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OK, I guessed I don't have any knowledge to propose a solution here. :) I still doubt that HFT serves the real economy in any noticable positive way. Does the

OK, I guessed I don't have any knowledge to propose a solution here. :) I still doubt that HFT serves the real economy in any noticable positive way. Does the HFT firm's spending on technology really outweight their effect on the traded stock? And is it aceptable that they earn money purely by gaming the system?

kasey_junk 12y ago
HFT firms drive down the price of trading stocks by lowering the bid/ask spread, increasing competition amongst exchanges (especially in regards to fees), and spreading technology throughout the trading industry. There is an argument to be made that they also provide needed liquidity but it is a contentious one.
- chrisbennet 12y ago
  I'm not sure that they actually reduce the cost of anything. I just finished reading "Flash Boys" by Michael Lewis and; as I understand it, this is how HFT works: 1. You the buyer, tell N exchanges that want to buy at a maximum price $X. 2. HFT "watches" the exchange that my bid reaches first (by milliseconds) 3. HFT traders then place themselves between you and the N-1 exchanges and offer to sell you the stock at the maximum bid price. They do this by finding the stock on those other exchanges at less than your max bid price and owning it for a fraction of a second before they sell it to you at a higher price.
  - kasey_junk 12y ago
    This is the single biggest problem with the Michael Lewis book is that it implies that this is happening without ever walking through it. What is actually happening is that: 1. HFT is quoting both buy and sell prices on every exchange. 2. A big buyer sends orders to all of the exchanges trying to buy (or sell) all of the available inventory at a given price. 3. On 1 exchange the big buyers order gets there earlier than on other exchanges, triggering a transaction with the HFT. 4. The HFT uses that transaction as a price signal to change their prices on all the other exchanges and if they are faster than the big buyer, the big buyer cannot take advantage of the lower price. There is no middleman buying from 1 place and selling to another and driving up the price. What this sort of price signaling does is allow the HFT to quote smaller spreads in the more common case, when 1 participant is not trying to wipe out all of the liquidity in the market at a given price point.
    - nkurz 12y ago
      I'm ignorant and only working from first principles, while you seem knowledgeable about actual practice. In your explanation, the fastest HFT knows before anyone else that the someone is buying large quantities of a stock at Exchange A at a price higher than the ask at Exchange B. From this, they know to raise their asking price at B, since they (and no one else) know that there is a buyer willing to pay a higher price. This makes sense, and they would make some money doing this. But why wouldn't they also buy up all the stock at B that is priced less than transaction price they observed at A? If they do, they (hopefully) get to quickly resell it for a slightly higher price. If they don't, much of the order from the big buyer they are counting on will be filled with lower priced stock from their slower competitors, and they will make less money. There is no middleman buying from 1 place and selling to another and driving up the price. If they have the knowledge and they ability, why wouldn't they? I'd think it would be in their financial interest to do so. Or is your point that they are indeed doing what would normally be called "frontrunning", but that the knowledge comes from one exchange while the transactions all take place at another?
      - kasey_junk 12y ago
        Let me first clarify, there very well may be certain HFT that try to do this, but it isn't a large class, because the sophistication and speed required would mean that you could market make more profitably in most instances. The short answer to your question, is that other HFT prevent them from doing this. It is very rare for a single HFT entity to represent the entire order level at a price. Therefore just because they can react to their own transactions (the only ones that aren't on a public feed) faster doesn't mean they can react to everyone else. Further, just because demand on one exchange implies demand on others, it doesn't require it. So in the case where you read the demand wrong, and you are just changing your price you lose priority at the old price point and therefore there is an opportunity cost, but if you are actually making a transaction you lose both priority and the bid/ask spread which is a real cash cost. Finally, we need to be very careful about the term frontrunning. It is a specific thing. Acting on the same information available to a counterparty faster than them is never frontrunning. The only time it is frontrunning is if you have a fiduciary duty to be acting on a parties behalf and you don't live up to that duty by trading ahead of orders they placed with you.
mlrtime 12y ago
"I don't know anything about trading" Why do you feel so strongly about banning a practice that you admit know nothing about? Is this just a gut feeling?
- moreentropy 12y ago
  Actually yes, it's a gut feeling and I think it's justified. I can totally understand the general idea of stock trading and how it helps both those who have good ideas and need money and those who have the money and invest it according to their taste. But it's very hard for me to believe that something like HFT where firms go to unbelievable lengths to implement purely technological trading advantages benefit the real economy. The fact that financial industry as a whole just recently in the 2008/2009 crash and it's aftermath were able to extract obscene amounts of money from our governments (i.e. us) to keep the world's finance system from collapsing makes the suspection that most financial products purely based on a material advantage (be it monetary or technological) are akin to a scam very reasonable.
  - kasey_junk 12y ago
    "I can totally understand the general idea of stock trading and how it helps both those who have good ideas and need money and those who have the money and invest it according to their taste." This is a cognitive bias that is very prevalent (for obvious reasons) on HN. The markets are not primarily vehicles for moving money from investors to enterprises. Another important, and probably dominant, purpose of the markets is to accurately price and allow the buying and selling of risk. This is neither a new or unexpected phenomenon. "But it's very hard for me to believe that something like HFT where firms go to unbelievable lengths to implement purely technological trading advantages benefit the real economy." This is because of your cognitive bias and your ignorance (I mean this in the non-perjorative sense that you haven't investigated this). HFT firms, like any other trading participant, smooth demand curves generated either in time (buying from a participant now and selling later), venue (buying in one place and selling in another), or other ways. This allows other participants, who are not interested in being traders to hedge their risk more efficiently and thus more cheaply. "The fact that financial industry as a whole just recently in the 2008/2009 crash and it's aftermath were able to extract obscene amounts of money from our governments (i.e. us) to keep the world's finance system from collapsing makes the suspection that most financial products purely based on a material advantage (be it monetary or technological) are akin to a scam very reasonable." And now we see why gut feelings are dangerous in this discussion. You rightly feel deeply troubled by the big bailouts that cost all of us to the advantage of a very powerful few, and you correlate that with HFT. When in fact, HFT did not receive any bailouts and for the most part small independent shops without the size or power to engineer them. The 2008/2009 crash was based on non-HFT traded instruments where single deals could dwarf the entirety of the HFT industry.
tptacek 12y ago
What "effect on trading stock"? The benefits of automated trading are not abstract: you can go ask Google for spreads from the 1980s to 2010 and see the impact.

kasey_junk 12y ago

HFT firms drive down the price of trading stocks by lowering the bid/ask spread, increasing competition amongst exchanges (especially in regards to fees), and spreading technology throughout the trading industry. There is an argument to be made that they also provide needed liquidity but it is a contentious one.

chrisbennet 12y ago
I'm not sure that they actually reduce the cost of anything. I just finished reading "Flash Boys" by Michael Lewis and; as I understand it, this is how HFT works: 1. You the buyer, tell N exchanges that want to buy at a maximum price $X. 2. HFT "watches" the exchange that my bid reaches first (by milliseconds) 3. HFT traders then place themselves between you and the N-1 exchanges and offer to sell you the stock at the maximum bid price. They do this by finding the stock on those other exchanges at less than your max bid price and owning it for a fraction of a second before they sell it to you at a higher price.
- kasey_junk 12y ago
  This is the single biggest problem with the Michael Lewis book is that it implies that this is happening without ever walking through it. What is actually happening is that: 1. HFT is quoting both buy and sell prices on every exchange. 2. A big buyer sends orders to all of the exchanges trying to buy (or sell) all of the available inventory at a given price. 3. On 1 exchange the big buyers order gets there earlier than on other exchanges, triggering a transaction with the HFT. 4. The HFT uses that transaction as a price signal to change their prices on all the other exchanges and if they are faster than the big buyer, the big buyer cannot take advantage of the lower price. There is no middleman buying from 1 place and selling to another and driving up the price. What this sort of price signaling does is allow the HFT to quote smaller spreads in the more common case, when 1 participant is not trying to wipe out all of the liquidity in the market at a given price point.
  - nkurz 12y ago
    I'm ignorant and only working from first principles, while you seem knowledgeable about actual practice. In your explanation, the fastest HFT knows before anyone else that the someone is buying large quantities of a stock at Exchange A at a price higher than the ask at Exchange B. From this, they know to raise their asking price at B, since they (and no one else) know that there is a buyer willing to pay a higher price. This makes sense, and they would make some money doing this. But why wouldn't they also buy up all the stock at B that is priced less than transaction price they observed at A? If they do, they (hopefully) get to quickly resell it for a slightly higher price. If they don't, much of the order from the big buyer they are counting on will be filled with lower priced stock from their slower competitors, and they will make less money. There is no middleman buying from 1 place and selling to another and driving up the price. If they have the knowledge and they ability, why wouldn't they? I'd think it would be in their financial interest to do so. Or is your point that they are indeed doing what would normally be called "frontrunning", but that the knowledge comes from one exchange while the transactions all take place at another?
    - kasey_junk 12y ago
      Let me first clarify, there very well may be certain HFT that try to do this, but it isn't a large class, because the sophistication and speed required would mean that you could market make more profitably in most instances. The short answer to your question, is that other HFT prevent them from doing this. It is very rare for a single HFT entity to represent the entire order level at a price. Therefore just because they can react to their own transactions (the only ones that aren't on a public feed) faster doesn't mean they can react to everyone else. Further, just because demand on one exchange implies demand on others, it doesn't require it. So in the case where you read the demand wrong, and you are just changing your price you lose priority at the old price point and therefore there is an opportunity cost, but if you are actually making a transaction you lose both priority and the bid/ask spread which is a real cash cost. Finally, we need to be very careful about the term frontrunning. It is a specific thing. Acting on the same information available to a counterparty faster than them is never frontrunning. The only time it is frontrunning is if you have a fiduciary duty to be acting on a parties behalf and you don't live up to that duty by trading ahead of orders they placed with you.

mlrtime 12y ago

"I don't know anything about trading" Why do you feel so strongly about banning a practice that you admit know nothing about? Is this just a gut feeling?

moreentropy 12y ago
Actually yes, it's a gut feeling and I think it's justified. I can totally understand the general idea of stock trading and how it helps both those who have good ideas and need money and those who have the money and invest it according to their taste. But it's very hard for me to believe that something like HFT where firms go to unbelievable lengths to implement purely technological trading advantages benefit the real economy. The fact that financial industry as a whole just recently in the 2008/2009 crash and it's aftermath were able to extract obscene amounts of money from our governments (i.e. us) to keep the world's finance system from collapsing makes the suspection that most financial products purely based on a material advantage (be it monetary or technological) are akin to a scam very reasonable.
- kasey_junk 12y ago
  "I can totally understand the general idea of stock trading and how it helps both those who have good ideas and need money and those who have the money and invest it according to their taste." This is a cognitive bias that is very prevalent (for obvious reasons) on HN. The markets are not primarily vehicles for moving money from investors to enterprises. Another important, and probably dominant, purpose of the markets is to accurately price and allow the buying and selling of risk. This is neither a new or unexpected phenomenon. "But it's very hard for me to believe that something like HFT where firms go to unbelievable lengths to implement purely technological trading advantages benefit the real economy." This is because of your cognitive bias and your ignorance (I mean this in the non-perjorative sense that you haven't investigated this). HFT firms, like any other trading participant, smooth demand curves generated either in time (buying from a participant now and selling later), venue (buying in one place and selling in another), or other ways. This allows other participants, who are not interested in being traders to hedge their risk more efficiently and thus more cheaply. "The fact that financial industry as a whole just recently in the 2008/2009 crash and it's aftermath were able to extract obscene amounts of money from our governments (i.e. us) to keep the world's finance system from collapsing makes the suspection that most financial products purely based on a material advantage (be it monetary or technological) are akin to a scam very reasonable." And now we see why gut feelings are dangerous in this discussion. You rightly feel deeply troubled by the big bailouts that cost all of us to the advantage of a very powerful few, and you correlate that with HFT. When in fact, HFT did not receive any bailouts and for the most part small independent shops without the size or power to engineer them. The 2008/2009 crash was based on non-HFT traded instruments where single deals could dwarf the entirety of the HFT industry.

tptacek 12y ago

What "effect on trading stock"? The benefits of automated trading are not abstract: you can go ask Google for spreads from the 1980s to 2010 and see the impact.