- Is HFT a healthy or unhealthy part of the economy? Meaning does it help flatten out the highs/lows, or does it emphasise them?
- Aside from a micro-tax on trading (e.g. 1c/trade) is there any other mitigations/solutions to HFT?
But volatility isn't the only axis on which to measure the health of the markets. The advent of electronic automated market making is also tied to drastic reduction of spreads, which are a tax that anyone trading has to pay to the market for the privilege of buying at the market.
A lot of people talk about spreads as if they were a meaningless abstraction, in sort of the same way as they talk about "liquidity". But in the 1990s, crooked human market makers (read: all market makers) rigged spreads to skim extra money off trades; look up the "odd eighths scandal". That doesn't happen anymore, and, more importantly, spreads (and their attendant cost to trading) are razor thin.
That's not the only thing automated electronic trading does to improve the markets. For instance, in the 80s and 90s, simply placing an order with a broker was extremely expensive. Today, there are no-fee brokers. Why? Because automated trading systems purchase the rights to internalize orders from retail brokers; if you're an automated market maker, retail order flow is practically risk free revenue, and all you have to do to earn it is hook your trading system up to brokers.
"Most HFTs run a market making strategy. What this means is they play both sides of the table - they take no position on whether a stock will go up or down. Instead, they try to offer securities both to buy and sell. If you want to buy, they will sell to you at $20.10. If you want to sell, they'll buy from you at $20. As long as their buys and sells match don't get too out of whack, the HFT will collect $0.10 = $20.10 - 20.00."
That does provide more immediate trades for both the buyer and seller, which the pro-HFT camp calls liquidity. Unfortunately it's usually not needed - both the buyer and seller were already in the market and willing to trade, and now they both just had an additional $0.10/share sucked out of their trade by some HFT.
The problem is, how much immediacy do traders actually want? HFT provides immediacy in microseconds; its needed for continuous-time auctions because buyers sellers usually aren't in the market at the exact same microsecond interval (while the HFT is there at every interval).
Frequent Batch Auctions[1], where orders are matched in batches with single-price clearing (call auction style) - just like the opening and closing sessions of NYSE, but much more frequently with shorter periods of say 30 seconds, 1 second, or even 100ms per batch. Their models show that frequent batch auctions will reduce spreads even further (because it eliminates mechanical/latency arbitrage rents). In theory, retail traders should get even better prices (because the spreads will be smaller) if they are willing to give up microsecond immediacy for 1 second order matching.
http://faculty.chicagobooth.edu/eric.budish/research/HFT-Fre...
I don't particularly have an opinion about the Budish paper, other than it has some serious impacts to globally traded products and it is way more disruptive than people seem to suggest.
I do worry that fundamentally altering the way the markets work, because some participants don't understand order types is particularly troublesome.
The complicated types (hide-n-slide, NBBO pegs, and conditional pegs[1]) may help some players at the expense of others. The only players who wouldn't benefit from batch auctions (according to Budish et. al.) are latency arbitrageurs.
1. https://mechanicalmarkets.wordpress.com/2015/10/05/iex-peg-o...
Thats not quite true. Price improvement happens all the time on limit orders, but I'll concede you'll pay close to it if it fills.
> The complicated types (hide-n-slide, NBBO pegs, and conditional pegs[1]) may help some players at the expense of others.
This is true of limit/market/stops as well.
The Budish paper is very interesting.
What we don't know is what it would do to the spread, which is very important especially given that it will be harder to predict the clearing price. It is also a major change to the markets, virtually impossible to implement and its not clear to me what that risk is buying us, especially given that I fully expect most participants to go through an intermediate first.
A) a counter-party never showed up B) a counter-party only showed up when the stock dropped so you end up buying on the way down.
Taking this risk is a perfectly fine thing to do and many people do this. Others would prefer to pay the market maker a small fee for providing liquidity. That fee is not being sucked out by some HFT. It's a fee for providing a service.
And BTW, thanks to automation and sophisticated trading algorithms that service is provided at EXTREMELY low cost these days. Bid/ask spreads are tiny.
This is a great example of how the modern economy fails to link wealth created with wealth extracted.
I'd rather we found a way to get everyone to work on drug discovery and civic engagement, but unfortunately, we don't generally put regulatory brakes on technologies simply because they attract developers that would otherwise be working on our pet issues.
When firms make lots of money from trading platforms and then pay staff who go and consume real resources that is ultimately coming by transferring from wealth producers.
EDIT: cannot reply due to HN rulz, hence inline...
The exchanges compete. The more asymmetric you make the platform for HFT vs the rest the more business you get.
Where would you trade? Somewhere you can win or not? Do I want a piece of that? I might let you know the incantations required if you pay me for the "service".
In theory other liquidity might move away but many ECNs have a very dominant position. For example NYSE.
You understand that exchanges compete with each other, right? The markets are now decentralized; there are like 15 different lit exchanges on which you can trade stocks.
But it's often not "real" liquidity. Let's say there's 100 shares available at $100.00, 200 at $100.50, etc. Such that there's a total of 5k shares on the book at this time at any price. But we want to buy 10k shares.
The average fill price assuming no intervention and only marketable orders would be (100$100 + 200$100.50 + ...)/5000.
An intervening HFT firm will only be adding useful liquidity if the average fill price drops somehow. Shittier algos will lose some money by lowering the average fill price so they match your order and get the liquidity rebate from the exchange. This adds true liquidity. But intelligent market makers generally will just add identical liquidity to what's already available but at 1 or 2 cents higher (and a few slots higher on the order book). As a result, you just end up paying more for the same quantity of shares. That's not true liquidity because it's really only triggered by your order, doesn't move the price significantly, and is limited to exactly the size of your order.
Why wouldn't the sudden appearance of a big buyer that wanted more liquidity at near levels than is available indicate the price should go up? That's supply and demand. Am I missing something about your argument?
It's worth noting that after the Canadian regulatory authorities added a per-message fee, bid-ask spreads rose, liquidity dropped, and it was retail traders who suffered the most. http://marginalrevolution.com/marginalrevolution/2014/04/a-s...