5 ms·

What is happening here is really quite simple, and doesn't deserve an entire blog post. There are two exchanges, A and B, and a market maker Jill is quoting (s

What is happening here is really quite simple, and doesn't deserve an entire blog post. There are two exchanges, A and B, and a market maker Jill is quoting (say) 10,000 shares on each of those two exchanges for $17. Big institutional trader Jack sees the 20,000 shares and decides that he wants to buy 15,000 of them, so he sends two orders for 7,500 shares each to A and B. Because of various effects (network latencies, routing switching delays, whatever) his order arrives at exchange A first, and is immediately filled at $17. Jill, who has her computer co-located at exchange A, sees that she has sold 7,500 shares for $17, and realizes that there is demand for shares. Because of this demand, she decides to raise her prices. She immediately cancels her remaining 2500 shares on exchange A and replaces them with 10,000 shares at $17.05 and sends an instruction to do the same thing at exchange B. Because Jill has fast computers and low-latency connections, her cancellation arrives at exchange B before Jack's buy order, so Jack is told that there are no longer shares available on exchange B at $17. RESULT: Jack is filled for 7500 shares at $17 (half of what he requested) and the new market best offer is $17.05. Jack is welcome to submit another order for $17.05 if he wants to buy at that price. Jill is now short 7500 shares at $17, and will try to buy them back at a lower price (she may or may not succeed - until she does, she is exposed to the risk of further price rises). Jill was able to use her speed advantage to detect that there was additional demand to buy this stock, and raise the price at which she was willing to sell it before Jack had finished buying all that he wanted to. This is exactly the way that an efficient market is supposed to work - it reacts to fluctuating demand (and other information) to set appropriate prices. I think there are several things that get glossed over while people are working themselves up about this - 1. Jack is upset because he couldn't buy 15,000 shares at the price he wanted to buy them. But Jack has no god-given right to be able to buy shares at the price he likes best. He is subject to the laws of the market, just like everyone else. 2. The only reason that Jill has a speed advantage over Jack is because she has paid for it! She has paid to co-locate her server at the exchange, and she has paid to use high-speed connections between exchanges. Are we going to declare that paying for a competitive advantage is suddenly immoral? 3. If Jack doesn't like this state of affairs, he has several options. He can invest in high-speed infrastructure as well. He can use smarter order-routing logic (e.g. adding delays to his orders so that they arrive at the exchanges approximately simultaneously, or splitting his large order up into multiple smaller orders). Or he can use a broker who will do these things for him. If Jack doesn't want to pay for any of these things, then he has to put up with lower quality execution. As much as he might wish it, the ability to buy as many shares as he wants at the price he wants them is not a universal human right.

carlob 12y ago
There is still something that nags me. I've heard a bunch of explanation about liquidity and how HFT allows for large orders to be fulfilled, but it seems like this is quite the opposite. What purpose does this serve? Is society as a whole better off when Jill is able to make this .05 per share more? I wouldn't frame the debate as 'god given rights' and 'competitive advantage'. What I really want to know is why a society where trades and quotes happen on a millisecond scale is better off than one where they happen on a second scale. It's an honest question. Someone please convince me.
- throwaway283719 12y ago
  What's great is that we don't have to engage in thought experiments about what would happen if we didn't have trading activity with fast computers on a millisecond scale - we can just look back to any time before the 1990s, when most market making was done by humans, on human time scales. Before 2001 the minimum tick size on any exchange was 1/16th of a dollar ($0.0625) and before 1997 it was 1/8th ($0.125), so the absolute minimum you would pay for a round trip (buying a stock and later selling it) was that much. Frequently, the bid-offer spread would be many ticks wide, so you could easily be paying $0.25 or $0.50 for each round trip. The current minimum tick size is $0.01, and there are many stocks which trade at that level. Even if you suffer $0.05 of slippage on a round trip, you're still better off than you would have been under the old regime. In the old regime, instead of high frequency traders, you had floor brokers who would work orders. Fortunately, floor brokers were paragons of virtue and morality, who would certainly never front run their clients orders, and would take any trade even if it worked to their disadvantage (NB in case you don't get it - this is sarcasm. In the 1987 crash, most brokers wouldn't even pick up their fucking phone because too many people were trying to sell stock, and the brokers didn't want to buy). I honestly find it hard to believe that some people think that was better than what we have today. --- Edit: The other thing I don't get is why ordinary investors (by which I mean anyone with less than $100m to invest) care about this. For a small investor, you are actually getting an even better deal because your order for 1000 shares or whatever can get filled instantaneously, in one chunk, for a great price! It's only when you're trying to buy hundreds of thousands of shares in a few minutes that you end up suffering price slippage. The standard response is that ordinary investors have their money invested in mutual funds and pensions, who are large investors. But in that case you are already paying 0.5-2% per year to your fund manager, and why do you give a shit if they lose 10 basis points (0.1%) in price slippage because the market is more efficient than it used to be? In fact, why is my pension fund manager trading so fucking much anyway? I don't have a pension because I think the fund manager is some genius stock picker, I have it because it's tax efficient and my employer contributes to it. Just buy the S&P500 and sit on it.

carlob 12y ago

There is still something that nags me. I've heard a bunch of explanation about liquidity and how HFT allows for large orders to be fulfilled, but it seems like this is quite the opposite. What purpose does this serve? Is society as a whole better off when Jill is able to make this .05 per share more? I wouldn't frame the debate as 'god given rights' and 'competitive advantage'. What I really want to know is why a society where trades and quotes happen on a millisecond scale is better off than one where they happen on a second scale. It's an honest question. Someone please convince me.

throwaway283719 12y ago
What's great is that we don't have to engage in thought experiments about what would happen if we didn't have trading activity with fast computers on a millisecond scale - we can just look back to any time before the 1990s, when most market making was done by humans, on human time scales. Before 2001 the minimum tick size on any exchange was 1/16th of a dollar ($0.0625) and before 1997 it was 1/8th ($0.125), so the absolute minimum you would pay for a round trip (buying a stock and later selling it) was that much. Frequently, the bid-offer spread would be many ticks wide, so you could easily be paying $0.25 or $0.50 for each round trip. The current minimum tick size is $0.01, and there are many stocks which trade at that level. Even if you suffer $0.05 of slippage on a round trip, you're still better off than you would have been under the old regime. In the old regime, instead of high frequency traders, you had floor brokers who would work orders. Fortunately, floor brokers were paragons of virtue and morality, who would certainly never front run their clients orders, and would take any trade even if it worked to their disadvantage (NB in case you don't get it - this is sarcasm. In the 1987 crash, most brokers wouldn't even pick up their fucking phone because too many people were trying to sell stock, and the brokers didn't want to buy). I honestly find it hard to believe that some people think that was better than what we have today. --- Edit: The other thing I don't get is why ordinary investors (by which I mean anyone with less than $100m to invest) care about this. For a small investor, you are actually getting an even better deal because your order for 1000 shares or whatever can get filled instantaneously, in one chunk, for a great price! It's only when you're trying to buy hundreds of thousands of shares in a few minutes that you end up suffering price slippage. The standard response is that ordinary investors have their money invested in mutual funds and pensions, who are large investors. But in that case you are already paying 0.5-2% per year to your fund manager, and why do you give a shit if they lose 10 basis points (0.1%) in price slippage because the market is more efficient than it used to be? In fact, why is my pension fund manager trading so fucking much anyway? I don't have a pension because I think the fund manager is some genius stock picker, I have it because it's tax efficient and my employer contributes to it. Just buy the S&P500 and sit on it.