'Flash Boys' Exchange Isn't About the Little Guy
bloombergview.com
bloombergview.com
However, the IEX opponents decided to pretend that this minuscule fraction of trades was important, and Matt Levine was either careless in believing this; or he purposefully wrote a dishonest and misleading article.
I won't state which it is, but he's a smart guy... it's hard to believe that he'd make such an egregious error by accident.
The current HFT-driven market penalizes haphazard execution of much larger orders.
Many of which are made on the behalf of the little guy (through pension or mutual funds).
https://www.sec.gov/comments/s7-02-10/s70210-122.pdf
Choice quotes:
As the number of trading venues increases, discrepancies in prices across those venues will naturally result. The price discrepancies across multiple markets create an opportunity for nimble traders to make a small arbitrage profit by scouring the markets for these discrepancies and eliminating them. As the number of trading venues expands, the number of such arbitrage opportunities increases. So, it is not surprising that we have seen a tremendous increase in trading volume over the past decade, and that the activity is increasingly dominated by "high frequency traders." While Vanguard does not engage in this type of trading, we recognize that such trading has a positive impact on the markets at large, including longer term investors. Such arbitrage trading enables investors to get a fair price across market centers. Vanguard believes that the market structure changes facilitated by the Commission's various regulatory initiatives and the "knitting" together of the marketplace by "high frequency trading," have led to a significant decline in transaction costs for long-term investors over the past ten years through increased liquidity and tighter bid-ask spreads.
and
Various groups have attempted to quantify the reduction in transaction costs over the last ten to fifteen years. The Commission will continue to receive this data throughout the comment period. While the data universally demonstrate a significant reduction in transaction costs over the last ten to fifteen years, the precise percentages vary (estimates have ranged from a reduction of 35% to more than 60%). Vanguard estimates are in this range, and we conservatively estimate that transaction costs have declined 50 bps, or 100 bps round trip. This reduction in transaction costs provides a substantial benefit to investors in the form of higher net returns.
http://www.bloombergview.com/articles/2016-02-24/oil-loans-a...
I found it odd given what we saw in the US exchanges was the opposite of that before fragmentation, but the argument is that the network effects of large exchanges reduces the overall costs.
From what I've seen, exchanges are basically functionally equivalent, since they provide a utility-like service. And, as Vanguard points out, more trading venues means higher market frictions and costs.
TBH I'm still trying to forming a strong opinion on the issue, as indicated by "probably" in my initial comment. And I think it's a topic worth discussing.
Why, what's wrong with distribution and competition? These are good things.
Interestingly IEX's application has attracted 388 comment letters, with 99% supportive and Citadel's one of the handful against: http://www.nanex.net/aqck2/4709.html
For contrast, the BATS application received 3 comments only.
BATS when it became an exchange was nothing but a vanilla competitor marketed as a Better Automated Trading System. It didn't have anything like a speed bump.
You could argue that these are direct competitors of IEX and therefore have a vested interest in preventing the new exchange - or you could argue they are best suited to see the holes in the application.
Keep in mind that previous exchange applications have went through without this level of discussion. You could argue that this is because the other exchanges are "scared" of IEX. Or... consider the possibility that IEX's application has some faults. For example, much of the focus has been on IEX's smart order router not following the same rules as all the other exchange participants. The argument is too nuanced to summarize here... but you should never decide an argument based on number of responses!
I for one would like to see traders compete something other than speed and hope to see the IEX up and approved as an exchange sooner rather than later.
> why exchanges that encourage HFT are costing all of us with retirement funds lots of extra dollars.
Why do you believe this, HFT lowers the spread making entering the market cheaper for those guys.
I do think that an exchange that places less of a premium on speed like the IEX is a reasonable way to let the market itself evaluate the benefits of HFT. If the exchanges with HFT do provide a better value in terms of liquidity or price then the IEX will suffer as it provides an inferior product. If IEX flourishes then it is providing some value to investors. Let investors vote with their dollars
The article doesn't make that case because Levine is semi-famous for repeatedly calling Flash Boys into question, particularly with regards to the book's claim that HFT allows "front-running".
Flash Boys doesn't make that case because it's an incoherent mish-mash of different arguments that don't add up to a definition of "virtual front running", let alone an argument that it's happening.
The biggest reason for that is that I believe that individual investors are dramatically better off in a world of cheap wholesale market makers than they could ever be being dumped in the shark tank of hedge funds that is IEX. I have no problem with institutional investors who want to take advantage of IEX if they think that is best, they are professionals and that is their job to figure that out (though I wouldn't want to be invested with an institutional investor who wanted to trade on IEX because I would be suspicious of their competence). What I find really scummy is the marketing ploys of IEX to try to frame this as in someway good for individual investors.
[edit] Obligatory, please if you've read Flash Boys read "Flash Boys: Not So Fast". No one who understands/has worked in electronic trading that I've met believes that Flash Boys is anything but misrepresentative and bad.
Except it didn't, it merely showed that the author has no understand of what HFT is. Flash boys is full of hyperbolic bullshit that may sell books but shows no real understanding of how the market works. He misuses the term front running (which is illegally using knowledge of your clients positions to trade ahead of them) and applies it to being a faster speculator, which is in no way front running. The guy quite simply doesn't know what he's talking about.
I'm not an insider or an expert, and I'm sure there are many nuanced arguments for and against individual use cases. I'm really just trying to point out that there it is not clear what the systemic risks are, or how algorithms will behave in a market that is drastically different than the what we've seen in the last 4 years. It is impossible to test a system like this as a whole. My personal lack of knowledge about the inside baseball does not change this fact. And dismissing the macro view because of nuanced micro arguments comes off as flippant, elitist, irresponsible, and incorrect in my opinion.
For example, one worry I have is that algorithms may crowd out non-silicon short sellers. As much as short sellers are demonized as "evil speculators" in times of market stress, sometimes in a down market they are in fact the only buyers available and actually slow down declines when they cover. I don't have solid evidence that short sellers are crowded out by HFT... but I am trying to provide an example of a scenario where the "macro" effects could transcend the nuanced "micro" arguments about cost, efficiency, liquidity, etc. There are numerous other plausible scenarios that fit this bill as well, and it is the uncertainty around them that I am trying to point out.
Of course, none of these things have to do with IEX or a time delay... maybe things like order stuffing or spoofing are related but even those things are not what I'm talking about. Especially considering the dialog that has taken place since Flash Boys was released, I feel that both industry and regulators risk getting caught up in a cost/benefit analysis of the small issues while ignoring potential systemic problems.
As an investor I don't really have a huge dog in this fight... I'm not expecting any pension, and I don't own any managed funds. I generally use fundamental analysis to do long term investing in broad sectors using ETFs and a smattering of individual stocks. I manage my own money and so I will have no one to blame but myself if things go wrong. And frankly, if I lose $0.0002 on a trade by being frontrun in a dark pool it doesn't change my life, so for me to argue for or against IEX is somewhat irrelevant. However as a taxpayer I am concerned that public pension systems could very quickly find themselves vastly underfunded in a short period of time, and as a human being I worry about people who have worked their whole lives and just want to retire in peace.
I think that my concerns are not entirely disconnected from what the general public feels/understands about "modern markets", so while in most cases I probably have no basis to refute your specific arguments, I suppose I take exception to people with "macro" views such as mine being dismissed as unsophisticated proles. Even if that is not what you were trying to do... Matt Levine definitely comes off like that in his article.
If you send an order to an exchange (say NYSE) and they don't have the Best Bid then they will route your order to the other exchanges (NASDAQ/BATS/etc). Is this what you are getting at?
His best example is ES and SPY, two different ways to trade the S&P500.
There's a straightforward high-frequency arbitrage strategy to deploy against that problem: if ES or SPY is "mispriced", trade in offsetting amounts, in the expectation that the correlation will be restored (as it must eventually be). In Budish's view, this trading is a needless cost that doesn't improve price discovery.
I'll just say, that's not IEX's argument against HFT.