades. Whether this is adding any real value to the system is harder to say because while the spreads are smaller, the volatility is higher.
- tptacek 12y ago
  It doesn't make much sense to challenge the liquidity provided by automated market-makers while conceding that they reduce spreads; spreads are essentially a proxy measurement of liquidity.
  - goodcanadian 12y ago
    I didn't say that they didn't provide liquidity; I said that I am not sure that the additional liquidity they provide actually matters to anyone other than high speed traders.

001sky 12y ago

Ugh. The memes. HFT is not "liquidity". The purpose of the "speed" is to elicit information.

tptacek 12y ago
This comment isn't even wrong.
- 001sky 12y ago
  Thanks for the clarification. /S
chimeracoder 12y ago
> The purpose of the "speed" is to elicit information. Not quite. HFT uses information that you probably don't have, and acts on that information using software and hardware that you probably don't have[0]. You can obtain that information and that software/hardware - it's just expensive (high barrier to entry)[1]. As explained above, HFT exists because portions of the market are not perfectly competitive in the economic sense[2], but that's always been the case (and arguably was more so before the advent of computerized HFT). [0] It's not so much that you don't have the information - it's that the latency is too high for most players. [1] At least some portion of these costs are very real - the cost of maintaining low-latency connections between exchanges, colocating hardware, etc. [2] https://en.wikipedia.org/wiki/Perfect_competition https://en.wikipedia.org/wiki/Perfect_competition
- toledotown 12y ago
  The HFT traders are most certainly getting information from the speed. They are submitting flash orders of a low quantity to gauge the demand of a stock, the if a buy order is detected, they buy all of the stock from the other exchanges.
idohft 12y ago
Where does this assertion come from? If you take a look at the market book, then you might see that yes, most market-makers (liquidity) in the equity markets are high-frequency orders.
ChuckMcM 12y ago
Language is such a tricky thing. 'Speed' is the time it takes to act on information, hence the 'high frequency' in the name to distinguish it from 'regular frequency' but it isn't the purpose. The fact that these traders exist, and their only motivation is to buy or sell at a marginal gain, means that there are always buyers and sellers for a given commodity in the presence of an HFT firm, they do provide the 'other side' of the buy/sell transaction and thus by definition provide liquidity to the assets being traded. I read a copy of the Mentat prayer that had been written for traders somewhere but have lost track of it, that was something like 'by liquidity I give my transactions life, by speed I give them value, by value I make me wealthy' or something along those lines. It was much more clever than I could come up with, but modest google fu has not revealed its location.
- deleted 12y ago
  [deleted]

lucisferre 12y ago

I'm not an expert here by any means but I think HFT seems like stealing to most of us because it is largely hidden from public view and from any serious scrutiny. The price it extracts is largely unknown and not well understood by those who are paying it. The biggest HFTs seems like a shadow government running the markets and extracting a hidden trade tax. As for the argument that the value they provide is "liquidity", that also seems dubious. I've seen that argument thrown around a few times now, but I'm not entirely convinced that HFTs, as they exist and work now, are achieving this goal fairly, nor that this is necessarily the best solution.

tptacek 12y ago
The odd-eighth spread pricing scandal was also something that was hidden from public view for decades, and it had a far more profound impact on the fairness of the markets!
- lucisferre 12y ago
  How does one scandal being worse justify another? Unless you can say that the "price extracted" is fair and self regulating without any clear and transparent oversight, I think there is probably room for improvement and a benefit from increased scrutiny. However, as I said, my knowledge of the internal workings of the markets is still pretty limited.
  - tptacek 12y ago
    If you understand the scandal, you understand the answer to that question: automated trading, opaque as it is, strangled the spreads that human market makers had been capitalizing on.
yummyfajitas 12y ago
The price is completely transparent. It's the bid/ask spread.
icambron 12y ago
Do you think that pre-HFT trading practices are transparent and easily understood, and that they're under a proper amount of scrutiny? Are large banks trading at lower frequencies less shadow governmenty? I posit they are not, and I don't understand why the speed of the transactions would be dispositive. (I'm told by knowledgeable people that there are indeed some shady things that happen in HFT, such as quote stuffing, that ought to be fixed, which makes sense. But I don't think that brings us anywhere near "shadow government", nor does it seem like a damning problem for HFT as a concept.)

Ologn 12y ago

Yes. You get liquidity, meaning more investment is available for some companies - people who would have not invested now will invest. The spread is lower, benefiting buyers and sellers. Work is automated meaning market makers do not have to stand around on the NYSE or CBOE all day - people can sit in their offices, thinking up algorithms, backtesting them etc. (of course the quants doing this are not the same people who had been doing it usually). The old time finance guys have no idea what a back-propagating multilayer neural network is and how it's eating their lunch, and there is resentment and suspicions of foul play. I am more suspicious about the suspicion. You can pitch a tent and set up a hedge fund like Renassiance or DE Shaw without the blessing of an investment bank, and perhaps the banks resent this, despite the fact that they're doing HFT as well.

workermonkey 12y ago

The do not 'provide liquidity' -- the liquidity is already there. Suppose there is a stock selling at $100. You want to buy 100,000 shares, and there are people willing to sell. A HFT leaves some bait 100 share blocks for sale at that price. You buy those first, they use the advantage of speed to buy any other $100 shares available. They then sell you what you wanted to buy at $100.10. What value did they add to the market? Bringing buyers and sellers together? Nope. Provide capital to the market? (Which is why stocks supposedly exist...) Nope. They end every day owning nothing. Lewis's book also shows that many banks and brokers instead route some trades through their own internal 'markets' first, trying to find a match, instead of just trying to get the fairest price available. Everyone gets screwed. There was a HFT trader who boasted that they went years without ever having a losing day. The only way to do that is in a market that isn't fair, where not all parties have equal access to information.

yummyfajitas 12y ago
Your story indicates that you don't understand how a matching engine works. I wrote a tutorial on it a few years ago, you might find it helpful: http://www.chrisstucchio.com/blog/2012/hft_apology.html http://www.chrisstucchio.com/blog/2012/hft_apology.html http://www.chrisstucchio.com/blog/2012/hft_apology2.html http://www.chrisstucchio.com/blog/2012/hft_apology2.html http://www.chrisstucchio.com/blog/2012/hft_whats_broken.html http://www.chrisstucchio.com/blog/2012/hft_whats_broken.html
- pdonis 12y ago
  There was a similar discussion on HN a while back that never reached a resolution (at least, not to me). See here: https://news.ycombinator.com/item?id=7546104 https://news.ycombinator.com/item?id=7546104 Can you respond to my post in that subthread?
  - idohft 12y ago
    I can't reply to that thread (maybe it's because it was too long ago), but you draw a difference between someone moving a large block (as described in yummyfajitas' post), and someone trading a small size (50 shares). So let's say that someone does want to trade 50 shares, in your example, and breaks up their order into 2 25-share orders. At the point at which a 25-share order is executed on the market, the sheer size of the trade is not very much. It's not likely to signify a market move. At that time, nobody has knowledge that there is a second 25-share order heading to the second market. It is possible that an HFT player sees the first execution and takes out the shares at the second market, but with such a small execution, they are pretty much guaranteed to lose money.

danbruc 12y ago

I have a hard time to imagine how that works out. After all they are not interested in buying any shares so they have to quickly sell everything they buy effectively canceling the buy. How does that provide liquidity?

tptacek 12y ago
Didn't you just describe the operating theory of every market maker ever?
- danbruc 12y ago
  I guess so. The problem is I really can't get my head around how market makers are supposed to work. If my stock performs well it should be easy to sell it for a fair price in case I need the money because somebody else will happily take the opportunity to make some money. If the stock does not perform well I will feel more comfortable with a market maker offering to buy the stock but what is the incentive of the market maker to buy my stocks? Almost the same goes for the other way - why should a market maker sell a well performing stock to me? If on the other hand the stock does not perform well but I really want some I should be able to get some anyway because others will be happy to get rid of them. I am always tempted to call bullshit on stock market liquidity but then the term is all over the place and I am pretty sure that not everybody besides me is an idiot and so I guess I am just missing an important point.
  - tptacek 12y ago
    I wrote this a few months ago, trying to explain market makers; I lightly edited it to make it make sense on this thread. At any given point in time, the "true" (buy-side) investors are likely to be relatively far apart on prices. This is especially true in thinly-traded markets. For example: consider housing, which is the canonical example of an illiquid market. I know the value of my house (it's around $300k). Say I want to sell it. The more liquidity I need, the worse price I'm going to get. Anyone with any intuition for the housing market knows that if I have to sell my house tomorrow, I am going to get a god-awful price for it; the "tomorrow" price for my house is many tens of thousands of dollars off its true value. This creates huge problems for homeowners. The obvious standard advice for sellers is to wait patiently for the best price, counting on many weeks or months before a reasonable offer arrives. But I have to pay money every month I hold on to the house. If I need to move immediately, for instance for a job, or because my financial circumstances have changed, I might need the house to sell quickly, and because houses are illiquid I have to accept a crappy price. Or consider trends in the market: by forcing me to hold the house for months rather than days, I'm maximally exposed to swings in the market. So if Chicago housing prices crater while I'm trying to sell, the extra time it takes to unload the house takes that price swing out of my hide. (You can easily see how the same thing happens in reverse in "hot" markets like Palo Alto, with the buyer now assuming the role of the hapless Chicago seller). The exact same thing happens in the public markets; it's just not as intuitively obvious because we're working in smaller deltas of time and price. But the public markets have a huge advantage that the real estate market doesn't: market makers. Imagine if houses traded (were bought and sold) so frequently that a smart company could make good educated guesses about the current value of any given house. Imagine if that company would on any given day snap up a house offered for sale. That company wouldn't pay my asking price for my Chicago house, but it would pay something much closer to it than the "true" market would. After buying my house, the company would immediately offer my house for sale at any price greater than what it bought the house for. I wouldn't care, though: either I'd be thrilled for the opportunity to sell my house quickly and painlessly, or I just wouldn't accept their offer and instead do what I do now, which is to wait for the best offer. Assuming the housing market makers were smart, the money they'd get by forcing me to accept a lower bid would be "free money" they get simply by being smart about valuing houses and having capital available to deploy. We'd all be a little irritated at them for scalping distressed buyers and sellers. But something else will inevitably happen: other smart firms will smell the free money, and they will compete for it. To capture a share of the premiums, all they have to do is offer a slightly more favorable price, so that's what they'll do. Over time, the money the housing market makers will get less and less "free", and the price penalty for immediate liquidity will get lower and lower. In my fantasy real estate market, I now have the opportunity to avail myself of a reasonable "market" order, or to buy or sell on a "limit" price. I could do that if there were housing market makers, but in their absence I can't, because the price hit for selling tomorrow is too great; it might be a 25% discount on my asking price, or even something close to 50%. That's the cost of illiquidity, or, stated more directly, the value of liquidity. It's probably also worth saying that liquidity is a presumption of the public electronic markets. Because it's taken for granted, there are whole trading strategies (hedging, for instance) that depend on its presence. These trading strategies face execution risk: if they can't bail out of a position within a specific window of time, they incur losses for the trader.

UweSchmidt 12y ago

But who needs the liquidity anyway? Seems like a "real" investor would buy e.g. shares for the expected dividends/profit after carefully studying the books, or for strategic business related reasons. Both buyers neither need to buy this very split-second nor do they care about the smallest price deviations. Remove the liquidity (which comes at quite a steep price it seems), now what? There seems to be plenty of capital looking for investments. The immense effort spent on HFT could now be concentrated on a) finding things worth investing and finding better ways to do so b) create more things worth investing in

chimeracoder 12y ago
> Remove the liquidity (which comes at quite a steep price it seems), The price of liquidity is less than the inefficiency (loss) that comes from an illiquid market (people who mutually want to execute a trade but cannot). This is rather straightforward to demonstrate mathematically. Just because HFT extracts a premium (similar to a transaction fee) on the spread doesn't mean both parties (and the rest of the market) can't still benefit. > The immense effort spent on HFT could now be concentrated on a) finding things worth investing and finding better ways to do so b) create more things worth investing in This is analogous to the argument often levied by non-techies at the entire tech sector: "They could be developing software to cure cancer, so why are they creating more apps to send selfies to their friends?"
- UweSchmidt 12y ago
  I fail to see how the "real" investors which I described above cannot execute a trade. Could your mathematical model describe some hypothetical situation? The "premium" could then be split between the both parties. The cake is larger (but maybe not split as evenly). The argument about webapps vs. curing cancer is also levied by techies right here on this site and might be valid, (yet weaker, since webapp-big data might eventually help with medical-big data?). Either way you have not made an argument for HFT with your last sentence.
  - gd1 12y ago

guiomie 12y ago

Read Flash Boys, lots of HFT firms are exploiting the system, and they aren't adding any liquidity. They are using their speed to discover who wants to buy at what prcice, then they buy stocks faster then the other participant, to then sell it higher to that participant.

tptacek 12y ago
Don't read Flash Boys. Read Dark Pools. Dark Pools is also critical of HFT, but doesn't have the baggage that Flash Boys does. If all you know about HFT comes from Lewis' book, you should be concerned about having the whole picture. In particular: you can come away from Lewis' book believing that the markets prior to electronic trading were reasonable fair, when the reality is the opposite: the trendline of fairness and transparency in the market is sharply positive, and the inflection point of that trendline is the advent of fast electronic trading.

fzltrp 12y ago

> HFT provides liquidity For those like me who don't understand, what does it mean? What are the benefits? What are the drawbacks?

washedup 12y ago
Liquidity directly relates to the number of participants (or quotes) in a market place. Let's think about a simple market, where the price of a good can go from 1 to 10 dollars. One person is looking to sell the good for $8, while another person is looking to buy at $2. The market currently has a bid-offer spread of $6. With only two participants in this market place, they will have to meet somewhere in the middle, or never trade. The seller will lose value because he has to sell at a lower price, while the buyer will lose money by paying more. However, if there were more participants in the market place, all with different ideas about how valuable the good is, the buyer is more likely to get their $2 price while the seller is more likely to get their $8 price. For example, if a new seller joins the market at a price of $6, the person looking to buy can now do so at a cheaper price. Basically, with more participants, the bid-offer spread will begin to close, and trading will occur at more prices.
danbruc 12y ago
While I get the general idea of liquidity I really can't get my head around how it is supposed to work out in practice, especially in HFT. So let me make the question a bit more concrete. A very illiquid market, I want to buy for $9, somebody else wants to sell for $10, nothing else. And now? How does HFT help? How does a traditional market maker help? He buys for $10 and sells for $9 and then somehow recovers the loss? (Further down tptacek posted a great analogy. https://news.ycombinator.com/item?id=7853500 https://news.ycombinator.com/item?id=7853500)
- maxerickson 12y ago
  The market maker might have open orders to buy at $9.25 and sell at $9.75. So you and the seller see better offers than if they didn't exist, even if those offers aren't good enough to get you to trade.
- 12y ago

toledotown 12y ago

liquidity by propping up the market is not value.

SilasX 12y ago

One explanation I've heard for HFT's profitability (which I'm too lazy to source at the moment) is that it's also an artifact of the granularity of prices permitted by the exchange, just like the 1/8 limit. Instead of competing to save you a few more slivers of a cent per share, they compete to fill your order a few microseconds faster (at the next-highest price permitted). Seems most traders would prefer the money.

btilly 12y ago

Market makers had two jobs. Provide liquidity, and provide price stability. HFT does a better job than they did at providing liquidity, for a lower premium. However it does a worse job at providing price stability. Furthermore to me HFT looks like stealing because it is very inefficient relative to the need. If exchanges were to reorganize how they work slightly, we would get much better price stability, somewhat less liquidity, and have a much lower premium. The necessary change is simply this. Exchanges would have to set a price at which orders are to execute. Whenever there are excess orders in one direction or the other, that price would drift up or down, slowly, until the order executes. The result is that trades might take a minute to execute, but margins would be far less. Sure, a ton of finance people would jump up and down screaming bloody murder about how many of their complex trades would be affected. But my opinion is that that economic activity takes a lot of brains and resources, and doesn't significantly add to the purported purpose of finance - to make money available to companies engaged in useful production.

chollida1 12y ago
> The necessary change is simply this. Exchanges would have to set a price at which orders are to execute. Whenever there are excess orders in one direction or the other, that price would drift up or down, slowly, until the order executes. How would this even work? Understanding Market micro structure is literally my day job and I'm having trouble parsing your proposal. Consider the market where I want to buy at a limit of 9.90 and someone else wants to sell down to a limit of 10.00. What price would the exchange set? People have already said the maximum the market will buy for is 9.9 and the minimum the market will sell for is 10. if there is no overlap you just cant' trade no matter what the exchange does.
- jedberg 12y ago
  > if there is no overlap you just cant' trade no matter what the exchange does. How does HFT change that?
  - tptacek 12y ago
    By literally creating the overlap.

unabridged 12y ago

But how much more liquidity would it provide versus frequent batch auctions where trades are grouped in 1 sec (or maybe 100 ms) intervals and matched? Batch auctions would entirely remove the benefits of the HFT arms race (and other gaming like flashing a price and cancelling instantly) Paper on frequent batch auctions: http://faculty.chicagobooth.edu/eric.budish/research/HFT-FrequentBatchAuctions.pdf http://faculty.chicagobooth.edu/eric.budish/research/HFT-Fre...

jal278 12y ago
Great quote from that paper: "There are some subtleties involved [...] since it takes light roughly 4 milliseconds to travel between Chicago (where ES trades) and New York (where SPY trades), [...] We would also like to suggest that the fact that special relativity plays a role in these calculations is support for frequent batch auctions." (emph added)
kasey_junk 12y ago
Batch auctions do not deal with the central problem which is tie-breakers. What happens if there are more participants on one side of a price level than the other? What mechanism do you use to determine ties? If it is FIFO then you still have a latency race.
- unabridged 12y ago
  Order size is a good way to break ties, then I'd say random draw after that. And if ties are so frequent its time to add another digit to the price.

goodcanadian 12y ago

HFT provides liquidity . . . I always see this argument. Market makers provide liquidity, and yes, HFT often act as market makers. However, I am not at all convinced that the high frequency element adds anything useful to the equation. I don't care whether my trade executes in a microsecond or a second. In fact, I often leave limit orders open for DAYS in order to get the price I want. I am also not convinced that most HFT are truly acting as market makers. I think the most charitable thing that can be said about HFT is that it narrows the spread. In order to make it worth their while, the HF traders then have to make a lot more trades. Whether this is adding any real value to the system is harder to say because while the spreads are smaller, the volatility is higher.

tptacek 12y ago
It doesn't make much sense to challenge the liquidity provided by automated market-makers while conceding that they reduce spreads; spreads are essentially a proxy measurement of liquidity.
- goodcanadian 12y ago
  I didn't say that they didn't provide liquidity; I said that I am not sure that the additional liquidity they provide actually matters to anyone other than high speed traders.