3 ms·

I have a couple of questions for the people on here who actually understand all this stuff. The argument, as I understand it, for why it is useful to have HFTs

by mrow84 12y ago

I have a couple of questions for the people on here who actually understand all this stuff. The argument, as I understand it, for why it is useful to have HFTs in markets like the one in the article, is that they provide extra liquidity. My understanding of liquidity is that it is some kind of measure of how quickly an asset can be sold. I'm sure there are some formal definitions, but that has to be something like [asset value/sale time], where larger is more liquid. It seems to me, though, that liquidity is necessarily very time-scale dependent. For example, there is basically no liquidity in any market at the picosecond (or whatever is faster than current trading) timescale, because (by definition) no-one trades that fast. So really, although liquidity can be calculated as a rate, it is more appropriate to look at the distribution of available liquidity over different time scales. In other words, being able to sell $10 of assets in 10 days is not really the same as being able to sell $1 of assets every day for 10 days. My questions are: 1) is my understanding of liquidity as being timescale dependent correct, and if not, why not? 2) if yes, what is the social value of "faster" liquidity? 3) if "faster" liquidity has greater social value, is there any point at which the cost of maintaining that liquidity (which is what I understand HFT profits to be) exceeds the value of having liquidity at that timescale? edit: spacing for visual clarity

friendzis 12y ago
I want to add to the argument: quite many people seem to be convinced that liquidity created by HFTs is almost a necessity for a pool/exchange to exist. What about pre-HFT times then? Did HFTs change the way we trade to the extent that it is impossible to trade without them now?
consz 12y ago
Liquidity is a measure of how much you can execute/trade immediately at any one moment in time. You can think of the fair price as the midpoint of the best bid and best offer -- but nobody can trade at this, so if you want to buy or sell, you have to buy slightly above the fair price or sell slightly below the fair price. And if you want to buy or sell a lot, you have to buy or sell standing bids/offers at prices worse than the best bid/offer, e.g. MSFT has best bid at 36.60 and best offer at 36.61 with 30,000 shares at every price. If you wanted to buy 100k shares immediately, you'd have to buy 30k at 36.61, 36.62, 36.63, and 10k at 36.64, for some average price slightly higher than 36.62. So I would say that liquidity is not timescale dependent -- its a measure of the quality of your execution (relative to the fair price) if you executed everything you needed to right now. Personally, I would say no to (3) -- HFT offers liquidity at all times and only transacts when their counterparty decides to cross bid-ask spread, so if they didn't want the price HFT was offering than they wouldn't hit their bid/offer. The cost of all the ancillary infrastructure (wireless connections, backspace, hiring harvard/mit quants) is independent of the direct cost (crossing bid-ask spread) a consumer pays to the HFT, so the actual cost paid by the customer is a fraction of what the HFT has to pay to be able to display the quotes it does.
- mrow84 12y ago
  Ok, I think I understand what you're saying in principle, but I still don't really understand how HFT, or indeed anyone who is only trading on prices, adds liquidity as you have defined it, beyond the addition of their initial capital: it's not having quick trades that makes a market liquid, just having available trading partners with enough capital to complete the trade you want. It strikes me that, if you roughly assume that price-based trading is random, then all that fast trading "really" does is speed up the process by which some people randomly lose their money and others are randomly given that money (those people generally being the price-based traders themselves, presumably, because they will be the ones involved in the majority of the trades). So my follow-up question is: what is the particular benefit of being able to trade as quickly as possible? And a related, more specific, question that might be easier to target and explain: I'm sure I've heard people suggesting capping trading frequency (which might be a ridiculous idea, I don't know); how would doing so harm liquidity? Also, just to clarify my previous question about cost, I was trying to refer to the "cost to the system", rather than direct costs. I'm not sure I can properly define what I mean by that, but I suppose it would be something like if the total revenue going to the HFT firms or similar people was greater than the return to the rest of the system of having their services. I'm not really convinced by market arguments against such cost/benefit inversions taking place, because inertia and changing circumstances can move institutions from being helpful to being unhelpful without markets being in a position to compensate. If I've made any other bad assumptions, please point them out as well.
  - Tycho 12y ago
    Maybe the correct way to look at it is that you can't have a functioning market without market makers (as this article suggests), so once you've accepted the need for them, the natural question to ask is 'who gets to be the market maker?' - whoever can respond/execute the fastest and most effectively. So the question of super fast trading becomes not one of liquidity provision for investors (for whom millisecond timescales are irrelevant), but rather one of competition (and interaction) between market makers. Since spreads have gone down in the HFT era, I suppose the 'cost to the system' in aggregate must be lower than before, unless I'm overlooking something. I'm not saying any of this with certainty, just sharing my thoughts.

by mrow84 12y ago

friendzis 12y ago

I want to add to the argument: quite many people seem to be convinced that liquidity created by HFTs is almost a necessity for a pool/exchange to exist. What about pre-HFT times then? Did HFTs change the way we trade to the extent that it is impossible to trade without them now?

consz 12y ago

Liquidity is a measure of how much you can execute/trade immediately at any one moment in time. You can think of the fair price as the midpoint of the best bid and best offer -- but nobody can trade at this, so if you want to buy or sell, you have to buy slightly above the fair price or sell slightly below the fair price. And if you want to buy or sell a lot, you have to buy or sell standing bids/offers at prices worse than the best bid/offer, e.g. MSFT has best bid at 36.60 and best offer at 36.61 with 30,000 shares at every price. If you wanted to buy 100k shares immediately, you'd have to buy 30k at 36.61, 36.62, 36.63, and 10k at 36.64, for some average price slightly higher than 36.62. So I would say that liquidity is not timescale dependent -- its a measure of the quality of your execution (relative to the fair price) if you executed everything you needed to right now. Personally, I would say no to (3) -- HFT offers liquidity at all times and only transacts when their counterparty decides to cross bid-ask spread, so if they didn't want the price HFT was offering than they wouldn't hit their bid/offer. The cost of all the ancillary infrastructure (wireless connections, backspace, hiring harvard/mit quants) is independent of the direct cost (crossing bid-ask spread) a consumer pays to the HFT, so the actual cost paid by the customer is a fraction of what the HFT has to pay to be able to display the quotes it does.

mrow84 12y ago
Ok, I think I understand what you're saying in principle, but I still don't really understand how HFT, or indeed anyone who is only trading on prices, adds liquidity as you have defined it, beyond the addition of their initial capital: it's not having quick trades that makes a market liquid, just having available trading partners with enough capital to complete the trade you want. It strikes me that, if you roughly assume that price-based trading is random, then all that fast trading "really" does is speed up the process by which some people randomly lose their money and others are randomly given that money (those people generally being the price-based traders themselves, presumably, because they will be the ones involved in the majority of the trades). So my follow-up question is: what is the particular benefit of being able to trade as quickly as possible? And a related, more specific, question that might be easier to target and explain: I'm sure I've heard people suggesting capping trading frequency (which might be a ridiculous idea, I don't know); how would doing so harm liquidity? Also, just to clarify my previous question about cost, I was trying to refer to the "cost to the system", rather than direct costs. I'm not sure I can properly define what I mean by that, but I suppose it would be something like if the total revenue going to the HFT firms or similar people was greater than the return to the rest of the system of having their services. I'm not really convinced by market arguments against such cost/benefit inversions taking place, because inertia and changing circumstances can move institutions from being helpful to being unhelpful without markets being in a position to compensate. If I've made any other bad assumptions, please point them out as well.
- Tycho 12y ago
  Maybe the correct way to look at it is that you can't have a functioning market without market makers (as this article suggests), so once you've accepted the need for them, the natural question to ask is 'who gets to be the market maker?' - whoever can respond/execute the fastest and most effectively. So the question of super fast trading becomes not one of liquidity provision for investors (for whom millisecond timescales are irrelevant), but rather one of competition (and interaction) between market makers. Since spreads have gone down in the HFT era, I suppose the 'cost to the system' in aggregate must be lower than before, unless I'm overlooking something. I'm not saying any of this with certainty, just sharing my thoughts.