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Comment by kasey_junk | Hacker News Reader

> when the activity consumes a bunch of resources on zero sum activity

The thing to remember about the markets is that each individual trade is always zero sum, but the value of the markets comes from the aggregate total.

The behaviors that we want in our markets, price discovery, liquidity, easy risk management are all outcomes that are enabled by speculative market participants like market makers engaging in lots of zero sum activity.

So instead of decrying the zero sum activity what we want to do is drive down the price of it to the non zero sum participants. And HFT market making has been prodigiously good at that.

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Trading is not a zero sum activity, trades happen because each side want what the other person has more than what they have which is a net positive. aka I want lunch more than money.

HFT trading is zero sum because the traders don't actually want or keep stock.

Grocery store owners don't want vegetables either. They just want to hold them a little while before they sell them to you.

Are they zero sum?

Grocery stores trade low cost bulk purchases for lot's of little transactions. However, stock markets already preform this function.

Yes, and in order the markets to perform this function they needs lots of active participants with differing investing time horizons. Without market makers markets tend to be very inefficient at their job.

No, stock markets do not perform the same function as grocery stores. Grocery stores take on inventory risk by purchasing (in bulk) the goods that they think they can sell. If their inventory goes unsold or spoils, they lose. Stock markets provide a _venue_ for trading, but it is the market maker which takes on the inventory risk. An appropriate analogy would be that the grocery store is renting from a separate property owner. The property owner collects rent from the grocery store, just as stock markets collect "rent" (trading fees, colocation fees, system access fees) from market makers. In both cases, the inventory risk is managed by the middleman (grocery store, market maker).

Markets function without a 'market maker'. ex: Berkshire Hathaway Class A.

That's a pretty weird example, because that is the _only_ stock that trades at $200,000/share. Such a high price forces away liquidity intentionally, because the capital requirements of even 1 share are larger than most futures contracts. For most individuals it is more like buying a house than a stock! As a result, there is a NYSE employee (I forget the title, maybe DMM?) on the floor which _manually_ matches buyers against sellers. Other exchanges I believe still match electronically.

Aside from that, how does your statement relate to inventory risk? Market makers and grocery stores take on inventory risk. An absence of market makers in BRK.A* would only show that nobody wants to take on that risk. It does not change the role of the exchange. Exchanges facilitate matches, they are not a counterparty.

* which is not actually true, see http://batstrading.com/bzx/book/BRK.A/ during market hours and you'll find active quotes at a 2% spread.

Haha! :) Clever point but grocery stores provide utility. HFT is more like if you set out to go buy a whole lot of peppers (because you have a pepper index fund :) and some guy saw you doing this at the first store... knew that was your plan, called all around town placing orders to buy all the other peppers in town and offered to sell them to you for a premium, but cancelled those orders if you declined.

It's flawed analogies either way, but a better analogy would be you are a store owner with many branches. The worlds largest pepper buyer walks into your store and buys your entire supply. You call your other branches and tell them to change the price on your own inventory because you are assuming that the worlds largest pepper buyer doesnt need just one stores worth of peppers.

Agree that all the analogies are flawed, although funny. Just as the market made this I'm sure the market will find a solution if it really is a problem.

You're confusing the order of operations for this pepper middle man. He can't place an order for peppers contingent on me buying them. He has to buy them or not. Ignoring this key difference fundamentally misrepresents the risk he is taking and the utility (price discovery) he is providing to the market.

No one wants actual stock. They want to gain money on price differences in stock, or get the dividends that owning stock gives rights to, or I suppose they want to be able to have the voting rights stocks grant.

The difference is all about timing. I may want something else more than you do but am willing to sell now. If at the time you close out your trade (that is sell the shares from me) the price may have risen or fallen. If it rose you won and I lost by not holding longer.

This time mitigation is precisely what market makers have always done and what HFT market makers have driven the profits (and thus the costs to outside participants) out of.

Buying stock is trading future money than money today which is a real and meaningful trade. On the other side, I might want a new car, which means I want money, which means I want to sell stock.

Even stock to stock transitions can be meaningful as Bill Gates had a lot of MS stock and wanted a hedge so he sold stock. What he got was probably worth 'less' the diversification was valuable to him making the transaction a net positive.

What you are talking about are precisely the aggregate benefits to the markets I mentioned, liquidity and easy risk management.

That the markets provide those behaviors is what makes them valuable but the actual trades that make up those aggregates, your selling of shares when you need a car to someone else is zero sum. Either you would make more by holding or you wouldn't.

That something other than that is more important to you indicates that you are in the market for a middle man to bridge that time gap and buy some of the risk from you. Your time horizon is from share purchase to "need money for car", not from share purchase to "optimal selling point". The service you take advantage of when you bridge that gap is provided by the aggregate work of many zero sum interactions between speculative participants like market makers and "investors" like your self.

Continuing from the perspective of buying a car:

If I put a sell order on the market at 12:00 the only impact is the sales price. If it executes at 1PM or 2PM it makes zero difference to me as I can only access money at the end of the day. So, I only gain liquidity if I would have been otherwise unable to sell by the end of the day. Therefore, I don't gain liquidity from HFT.

If you don't want liquidity don't buy it. No one is forcing you.

https://www.chrisstucchio.com/blog/2014/how_to_not_get_rippe...

> get the dividends that owning stock gives rights to, or I suppose they want to be able to have the voting rights stocks grant.

IE: People want actual stock. The stock has innate value due to the potential for dividends or to influence the future of a company.

That is a significant amount of value.

But people don't care about value per se, they care about the extra value they get (over the price they're paying). Therefore, stock is only valuable inasmuch as what you pay for it is less than the present value of future dividends. Otherwise you're overpaying for it, and you might just as well keep the money.

> The thing to remember about the markets is that each individual trade is always zero sum

That's simply not true; your premise is flawed.

I used zero sum here incorrectly but didn't want to change the comment. It would have been more correct to say that any trade regardless of hold time is any more or less zero sum than any other trade.

>The behaviors that we want in our markets, price discovery, liquidity, easy risk management

None of which we get from HFT.

HFT cannibalizes the research done by value investors (oh, but it's not legally front running if they're not your customer!), rendering that a market for lemons, so there goes price discovery.

HFT floods the market with more liquidity than it needs during normal periods (there is no benefit to you being able to trade at split second intervals. nada. none) and then extracts it all during periods of market distress when liquidity would acually be useful.

And risk management? Please. They're only managing their own risks.

> None of which we get from HFT.

No but we do get it from market makers. HFT has led to a dramatic decrease in the price of market making. Unless your claim is that market making is not something that should be allowed?

> And risk management? Please. They're only managing their own risks.

My point about risk management was about the aggregate benefits of the markets, not about HFT providing someone risk management. If you have some risk that you want to sell, there will be a buyer for it because of the aggregate sum total of all the zero sum transactions available in the markets.

>No but we do get it from market makers. HFT has led to a dramatic decrease in the price of market making. Unless your claim is that market making is not something that should be allowed?

No, my claim is that market making was made significantly cheaper by electronic trading in the 90s-00s but HFT had very little effect on that.

HFTs do a lot of market making, make almost no profit from it and mainly use it as cover for their more nefarious activities.

>My point about risk management was about the aggregate benefits of the markets, not about HFT providing someone risk management

Great. So even you agree that if we banned HFT we'd be no worse off.

You are ignoring the context of the article in order to push an ideological point.

Levine is explaining how you can get a 95+% cancellation rate simply by running the most brain-dead simple possible market maker strategy: because you're required to post orders at multiple exchanges, and because every price change involves order cancellations (potentially lots of order cancellations, even on a single exchange, because of pairs trading and price ladders), and because adjusting prices on exchanges in near-real-time is the basic job of a market maker, virtually anyone running an electronic market maker is going to have a huge cancellation rate.

Levine brings this up to illustrate the silliness of proposals to regulate HFT by targeting entities with huge cancellation rates.

Comes now 'cdroconnor. You're playing a semantic game. You're defining "HFT" as "bad HFT", and everything else as simple "electronic trading". FINE. Nobody disagrees with you, except on the very boring point of what labels to attach to things.

But your argument here doesn't make any sense for the thread, because the good simple electronic trading you're condoning is also targeted by the cancellation regulation Clinton proposed. Which is the whole point of the article.

>You are ignoring the context of the article

The discussion went off course way before I dived in.

>Comes now 'cdroconnor. You're playing a semantic game. You're defining "HFT" as "bad HFT", and everything else as simple "electronic trading". FINE. Nobody disagrees with you, except on the very boring point of what labels to attach to things.

There is a very substantial non-semantic difference between robot-executed sub-millisecond trades (HFT) and trades which are are just executed electronically.

In every discussion about HFT the probability of someone falsely attributing the decreased transaction costs of "not shouting in a pit" to algorithms that execute sub-millisecond transactions approaches 1.

>But your argument here doesn't make any sense for the thread, because the good simple electronic trading you're condoning is also targeted by the cancellation regulation Clinton proposed

I'm no particular fan of that either. I'd prefer Italian style micro-transaction tax. That wipes out nearly all of the sub-millisecond trading and leaves the rest intact, including market making.

You've made it very clear how important it is to you that we call benign electronic trading --- and, I infer, electronic market making --- something other than "HFT".

What you haven't made clear is why you believe you're actually arguing with anyone here. I am 100% certain, because I've had the conversation with him multiple times, that 'kasey_junk agrees with you that there is such a thing as malignant electronic trading.

Exactly what is the controversy here? The people who are talking about HFT reducing spreads are talking about benign electronic trading, and none of them appear to be denying that there are other kinds of electronic trading.

>What you haven't made clear is why you believe you're actually arguing with anyone here. I am 100% certain, because I've had the conversation with him multiple times, that 'kasey_junk agrees with you that there is such a thing as malignant electronic trading.

I was arguing that sub-second algorithmic trading cannot be credited with substantially reducing spreads in the early 00s.

kasey_junk linked to an article that claimed that.

It's a defense of HFT that's rolled out so often that it's practically become a cliche.

> HFT has led to a dramatic decrease in the price of market making.

How? It seems like this should not be that hard to explain.

Link in the posted article:

http://www.bloombergview.com/articles/2014-03-31/michael-lew....

Quote from the posted article:

" it should be said that market makers have existed in the stock market for a long time and that electronic market makers do the job waaaaaaaaaay cheaper than their human predecessors."

Electronic market makers are a much larger category than HFT.

Microsoft Word is phenomenally heaper than hiring a typewriterist, because it is electronic.

Neither electronic market maker or HFT is a technically defined term, nor is it clear what people mean when they use those terms.

That said, when I was in the industry the common usage of the terms would be that electronic market makers were a subset of HFT.

That is there are HFT strategies that are not market makers, but there are no electronic market makers who are not HFT.

> How? It seems like this should not be that hard to explain.

Decreased spreads; trading is much cheaper now than it was before HFT.

> Decreased spreads; trading is much cheaper now than it was before HFT.

By how much? And is HFT the cause or is it merely correlated?

By a factor of 25, and it's only not more because there's a law against making them any smaller. And it's very much because of computerization; whether you consider it to be HFT is a question of whether you count the early days when computerized firms competed on price or the later ones when the aforementioned law meant they could only compete on latency.

In any case, compete they have, pushing their profits pretty close to zero. Look at the graphs in http://www.zerohedge.com/news/2013-02-13/how-getco-went-hft-... (article is terrible, it was just the easiest place to find the graphs).

It's directly causal, algo's fighting for better position directly decrease the spread. Competition has the effect of removing unnecessary markup as the next guy who sells just a bit cheaper or offers just a bit more wins until the price is as close as possible to barely profitable. Humans are too slow to play such a tight game, computers aren't.

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