5 ms·

it's not really gaming the system. if you have money, you can buy server space close to the exchange's computers. that may seem unfair, but that's not really

by andylei 17y ago

it's not really gaming the system. if you have money, you can buy server space close to the exchange's computers. that may seem unfair, but that's not really unique to trading. consider manufacturing: if you have more money, you can buy a bigger factory and leverage economies of scale to make your widgets for cheaper; that's a competitive advantage.

bhousel 17y ago
It's a bit different. Your metaphorical factory isn't making cheaper widgets by taking tiny pieces of your competitor's widgets away from them. I'm not arguing for or against high frequency trading, just saying that finance actually is a zero sum game unlike manufacturing.
- shimon 17y ago
  In this case, you may be right. Generally speaking, finance can have positive effects -- even commodity speculation can be argued to positively influence long-term price stability. But it's hard to imagine how competing for low-latency server space makes the world a better place, except perhaps to piss people off enough that someone might eventually implement an official timing methodology that can't be gamed by sub-half-second latency advantages.
- fizx 17y ago
  Finance isn't zero-sum. Better finance makes market capital allocation more efficient, which makes the pie bigger for everyone.
  - three14 17y ago
    I've never understood how this applies to arbitrage. Without arbitrage, the parties to the transaction would capture the money lost to arbitrage, and in a modern market, the same information would be learned. If I offer to sell 1000 at $3.03 and you offer to buy at $3.04, we can split the difference. If someone else gets the information of that spread faster than we can resolve it ourselves, they don't "lubricate the capital markets" or anything. They just get our money.
    - besquared 17y ago
      Arbitrage supplies liquidity at all prices, including prices where most trades might not otherwise occur. Liquidity is required for businesses to systematically eliminate risk, therefore it is highly valued as a source of stability for most companies who deal with financial instruments. Knight has some thoughts on systematic risk in his book Risk, Uncertainty and Profit.
      - three14 17y ago
        Did this answer my question? I'm really open to the possibility that it's just me, but I still don't get it. I see that some kinds of arbitrage could be useful to a market. I don't see how these microsecond-timing types of arbitrage can possibly help any market. Every last one of these trades will happen anyway. (*nitpicker's corner - of course some wouldn't happen, e.g. at the precise close of trading.)
        tptacek 17y ago
        He did answer your question. The value of arbitrage is liquidity. Liquidity is extremely valuable. Here, I'll quote Harris: Liquidity is the ability to trade large size quickly, at low cost, when you want to trade. It is the most important characteristic of well-functioning markets. Everyone likes liquidity. Traders like liquidity because it allows them to implement their trading strategies cheaply. Exchanges like liquidity because it attracts traders to their markets. Regulators like liquidity because liquid markets are often less volatile than illiquid ones. Market are not magical. Just because something may be fundamentally worth X does not mean you can automatically find someone to take the other side of a trade based on that valuation.
        three14 17y ago
        I still don't get it. I accepted that liquidity is valuable. This specific case adds no liquidity. None. Both sides are participating in the same market, and have enough information to make the trade. They will make the trade if no one interferes. Someone else comes in as a MITM, and collects the spread. What value did they add?
  - pbhjpbhj 17y ago
    Capital allocation only works towards efficiency if you remove capital from failing businesses ... but no one would prop up a failing business with billions of $USD and negate the whole process would they ...? Also, you need people to want what's good for them. Suppose we need better food supplies; food production companies need more capital to optimise their production. But, people want nicer trainers (aka sneakers) and so we allocate more money there for growth to recoup more profit from that id-ish desire for fashion. That's not efficiently running the system that's efficiently recouping the greatest profit. People's desire for better food needs to be improved but instead the profit from the shoe sales feeds-back and more money is spent on advertising and marketing and enticing people to want slick shoes in preference to healthy food. The feed back loop rolls on and more resources are allocated to shoes still at the expense of other sectors. Capitalism is not really about optimising production, IMO. The essence of capitalism is to maximise profit and the two ideals are not co-terminous.
- andylei 17y ago
  well, there is a limited demand for widgets. if i make cheaper widgets, i'm taking away sales from my competitor. isn't that the same? your observation isn't something unique to finance. capitalism, or just business, is inherently competitive. guy A wants 1 widget; your factory and my factor can't both sell our widget to him. isn't that also a zero sum game?
  - PebblesRox 17y ago
    But making cheaper widgets can increase widget demand to an extent, right? Maybe guy B, who couldn't afford a widget before, can now buy one. By producing more widgets for the same total cost, you are increasing the amount of wealth in the world.
  - bhousel 17y ago
    I think it would be more like if I get to find out that Guy A wants to buy some widgets before you get this information. I also get to find out that you're selling widgets before Guy A gets this information. I can buy widgets from you for cheap because you don't know that there is a market yet. I can sell them to Guy A for expensive because he doesn't know there are plenty of widgets to go around. On the face of it, there's really nothing wrong with this - too bad for you and Guy A that you don't have access to the information that I do. But I think the concern is that I can use my position to control the markets, or that everyone will lose faith in the game and stop playing.

by andylei 17y ago

bhousel 17y ago

It's a bit different. Your metaphorical factory isn't making cheaper widgets by taking tiny pieces of your competitor's widgets away from them. I'm not arguing for or against high frequency trading, just saying that finance actually is a zero sum game unlike manufacturing.

shimon 17y ago
In this case, you may be right. Generally speaking, finance can have positive effects -- even commodity speculation can be argued to positively influence long-term price stability. But it's hard to imagine how competing for low-latency server space makes the world a better place, except perhaps to piss people off enough that someone might eventually implement an official timing methodology that can't be gamed by sub-half-second latency advantages.
fizx 17y ago
Finance isn't zero-sum. Better finance makes market capital allocation more efficient, which makes the pie bigger for everyone.
- three14 17y ago
  I've never understood how this applies to arbitrage. Without arbitrage, the parties to the transaction would capture the money lost to arbitrage, and in a modern market, the same information would be learned. If I offer to sell 1000 at $3.03 and you offer to buy at $3.04, we can split the difference. If someone else gets the information of that spread faster than we can resolve it ourselves, they don't "lubricate the capital markets" or anything. They just get our money.
  - besquared 17y ago
    Arbitrage supplies liquidity at all prices, including prices where most trades might not otherwise occur. Liquidity is required for businesses to systematically eliminate risk, therefore it is highly valued as a source of stability for most companies who deal with financial instruments. Knight has some thoughts on systematic risk in his book Risk, Uncertainty and Profit.
    - three14 17y ago
      Did this answer my question? I'm really open to the possibility that it's just me, but I still don't get it. I see that some kinds of arbitrage could be useful to a market. I don't see how these microsecond-timing types of arbitrage can possibly help any market. Every last one of these trades will happen anyway. (*nitpicker's corner - of course some wouldn't happen, e.g. at the precise close of trading.)
      - tptacek 17y ago
        He did answer your question. The value of arbitrage is liquidity. Liquidity is extremely valuable. Here, I'll quote Harris: Liquidity is the ability to trade large size quickly, at low cost, when you want to trade. It is the most important characteristic of well-functioning markets. Everyone likes liquidity. Traders like liquidity because it allows them to implement their trading strategies cheaply. Exchanges like liquidity because it attracts traders to their markets. Regulators like liquidity because liquid markets are often less volatile than illiquid ones. Market are not magical. Just because something may be fundamentally worth X does not mean you can automatically find someone to take the other side of a trade based on that valuation.
        three14 17y ago
        I still don't get it. I accepted that liquidity is valuable. This specific case adds no liquidity. None. Both sides are participating in the same market, and have enough information to make the trade. They will make the trade if no one interferes. Someone else comes in as a MITM, and collects the spread. What value did they add?
- pbhjpbhj 17y ago
  Capital allocation only works towards efficiency if you remove capital from failing businesses ... but no one would prop up a failing business with billions of $USD and negate the whole process would they ...? Also, you need people to want what's good for them. Suppose we need better food supplies; food production companies need more capital to optimise their production. But, people want nicer trainers (aka sneakers) and so we allocate more money there for growth to recoup more profit from that id-ish desire for fashion. That's not efficiently running the system that's efficiently recouping the greatest profit. People's desire for better food needs to be improved but instead the profit from the shoe sales feeds-back and more money is spent on advertising and marketing and enticing people to want slick shoes in preference to healthy food. The feed back loop rolls on and more resources are allocated to shoes still at the expense of other sectors. Capitalism is not really about optimising production, IMO. The essence of capitalism is to maximise profit and the two ideals are not co-terminous.
andylei 17y ago
well, there is a limited demand for widgets. if i make cheaper widgets, i'm taking away sales from my competitor. isn't that the same? your observation isn't something unique to finance. capitalism, or just business, is inherently competitive. guy A wants 1 widget; your factory and my factor can't both sell our widget to him. isn't that also a zero sum game?
- PebblesRox 17y ago
  But making cheaper widgets can increase widget demand to an extent, right? Maybe guy B, who couldn't afford a widget before, can now buy one. By producing more widgets for the same total cost, you are increasing the amount of wealth in the world.
- bhousel 17y ago
  I think it would be more like if I get to find out that Guy A wants to buy some widgets before you get this information. I also get to find out that you're selling widgets before Guy A gets this information. I can buy widgets from you for cheap because you don't know that there is a market yet. I can sell them to Guy A for expensive because he doesn't know there are plenty of widgets to go around. On the face of it, there's really nothing wrong with this - too bad for you and Guy A that you don't have access to the information that I do. But I think the concern is that I can use my position to control the markets, or that everyone will lose faith in the game and stop playing.