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Everybody always cries "front running!" I believe front running is an overblown issue. I also believe that most defenses of HFT as "liquidity providers" overloo

Everybody always cries "front running!" I believe front running is an overblown issue. I also believe that most defenses of HFT as "liquidity providers" overlooks a large share of prop firms and hedge funds using HFT for speculation and are not in fact liquidity providers. But the firms that do play liquidity -- the firms that compete with one another for your order after it comes thru your broker -- aren't hurting anybody by front running. In fact, they value your order flow so much (for their own info) that they price-improve for you so they capture more/all of the order. IIRC over 60% of stock trades are price-improved.

tptacek 12y ago
As I understand it: provision of liquidity is not a function of intent. Liquidity is a property of the market, not of a trading strategy. Some strategies (happen to) add (sell) liquidity, and some remove (buy) it. The term "front-running" is terribly misused in these discussions (I can't tell from your short comment if you were, though). You "front-run" someone if they reveal their trading intent to you, and front-running usually involves an agency problem (ie, your broker and their responsibility to you as a client).
- hnnewguy 12y ago
  >front-running usually involves an agency problem Historically, in the HFT world, it also involved getting ahead of big orders in the order book by taking advantage of how orders are systematically queued or prioritized.
  - tptacek 12y ago
    How does that differ from the way every market maker deals with informed traders? (Serious question, not a challenge.)
    - hnnewguy 12y ago
      Well, this is merely a hobby interest to me, and it's a been a while since I read 'Dark Pools' but: it's less "using information" to front-run, and more "taking advantage of computational glitches" to jump the queue and get higher priority in the order book. I have no idea if this is still an issue (doubt it), but it was in the early days of HFT. Anyway, I'm out of my element...'Dark Pools' is a decent read if you're into this stuff.
      - tptacek 12y ago
        I like _Dark Pools_ ('kasey_junk recommended it as an antidote to _Flash Boys_) too. For a slightly older but more authoritative nuts-and-bolts explanation, and surprisingly well-written, Larry Harris _Trading and Exchanges_ is basically the _TCP/IP Illustrated_ of money.
- encoderer 12y ago
  The point about "front running" being misused correlates with my point that every time HFT gets discussed, ppl cry "front running" and blame HFT for various ills. About liquidity providing... brokers don't generally route orders directly to an exchange. In most cases your order will get routed to a 3rd party liquidity provider, a firm who agrees to buy at the bid and sell at the ask and do so quickly. Often, these guys will pay the broker for order flow or price-improve your order to capture all of it, or both. Competition between these firms goes a long way towards guaranteeing the NBBO price that your broker is obligated to provide. Connecting the dots leads you to a conclusion that the order flow is valuable enough to them (for purposes of their own prop trading, strategic option selling, etc) that they act as market makers.
  - chollida1 12y ago
    Some of this seems wrong. > In most cases your order will get routed to a 3rd party liquidity provider, This is only true if you are a regular person, ie using IB to buy in your rrsp or ira account. Almost exclusively, anyone who is a professional will go direct to market( DMA). They will never go through Citadel or some other liquidity provider. > Often, these guys will pay the broker for order flow Not often, always. They always pay for this, there are no freebies:) > a firm who agrees to buy at the bid and sell at the ask and do so quickly. If you can find someone who will guarentee that they will fill my buy orders at the bid and sell orders at the ask, please let me know and I'll give them all my flow:) > Competition between these firms goes a long way towards guaranteeing the NBBO price that your broker is obligated to provide. What does this even mean, even without someone buying your flow you are still guaranteed to get the NBBO price, RegNMS says this is the law. Let me be clear, 3rd party brokers have no part in guaranteeing you get the NBBO price. The law says if your order can trade at the NBBO, it must.
    - encoderer 12y ago
      I'm not a fan of the point-by-point redressing so I'll just say a few things and leave you the last word if you want it. And I'm sure that there are some fascinating differences when trading as a hedge fund, and maybe you can share more about them. The process I laid out is generally "how orders get filled" for just about everybody reading this. If you know enough about how your specific orders get filled, I suppose you're not the audience I was writing for. 1. Brokers don't only send orders to 3rd party market makers because they're being paid for order flow. You're right, they won't get order flow for free, but I didn't mean to imply that they did. 2. Quoting and buying at their published bid/ask is precisely their function. Possibly we're just disagreeing on terms. The SEC's website is fairly good at explaining this flow. http://www.sec.gov/investor/pubs/tradexec.htm http://www.sec.gov/investor/pubs/tradexec.htm 3. What I'm discussing is the actual mechanism for HOW nbbo is fulfilled. Competition in the marketplace -- third party market makers and arb firms -- absolutely play a role in ensuring the efficiency of the market. If brokers had to run this infrastructure themselves, it would be non-trivial and without any financial incentives that I can think of.
snowwrestler 12y ago
Speculation is providing liquidity. I don't understand how you could do one without the other.
- encoderer 12y ago
  > Speculation is providing liquidity. Right, but the inverse isn't true. Not all liquidity is speculative. And third party market makers are surely making money from providing liquidity but not by taking the other side of a trade.
wdewind 12y ago
I don't want to seem pedantic, but it's explicitly not front running, despite this articles misuse of the term. Front running is when you trade in front of your clients' trades based on the information they provide you, not your competitors'.

tptacek 12y ago

As I understand it: provision of liquidity is not a function of intent. Liquidity is a property of the market, not of a trading strategy. Some strategies (happen to) add (sell) liquidity, and some remove (buy) it. The term "front-running" is terribly misused in these discussions (I can't tell from your short comment if you were, though). You "front-run" someone if they reveal their trading intent to you, and front-running usually involves an agency problem (ie, your broker and their responsibility to you as a client).

hnnewguy 12y ago
>front-running usually involves an agency problem Historically, in the HFT world, it also involved getting ahead of big orders in the order book by taking advantage of how orders are systematically queued or prioritized.
- tptacek 12y ago
  How does that differ from the way every market maker deals with informed traders? (Serious question, not a challenge.)
  - hnnewguy 12y ago
    Well, this is merely a hobby interest to me, and it's a been a while since I read 'Dark Pools' but: it's less "using information" to front-run, and more "taking advantage of computational glitches" to jump the queue and get higher priority in the order book. I have no idea if this is still an issue (doubt it), but it was in the early days of HFT. Anyway, I'm out of my element...'Dark Pools' is a decent read if you're into this stuff.
    - tptacek 12y ago
      I like _Dark Pools_ ('kasey_junk recommended it as an antidote to _Flash Boys_) too. For a slightly older but more authoritative nuts-and-bolts explanation, and surprisingly well-written, Larry Harris _Trading and Exchanges_ is basically the _TCP/IP Illustrated_ of money.
encoderer 12y ago
The point about "front running" being misused correlates with my point that every time HFT gets discussed, ppl cry "front running" and blame HFT for various ills. About liquidity providing... brokers don't generally route orders directly to an exchange. In most cases your order will get routed to a 3rd party liquidity provider, a firm who agrees to buy at the bid and sell at the ask and do so quickly. Often, these guys will pay the broker for order flow or price-improve your order to capture all of it, or both. Competition between these firms goes a long way towards guaranteeing the NBBO price that your broker is obligated to provide. Connecting the dots leads you to a conclusion that the order flow is valuable enough to them (for purposes of their own prop trading, strategic option selling, etc) that they act as market makers.
- chollida1 12y ago
  Some of this seems wrong. > In most cases your order will get routed to a 3rd party liquidity provider, This is only true if you are a regular person, ie using IB to buy in your rrsp or ira account. Almost exclusively, anyone who is a professional will go direct to market( DMA). They will never go through Citadel or some other liquidity provider. > Often, these guys will pay the broker for order flow Not often, always. They always pay for this, there are no freebies:) > a firm who agrees to buy at the bid and sell at the ask and do so quickly. If you can find someone who will guarentee that they will fill my buy orders at the bid and sell orders at the ask, please let me know and I'll give them all my flow:) > Competition between these firms goes a long way towards guaranteeing the NBBO price that your broker is obligated to provide. What does this even mean, even without someone buying your flow you are still guaranteed to get the NBBO price, RegNMS says this is the law. Let me be clear, 3rd party brokers have no part in guaranteeing you get the NBBO price. The law says if your order can trade at the NBBO, it must.
  - encoderer 12y ago
    I'm not a fan of the point-by-point redressing so I'll just say a few things and leave you the last word if you want it. And I'm sure that there are some fascinating differences when trading as a hedge fund, and maybe you can share more about them. The process I laid out is generally "how orders get filled" for just about everybody reading this. If you know enough about how your specific orders get filled, I suppose you're not the audience I was writing for. 1. Brokers don't only send orders to 3rd party market makers because they're being paid for order flow. You're right, they won't get order flow for free, but I didn't mean to imply that they did. 2. Quoting and buying at their published bid/ask is precisely their function. Possibly we're just disagreeing on terms. The SEC's website is fairly good at explaining this flow. http://www.sec.gov/investor/pubs/tradexec.htm http://www.sec.gov/investor/pubs/tradexec.htm 3. What I'm discussing is the actual mechanism for HOW nbbo is fulfilled. Competition in the marketplace -- third party market makers and arb firms -- absolutely play a role in ensuring the efficiency of the market. If brokers had to run this infrastructure themselves, it would be non-trivial and without any financial incentives that I can think of.

snowwrestler 12y ago

Speculation is providing liquidity. I don't understand how you could do one without the other.

encoderer 12y ago
> Speculation is providing liquidity. Right, but the inverse isn't true. Not all liquidity is speculative. And third party market makers are surely making money from providing liquidity but not by taking the other side of a trade.

wdewind 12y ago

I don't want to seem pedantic, but it's explicitly not front running, despite this articles misuse of the term. Front running is when you trade in front of your clients' trades based on the information they provide you, not your competitors'.