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Comment by x0054 | Hacker News Reader

Every time I read stories about high speed trading, I have to wonder what is actually the point of high speed trading to the society. The point of a free and fast stock market is to provide monetary liquidity and stabilize the economy by shortening the feedback loop. But something tells me that our society and economy derives zero benefit from nanosecond resolution trading vs. trading with say 1 minute resolution. Meanwhile, the market is exposed to wild swings which might be smoothed over or even prevented if markets worked a little slower.

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Faster trading allows market makers to operate with smaller capital investments. This lowers the barrier to entry in the market making business, creating more competition. More competition reduces the costs of trading. (And not just in theory. Market making used to be exclusively the domain of a few big players. It's not anymore.) Reduced cost of trading matters to almost everyone who's involved in the markets. Passive index funds, for example, have to trade to reinvest profits and to rebalance their composition. That's why Vanguard -- the most evangelical of the passive fund managers -- firmly defends HFT.

You may ask, well, why do we need market makers at all? Well, you don't have to use them. You have other options for trading. Call up your broker and ask. What you'll discover is that these other options have far larger transaction costs.

A lot of the complaints about HFT I've seen on Hacker News seem to think that no one should get paid for market making. I don't think that's possible. (And if it is, I'd love to know how.) Transaction costs are an inescapable part of trading; ultimately, you're faced with the choice between tilting your hand to other traders or paying some intermediary to take on risk for you. Generally, it costs less to choose the second option.

How does HFT help market making? Would a market that operates with a 1 second resolution be inherently unable to provide the same levels of liquidity that we enjoy today?

You argument is that Vanguard is a market maker, Vanguard likes HFT, thus HFT must be good. That doesn't really follow at all. Vanguard could be arguing in favor of HFT for all kinds of reasons, one of them could be that they have the money to rent server space right next to the main exchanges, and pay for the ludicrously low latency connections to the exchanges, so they benefit from HFT by being able to be quicker than others, and they don't want to loose there edge.

Ummm... No. That's not remotely what I said. Vanguard is not a market maker, and definitely not a HFT shop. Vanguard is the world's largest mutual fund company. If you're not clear on who the major market players are, you should probably stop worrying about the arcane details of which middlemen these players use to interact.

No. Vanguard is a large participant in the markets because it manages funds for long-term investors. Markets have bid and offer prices where you can instantaneously sell or buy shares, and these bids and offers are often provided by professional market-makers. Before automation, these were humans on an exchange floor. They could only trade a single stock at a time, hence the name "specialist", since they specialized in that issue. Volumes were also lower. To make enough to earn a living, that human on the exchange floor had to charge a big spread between buy and sell prices. For a long-term investor, this spread is an additional friction cost that drags on their returns when rebalancing portfolios.

Now a small team of researchers can make markets on many securities at once. They don't have to make as much money on each, so the spreads get smaller. Additionally, instead of a monopolistic specialist, these professional traders compete to win transactions by making better prices (higher bids and lower offers) than others. Many market makers try to keep a neutral "book" of positions, so if they sell some GS they may bid higher in other bank stocks to reduce their exposure to market risk. The faster a market maker can update his quotes or hedge when conditions change, the less spread he needs to charge.

http://meanderful.blogspot.com.au/2013/01/hfts-dirty-little-...

Vanguard is like the opposite of a market maker; they're a mutual fund manager. They're the people HFT is ostensibly supposed to be screwing.

See, again, per the article, Chesterton's Fence.

> But something tells me that our society and economy derives zero benefit from nanosecond resolution trading vs. trading with say 1 minute resolution.

Not only does nanosecond resolution provide zero benefit, models indicate that it actually harms liquidity. To be specific, serial order processing in continuous-time is more efficient in "time-space", but less efficient in "volume-space". The better mechanism is batch order processing in discrete-time (i.e. process all arriving orders simultaneously in batch every 100 milliseconds, rather than one-by-one every nanosecond): http://faculty.chicagobooth.edu/eric.budish/research/HFT-Fre...

What about derived liquidity? A lot of liquidity in ETFs, futures, foreign exchange, dual-listed stocks and interest rate products works this way. Traders will do things like buy futures and sell correlated ETFs to hedge, buy ETFs and sell the basket of stocks it holds, and so on, as a way of making markets.

Because the markets are fast, there is less risk that their hedging product will "run away" from them before they can execute. Since the risk is low, they can make a very competitive and tight market. If they had a 100ms delay to hedge, they would need to make a bigger spread to compensate for the risk.

I don't think high frequency trading increases the probability of dangerous swings. I don't know if they add any value, but I doubt they cause all the problems people blame on them. When they do start doing something stupid, then they will lose money and be punished and other traders will profit from them.

the premise is they might add value in some circumstances, but in the mean time they extract value 24/7

>When they do start doing something stupid, then they will lose money and be punished

hehe no, trades will be reversed, people that "maliciously took advantage of poor algo error" will be punished instead

I think wild market swings have been happening as long as markets have been around. I don't necessarily see the connection between HFT and those swings. Here's a thought: If you assume that swings are going to happen regardless of HFT, then is it possible that HFT actually helps find the real "fair value" level in the market faster than if those player's did not exist?

Another thought on HFT's value to society: I generally agree that HFT does not provide "direct" value. There are clearly "arbitrage" opportunities that HFT firms consistently profit from. However, by definition, those arb opportunities will either be taken by someone else, or enough people will run into grab them such that the arb goes to zero. If there are consistent arb opportunities then something needs to change - namely the regulation which structures the market and allows people to take consistent advantage of it. Thus new regulation is issued and the market, inherently a complex and intricate system, becomes stronger as a result. This is maybe where the value to society lies. and maybe this is an idealistic view of how regulation, society and HFT interact in this case.... ?

You can only eliminate cross-market arbitrage by forcing everyone to trade in one place. Exchange competition lowers costs for everyone so it's not clear that this would improve things. Even on a centralized exchange, near-arbitrage would still exist between very correlated products within it or between similar but not identical products in other places (index futures vs. ETFs, different grades of oil, US treasuries vs. European bomds).

Like you said, if enough people do the arbitrage, it converges to zero very quickly. There's little profit in it and everyone reaps the benefits of near-instantaneous accurate pricing.

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