6 ms·

The fundamental idea of algorithmic trading doesn't really fall into the category of screwing-people-over. However, some techniques employed by institutions eng

by avz 11y ago

The fundamental idea of algorithmic trading doesn't really fall into the category of screwing-people-over. However, some techniques employed by institutions engaged in it can easily be seen as outright cheating. One common example is front running [1] where a player with access to real-time order information exploits the knowledge of pending trades from other players to turn a profit at the other players' expense. These techniques can also be used across exchanges. The issue is a consequence of the lack of market transparency. The exchanges are only required to make order information public with a significant delay. However, they sell the real-time order information to a few market players enabling them to engage in the dubious tactics at the expense of other players. Note that tactics like front running used to be employed by brokers before algorithmic trading and have since been banned. [1] https://en.wikipedia.org/wiki/Front_running https://en.wikipedia.org/wiki/Front_running

res0nat0r 11y ago
Front running is already illegal, so if any group is doing that they are already breaking the rules of the game, and should be punished/stopped if found out.
- JesperRavn 11y ago
  What some HFT traders are doing is economically equivalent to front-running, but is not legally front running since they are not front running the orders of their own clients. All of this is explained in the article, so if you disagree, it would make more sense to read it, find the parts you disagree with, and argue against them, rather than skim the article and then argue with our collective rehashing of the article's argument.
  - deleted 11y ago
    [deleted]
  - mrchicity 11y ago
    That's a huge difference though. A broker owes a duty to his client not to screw him over. He's supposed to be helping the client. A prop trader has no duty to others in the market. He's their adversary. They're both competing to buy underpriced shares and sell overpriced ones.
    - JesperRavn 11y ago
      For the purposes of this discussion, it's not a difference at all. The question is not what should be legal or not, but what customers would prefer, and what makes a better market. If you ask a customer "would you like an exchange that gives people enough information to front run your order" or "would you like a broker who front runs your order" the answer in both cases would be a resounding no. The claim in the article is that you can create a better exchange by providing an equal footing for all participants.
      - mrchicity 11y ago
        Everybody wants to trade with no price impact. If you asked me if anyone else should be allowed to colocate their servers, I'd say no, just give me a monopoly please. One participant's desires don't make a good market. Fair and non-discriminatory access to exchanges (not free, but anybody can pay to compete if they wish), fast trading engines and deep order book information are what let traders put up such tight spreads for customers in the first place. Vigorous competition between all market participants keeps prices fair.
        JesperRavn 11y ago
        EDIT: I think you are right, although I would express things a bit differently. I'm writing a top level post with my thoughts. ORIGINAL POST: When you make a trade, there are some information rents associated with that trade. If someone knew you were about to trade, they could capture all of those rents. When there is a monopoly on exploiting these information rents (as in frontrunning), they will be captured by the frontrunner. When there is perfect competition (as when a number of HFTs can trade in another exchange before your trade reaches it), these rents will be all wasted on technology to maximize speed, i.e. no one gets them, they become deadweight loss. I understand that there are other issues, such as knowing whether a trade comes from a single seller or multiple smaller sellers. But this is a separate issue from simply trading ahead of other people. I don't understand why it's so controversial that an exchange would advertise the fact that traders can rely on their orders reaching the exchange before anyone else knows about it as a good thing.
  - kasey_junk 11y ago
    The problem is that front running requires 2 things: - the ability to see orders ahead of someone, which this article implies you can, but you can't. - the fiduciary duty not to use someone's intent to trade against them. HFT traders do not fall into either camp. They can't see your order before it goes to an exchange and they don't have a duty not to change their prices on one exchange in reaction to price moves on other exchanges.
    - JesperRavn 11y ago
      The article claims that by colocating in one exchange, HFT can see you order arrive at exchange A, and send orders to exchange B before your order reaches exchange B. I don't know if this is true, but this is the most important part of the article. Given the fixed latency they introduce, you can send your trades to IEX before sending to any other exchange, safe in the knowledge that no other exchange will react to that information before your order. No one is talking about the fiduciary duty. Fiduciary duty is just a way to define a default contract into law. E.g. brokers could write a contract saying that they promise not to front run. But since this is something that almost every client would want, it's just written into law instead.
      - kasey_junk 11y ago
        There is a major caveat to what they are reporting that gets to the heart of this. HFT can't see your order as it arrives on exchange A before it arrives on exchange B, they can see the results of an order. That is, they can see a large trade happened on price X on A. With that information they may want to change their prices on exchange B and they may be able to do that before you can also place an order on B. There are lots of ways to mitigate this other than using a dark pool like IEX. All the exchanges offer exotic order types to make this easier for instance, and large block traders have for years had execution algorithms that spread their orders around venues and over time to minimize price impact. That IEX offers another option for large block traders does not bother me at all, that they market it via underhanded moralizing i find distasteful. Finally, in this context front-running has a specific meaning and it requires a fiduciary duty for it to be front running. By using that term incorrectly you ARE bringing fiduciary duty into the conversation, whether you want to or not.
tedks 11y ago
>The exchanges are only required to make order information public with a significant delay. However, they sell the real-time order information to a few market players enabling them to engage in the dubious tactics at the expense of other players. It's easy to see why you view this as unfair. But it is fair. Anyone can buy the real-time information if they have the capital. Obviously markets are going to be more friendly towards you the more money you throw at them. Just like everything else in capitalism, the fairness comes from anyone being able to have money. If you think this is unfair, you're essentially opposing capitalism.
- MereInterest 11y ago
  I'm having a hard time figuring out whether you are being facetious or not. What you are describing is nepotism and bribery, not capitalism.
vegabook 11y ago
The idea that HFT is front running any more than a human market maker is a fallacy. What HFT does, is to properly price the liquidity in the market. Previously, large institutional or more likely hedge fund orders would be priced very tightly, because it was in the market maker's interest to know the direction of the flow. By "winning" the trade he/she would have an information advantage on the subsequent likely move in the market (a good assumption here is that flow directions are auto-correlated, with a higher autocorrelation to important customers, which is why this makes economic sense). Armed with this information, said market maker would then pre-position against some of the slower "less in the know" flows who are inevitably triggered by price action, with such price action of course influenced by the market maker himself who can "dribble" out the big position at his leisure. He is "armed" with a position that he can move the market with. Such pre-positioning was profitable as smaller investors reacted to price action and sold. It was basically a game of "I pay for your directional information through tight bid offer for the privileged few". HFT says the following. If you start selling, then I will move the price downwards in accordance to my best guess as to the size of your flow. If I see serial sell orders, I will move the price subsequently lower on the evidence. I am pricing your liquidity correctly. Thus, if you are a huge hedge fund shorting the market, you face higher transaction costs because the liquidity you are demanding of the market is high, and the market maker can no longer offset your liquidity cost against ripping off smaller investors who will be stopped. This latter is the key point. In fact, for smaller investors, HFT means bid offers are much tighter. If you put a small order through the market you are instaneously filled almost at mid, thanks to HFT, whereas in the old days, retail would pay the same bid/offer for his tiny flow as huge hedge fund. The converse is true for buy orders, obviously. Have you wondered why HFT is most hated by large institutional funds? It's because suddenly they have to pay a fair price for their huge liquidity requirements. HFT has short-circuited the old game where large influential funds obtained tight bid offer at the expense of smaller players, and were thus able to dominate markets by trading size at unrealistically tight prices. Now we all pay for our liquidity at a fair price. It's actually really democratic (keeping in mind that competition is mega-fierce). Ultimately, those who accuse HFT of front running are 100% correct. But there is always "statistical" front running (autocorrelation remember), HFT or Human. The difference now with HFT is that the cost of this front running is proportional to the size of your flow, and thus for smaller/retail investors it is neglibeable (because pricing is now much tigher than under the old "human" regime), and therefore positive, but for the spoiled insitutional investors / hedge funds, used to being privileged, it is back to a level playing field. Need to sell a yard? Need to pay for that buddy. Not good for them. (obviously I am schematizing to a certain degree. Even humans price large orders wider. It's just they didn't price those large orders anything like wide enough. They sponsored the big client for the info advantage thus earned, info advantage wielded against the rest of the market: read smaller, and/or less in the know, investors).
tptacek 11y ago
In order front-run someone, you must have a fiduciary duty to them. HFTs do not. When you think about this broader proposed definition of front-running, where any anticipatory trading is "front-running", you quickly realize that virtually any informed trade could be described that way. Do extensive research on the supply chain of a billion dollar industry, notice a spike somewhere, and trade on that? You're front-running!

by avz 11y ago

res0nat0r 11y ago

Front running is already illegal, so if any group is doing that they are already breaking the rules of the game, and should be punished/stopped if found out.

JesperRavn 11y ago
What some HFT traders are doing is economically equivalent to front-running, but is not legally front running since they are not front running the orders of their own clients. All of this is explained in the article, so if you disagree, it would make more sense to read it, find the parts you disagree with, and argue against them, rather than skim the article and then argue with our collective rehashing of the article's argument.
- deleted 11y ago
  [deleted]
- mrchicity 11y ago
  That's a huge difference though. A broker owes a duty to his client not to screw him over. He's supposed to be helping the client. A prop trader has no duty to others in the market. He's their adversary. They're both competing to buy underpriced shares and sell overpriced ones.
  - JesperRavn 11y ago
    For the purposes of this discussion, it's not a difference at all. The question is not what should be legal or not, but what customers would prefer, and what makes a better market. If you ask a customer "would you like an exchange that gives people enough information to front run your order" or "would you like a broker who front runs your order" the answer in both cases would be a resounding no. The claim in the article is that you can create a better exchange by providing an equal footing for all participants.
    - mrchicity 11y ago
      Everybody wants to trade with no price impact. If you asked me if anyone else should be allowed to colocate their servers, I'd say no, just give me a monopoly please. One participant's desires don't make a good market. Fair and non-discriminatory access to exchanges (not free, but anybody can pay to compete if they wish), fast trading engines and deep order book information are what let traders put up such tight spreads for customers in the first place. Vigorous competition between all market participants keeps prices fair.
      - JesperRavn 11y ago
        EDIT: I think you are right, although I would express things a bit differently. I'm writing a top level post with my thoughts. ORIGINAL POST: When you make a trade, there are some information rents associated with that trade. If someone knew you were about to trade, they could capture all of those rents. When there is a monopoly on exploiting these information rents (as in frontrunning), they will be captured by the frontrunner. When there is perfect competition (as when a number of HFTs can trade in another exchange before your trade reaches it), these rents will be all wasted on technology to maximize speed, i.e. no one gets them, they become deadweight loss. I understand that there are other issues, such as knowing whether a trade comes from a single seller or multiple smaller sellers. But this is a separate issue from simply trading ahead of other people. I don't understand why it's so controversial that an exchange would advertise the fact that traders can rely on their orders reaching the exchange before anyone else knows about it as a good thing.
- kasey_junk 11y ago
  The problem is that front running requires 2 things: - the ability to see orders ahead of someone, which this article implies you can, but you can't. - the fiduciary duty not to use someone's intent to trade against them. HFT traders do not fall into either camp. They can't see your order before it goes to an exchange and they don't have a duty not to change their prices on one exchange in reaction to price moves on other exchanges.
  - JesperRavn 11y ago
    The article claims that by colocating in one exchange, HFT can see you order arrive at exchange A, and send orders to exchange B before your order reaches exchange B. I don't know if this is true, but this is the most important part of the article. Given the fixed latency they introduce, you can send your trades to IEX before sending to any other exchange, safe in the knowledge that no other exchange will react to that information before your order. No one is talking about the fiduciary duty. Fiduciary duty is just a way to define a default contract into law. E.g. brokers could write a contract saying that they promise not to front run. But since this is something that almost every client would want, it's just written into law instead.
    - kasey_junk 11y ago
      There is a major caveat to what they are reporting that gets to the heart of this. HFT can't see your order as it arrives on exchange A before it arrives on exchange B, they can see the results of an order. That is, they can see a large trade happened on price X on A. With that information they may want to change their prices on exchange B and they may be able to do that before you can also place an order on B. There are lots of ways to mitigate this other than using a dark pool like IEX. All the exchanges offer exotic order types to make this easier for instance, and large block traders have for years had execution algorithms that spread their orders around venues and over time to minimize price impact. That IEX offers another option for large block traders does not bother me at all, that they market it via underhanded moralizing i find distasteful. Finally, in this context front-running has a specific meaning and it requires a fiduciary duty for it to be front running. By using that term incorrectly you ARE bringing fiduciary duty into the conversation, whether you want to or not.

tedks 11y ago

>The exchanges are only required to make order information public with a significant delay. However, they sell the real-time order information to a few market players enabling them to engage in the dubious tactics at the expense of other players. It's easy to see why you view this as unfair. But it is fair. Anyone can buy the real-time information if they have the capital. Obviously markets are going to be more friendly towards you the more money you throw at them. Just like everything else in capitalism, the fairness comes from anyone being able to have money. If you think this is unfair, you're essentially opposing capitalism.

MereInterest 11y ago
I'm having a hard time figuring out whether you are being facetious or not. What you are describing is nepotism and bribery, not capitalism.

vegabook 11y ago

The idea that HFT is front running any more than a human market maker is a fallacy. What HFT does, is to properly price the liquidity in the market. Previously, large institutional or more likely hedge fund orders would be priced very tightly, because it was in the market maker's interest to know the direction of the flow. By "winning" the trade he/she would have an information advantage on the subsequent likely move in the market (a good assumption here is that flow directions are auto-correlated, with a higher autocorrelation to important customers, which is why this makes economic sense). Armed with this information, said market maker would then pre-position against some of the slower "less in the know" flows who are inevitably triggered by price action, with such price action of course influenced by the market maker himself who can "dribble" out the big position at his leisure. He is "armed" with a position that he can move the market with. Such pre-positioning was profitable as smaller investors reacted to price action and sold. It was basically a game of "I pay for your directional information through tight bid offer for the privileged few". HFT says the following. If you start selling, then I will move the price downwards in accordance to my best guess as to the size of your flow. If I see serial sell orders, I will move the price subsequently lower on the evidence. I am pricing your liquidity correctly. Thus, if you are a huge hedge fund shorting the market, you face higher transaction costs because the liquidity you are demanding of the market is high, and the market maker can no longer offset your liquidity cost against ripping off smaller investors who will be stopped. This latter is the key point. In fact, for smaller investors, HFT means bid offers are much tighter. If you put a small order through the market you are instaneously filled almost at mid, thanks to HFT, whereas in the old days, retail would pay the same bid/offer for his tiny flow as huge hedge fund. The converse is true for buy orders, obviously. Have you wondered why HFT is most hated by large institutional funds? It's because suddenly they have to pay a fair price for their huge liquidity requirements. HFT has short-circuited the old game where large influential funds obtained tight bid offer at the expense of smaller players, and were thus able to dominate markets by trading size at unrealistically tight prices. Now we all pay for our liquidity at a fair price. It's actually really democratic (keeping in mind that competition is mega-fierce). Ultimately, those who accuse HFT of front running are 100% correct. But there is always "statistical" front running (autocorrelation remember), HFT or Human. The difference now with HFT is that the cost of this front running is proportional to the size of your flow, and thus for smaller/retail investors it is neglibeable (because pricing is now much tigher than under the old "human" regime), and therefore positive, but for the spoiled insitutional investors / hedge funds, used to being privileged, it is back to a level playing field. Need to sell a yard? Need to pay for that buddy. Not good for them. (obviously I am schematizing to a certain degree. Even humans price large orders wider. It's just they didn't price those large orders anything like wide enough. They sponsored the big client for the info advantage thus earned, info advantage wielded against the rest of the market: read smaller, and/or less in the know, investors).

tptacek 11y ago

In order front-run someone, you must have a fiduciary duty to them. HFTs do not. When you think about this broader proposed definition of front-running, where any anticipatory trading is "front-running", you quickly realize that virtually any informed trade could be described that way. Do extensive research on the supply chain of a billion dollar industry, notice a spike somewhere, and trade on that? You're front-running!