One Way to Unrig Stock Trading
nytimes.com
nytimes.com
"It's important to realize that slowing everyone down by 350 microseconds can't possibly help anyone. As Hudson River Trading said in its comment letter: "Similar to a 100-meter sprint, if you simply add 350 microseconds to each participant’s time, neither the order in which they finish nor their time differentials will change.""
It would indeed be pointless if everything was slowed down by 350μs, which is why that is not the case. IEX lets its own "pegged orders" and "routable orders" cut the line, picking off liquidity at the other exchanges. If IEX is approved, there will be an arms race, with other exchanges inserting their own similar delays. Even worse, because of Reg NMS you can't legally avoid trading on IEX even if you wanted to. If the price of a stock is falling rapidly and you wanted to sell, IEX will always have the best price since it is stale by 350μs. Everyone will be forced to send their orders to IEX, even if everyone knows that the bid there is illusory.
The Matt Levine piece is very good. Do please read the whole thing.
[1] http://www.bloombergview.com/articles/2015-12-22/the-flash-b...
Placing a lower limit on latency allows a better balance between algorithmic complexity and latency. The strategy space will be larger and hopefully will be large enough that there's room for most everyone to try different strategies, making the market calmer.
To get a sense for the mechanism of this phenomenon, check out the El Farol Bar Problem (https://en.wikipedia.org/wiki/El_Farol_Bar_problem).
Unfortunately, IEX's proposed implementation of a delay is probably not as good as simply changing the precision of the exchange's clocks. If the exchange decided it would measure time only to the nearest second and orders occurring at the same second would be processed in random order, I expect that would be a better solution. Adding some randomness to the processing order at the 100s of milliseconds scale would go a long way to reducing front-running and overly simplistic momentum strategies. The latter are the main cause of market turbulence.
Or in terms of project planning, if you have 2 day sprints, you can course correct every 2 days and rapidly approach a usable product. If you have 3 month sprints, you might spend 2.9 months building something totally wrong. 2.9 months of moving the wrong way will get you a LOT further off course than a badly planned 2 day sprint.
Think of the market as a liquid near boiling point. If the energy of the system increases too much, it makes a phase transition. To raise the boiling point, add impurities. This is a flawed metaphor in many ways, but it might offer a new intuition for you. Unfortunately, in the case of the market (and many systems) efficiency is the enemy of stability.
If you prefer a project-planning metaphor: BigCo executives have caught Agile fever. They see that 2-month sprints are more effective than 2-year project plans and they've heard their competitors are finding great benefit from 2-week sprints. BigCo decides to leapfrog the competition and goes straight to 2-minute sprints. They've tested their engineers and found that 2-minutes seems to be a lower bound on writing a chunk of useful code. The executives declare that all engineers must report accomplishments and re-plan their next activities every 2 minutes in accordance with proper Agile workflow.
Obviously, extreme speed is disastrous. I'm not saying to slow down the market to making an order once monthly. Just slow down from nanoseconds.
If in doubt, build a small simulation. Simple agent-based models can produce very interesting phenomena.
Fast adjustments are not "energy" in any sense, and smaller but more rapid adjustments are in fact considered to be properties of an "orderly market" (to borrow SEC terminology). Your 2 minute sprint example has a problem with transaction costs, not rapid iteration.
Rather than analogies, can you just state directly how adding latency will stabilize things?
I tried to state the mechanism directly, but apparently didn't do so very well. I could try again, but I think it'd be more effective to appeal to authority. Check out "The Race to Zero" by Andrew Haldane at the Bank of England (http://www.bankofengland.co.uk/archive/Documents/historicpub...). It appears that the presence of too many low latency / high frequency players puts the market in a state where it can phase shift, crossing from normal "stable" dynamics to a dramatic spiking dynamic. In normal times, "HFT" increases liquidity and reduces spreads. Every so often those HFT players leave the market suddenly, nearly simultaneously, causing a liquidity crisis.
Note that many exchanges enforce a short pause in trading when the market seems to be going crazy. The delay appears to help, so long as traders don't move to a different exchange.
The issue of market makers pulling out during a crisis is a regulatory issue; an market maker might do the right thing and push the market back towards where it should be and then be punished by a regulator who breaks the buy trade. If this behavior is undesirable then eliminate the "clearly erroneous trade" rules.
Your citation also doesn't address any specific mechanism by which a delay would improve things. All it does is speculate that speed might be bad due to fat tails and handwaving.
You also haven't addressed the point that many exchanges currently implement delays in times of crisis.
The El Farol Bar Problem is great reading; thanks for that link.
But it's unclear to me how the random component would work that you all are talking about. Is my resting order subject to a random cancel delay as well? If it's not, then we still have a requirement for speed, as cancelling soon-to-be bad orders is arguably more important than placing soon-to-be good aggressive orders. And if it is subject to a delay, spreads are going to be MUCH wider, losing individual investors more money than they currently are to the current system.
Unfortunately, a loss of efficiency (increased spreads) is the price we will pay for less frequent crashes/spikes.
http://www.bloombergview.com/articles/2015-10-08/why-do-high...
Then it talks about selling order flow to HFTs as if this somehow harms the little guy. It doesn't - it lets HFTs offer liquidity (potentially at better prices, and never at worse prices) to the little guy that they would be too scared to offer to big guys.
https://www.chrisstucchio.com/blog/2014/fervent_defense_of_f...
Following all this FUD is a bit of shilling for IEX. Why is this nonsense here?
Do you think that's false? I trade the "markets" every day and I think they are almost completely broken. If HFTs supply liquidity, what do you think happened during the flash crashes of recent history?
Hint: they stopped supplying liquidity. That's why Virtu can make 2 years of trades with only one negative day - a feat that is almost impossible without the front-running advantage that they have.
The main reason HFTs pull out of markets during flash crashes and similar events is regulatory (broken trades). The only HFTs who can stay in the market during a flash crash are the ones who believe they can predict the retroactive actions of human regulators. Obviously this will only be a small subset of HFTs.
If you want to change this, eliminate the breaking of "clearly erroneous trades". (Japan doesn't have this rule and they do fine.)
You're clinging to the old definition. Pop culture has generalized the term to mean something different than it used to. It's like the word "hackers".
To throw out a bunch of cliches: that ship has sailed; you can't put the genie back in the bottle; no sense crying over spilled milk. Etc.
I urge you to progress quickly thru the five stages of grief and get to acceptance.
Of course, that's just the layman's meaning. I have absolutely no idea if the meaning of the words "front running" will ever change in a legal sense.
https://en.wikipedia.org/wiki/Front_running
If you disagree with my (technical definition) then I challenge you to provide a sound definition from which we can work. I would suggest that simply processing and executing orders quickly on the basis of public information is not sufficient.
I'm certainly not up to that task. But I think that lay people are using the term more generally than you are. The Wiki you cite has multiple, expanded, definitions in the section titled "other uses of the term". For example:
One common practice of high-frequency traders
(HFT) is a form of front running, where they
peer into various exchanges and try to detect
orders as they propagate from a broker's order
router.
The English language (or is it the American language?) is not static. Words change meaning all the time. E.g. take the word "gay". Once it meant happy, then it became a pejorative, and most recently it has been embraced by the LGBT community. That word sure has changed meanings over the years. Rather, it probably has retained all of those meanings. https://en.wikipedia.org/wiki/Gay
Edit: forgot to add this:
I would suggest that simply processing and executing orders quickly on the basis of public information is not sufficient.
Here's an example of using what should be non-public information. Various exchanges, who investors reasonably thought were working on behalf of investors, in the public interest, were instead working for HFTs (from whom they made the most money). Hence "flash" orders, where an exchange would take an order it received from the public and "flash" or show it to its HFT buddies.[1] I don't know if the SEC finally banned that.
How did receipt of my order at an exchange turn into "public" information ahead of its execution?
Naturally, but in a technical discussion about the technicalities of trading technology, we must agree on the meaning, whatever that happens to be.
Folks like E-Trade are the ones who could potentially front-run. Do you have any evidence that they are?
Do you understand the mechanics of paying for order flow? could you state explicitly (i.e., a sequence of trades) how you believe paying for order flow allows you to "front-run"?
Why do you not believe such results are possible? Do you think it's impossible for a firm to have statistically positive edge for sustained periods of time?
http://www.bloomberg.com/news/articles/2014-07-23/don-t-tell...
Of course, having an edge for a long time is possible, even essential. The entire argument here is about having a legitimate edge.
My examples are HFTs because those are the firms that make the largest number of bets per day, so they have the highest chance of having a day end up being positive (law of large numbers). That's why all the top HFT firms have ~100% positive days. Do you believe that no HFT firms have a legitimate positive edge? If so, do you have any proof that e.g. Jump/Tower/HRT have an "illegitimate" edge?
With that said, yeah, the NYT piece is terrible.
I'll not so briefly add:
- Stochastic delays have many externalities; people consuming liquidity will simply send many orders hoping to "win the dice roll" on your stochastic time noise system
- Stochastic delays plus limiting orders per day etc doesn't "easily" work because enforcement is tough when people trade on your exchange as multiple entities, multiple trading desks/groups etc (Huge pita for everyone involved)
- Stochastic delays plus pay per order doesn't consistently work well as value of orders is highly variant and there's no single magic # to make this economically optimal
- Fixed delays are pretty similar to the geo location of the exchange just moving. It effects the external RV situations but I don't feel does much internally except poison market data with more "not-really-there" stuff. (Because MD state is increasingly out of state with in-flight orders) Recognize that stale MD compounds issues as more people send orders at opportunities not really there and this is largely what leads to MD delay spikes etc and is generally destabilizing.
- Selling order flow is 100% bullshit. I wish all that crap was illegal -- this is where retail gets their faces most ripped off and how lots of chumps get to make hundreds of millions for no reason. Building models that tell you which customers in your captive flow to piggyback in which products is super disgusting to me. Anyone who trades with their flows exposed is surrendering alpha to parasites.
What's the argument here? Retail order flow is sold to HFT shops because it's assumed all around that retail flow is uninformed. HFT shops are incentivized to compete for those orders, because no matter who gets them, they're assumed to be lucrative to trade against. Things wouldn't be any better for retail investors if their orders made it all the way to "the exchange".
>Exchanges advance the interests of traders by sponsoring esoteric order types, which for hard-to-understand reasons receive the approval of the S.E.C. An example is the New York Stock Exchange Day Intermarket Sweep Add Liquidity Only Order. Regular investors have no idea such an order type exists or what it means.
Then they have no need to use it. Does anyone think we should cut out little used parts of programming languages, because "regular programmers" have little need for them? When did "it's complicated, therefore it's unethical" become a valid argument?
How does one change the rules to promote longer term investment and promote quality in trading algos over speed? How do we putting data centers where it's cost effective rather than across the street from the market?
Adding a random delay to orders which will execute it some time in the next few minutes is one alternative.
Having a mandated minimum transaction fee/tax is another. What if it's 1% (and a nonzero amount for cancelled orders)?
Changing the tax structure so that profits from instruments held for less than say a few hours or days are taxed at nearly 100% and then slopes down to a much lower floor for longer term investments (months or years).
Obviously any measure has to have wide international support, no market wants to scare the money across the border.
http://qed.econ.queensu.ca/pub/faculty/milne/322/IIROC_FeeCh...
Most of your other suggestions would probably have the same effect.
This is true for IEX -- the top volume participants there are all HFT firms.
Also, I don't see how IEX's claim of improving price discovery meshes with their 350us delay. Are they not locking the NBBO on basically every single price flip because they are delaying updating their quotes? In what world is this more fair?
>An example is the New York Stock Exchange Day Intermarket Sweep Add Liquidity Only Order.
This isn't even a thing -- what would an ALO ISO even mean?
>High-frequency traders pay to locate their computer servers inside of exchanges’ order execution centers, where they get early access to trade information that they use to jump in front of — front run — other clients.
Okay now he's just either misinformed or lying. Who wrote this article?
Wouldn't it be a good thing for them to compete with the other exchanges?
In reality their business model is to drive uninformed order flow to highly sophisticated hedge funds & to let those hedge funds deny the rest of us price discovery.
That said, I don't mind that they exist, I just wish they'd stop acting like they are doing it for the good of the "average" investor (whatever that is).
At the moment, the stock system massively rewards short-term speculation and companies only focus on quarter gains instead of long-term profitability/the company future. For example, reducing head count might improve this quarters' bottom line, but one year in the future the lack of heads will be problematic because the company is unable to keep innovating. But investors (and managers alike) don't care about the future because they already realized and pocketed the profit and move to the next company.