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Hmm,

So it doesn't bother you that this "investment" doesn't have any relation to building productive enterprises of any sort?

One might might think that the nastiness of 2008 would wake people up to the idea that markets can generate destructive speculation as well as constructive investment. But fixed ideas mostly resist reality.

And contrasting the NYSE profiteering to high frequency profiteering is kind of false argument. It's more a matter that deregulation has been a disaster and the situation cries for a modern version of re-regulation - except that the inmates are still well in control of the asylum.

> So it doesn't bother you that this "investment" doesn't have any relation to building productive enterprises of any sort?

As the article points out, these firms provide liquidity which makes trading faster and cheaper. Theoretically, more liquidity should also make it easier to move capital to the most profitable enterprises.

Actually, the article suggests that the firms pulled out of the market, and that their actions amplified the crash. HFT is a zero sum game, and these firms just demonstrated that they exist to extract value from the market, not provide it liquidity.

[edit]:Though there are obvious differences, I feel like HFT in general is just another form of side betting, alarmingly similar, in principle to CDOs and other derivatives, in at least a few ways. They're exotic, and theirfore unregulated, they dwarf and therefore distort "real" market activity, and they appear to provide value, but the geniuses behind them underestimate the risk because they can never account for all the possible black swan events.

When "real" markets depend on these educated guesses, and the guesses turn out to be wrong, the real markets suffer. Sure we know how to create fancy new financial products to back up these guesses, and exploit the leverage provided by developments in math and computer science, but the fact remains that we still can't even identify, let alone account for what we don't know.

The good news is that because these particular bets are shorter term, in this case the immediate damage is reversible, though their were definitely consequences that were irreversible, and if we keep allowing our equity markets get pushed around by HFT, the next time the system hiccups, the irreversible consequences may spiral out of control.

But I don't have a very deep finance background. I'd love to hear thoughts from some people who do.

Actually, the article suggests that the firms pulled out of the market, and that their actions amplified the crash.

Without high frequency traders, the market became far less liquid. This was considered a bad thing by almost all involved. It's almost as if high frequency traders are actually providing a valuable service for the rest of the world!

Also, HFT is not very vulnerable to "black swan" events. HFT doesn't usually use leverage, there are very few counterparties, no leverage, and almost no contagion.

>Without high frequency traders, the market became far less liquid.

I totally agree.

>This was considered a bad thing by almost all involved.

What I'm trying to propose is that the regulators involved in overseeing markets are becoming more and more out of touch with the techniques being used to improve their efficiency. What's important for long term economic health does not align with what is important for short term market efficiency. And as a result of this, the long term economic policy cannot keep up with the increasing degree to which short term regulation can affect markets.

Yet long term economic health has an impact on other metrics of "utility" beyond itself, and we're in trouble if the power of the people in charge of making the rules can't address the needs of the people who depend on them.

In other words, our regulators actions are predicated on the assumption that we knew how to improve the efficiency of the equity market. Lately, the influence they have on the markets has been increasing, but the amount of oversight they have been subjected to is decreasing. The skills that are relevant to getting politician into office are diverging from the skills and attention that are required to selecting these regulator in the first place. The politicians wind up screwing the people who both elected and depend on them.

--

Let's consider the current, using arbitrage to improve the market's liquidity case, as an example. The most effective arbitrage techniques are made possible in part by simultaneously exploiting developments in computer science theory with those financial theory, and combining our improved ability to process this newly discovered information with our improved ability to implement our improved knowledge. In other words, in this case our increasingly sophisticated understanding of finance and computer science is what allowed us to more efficiently implement and test our hypotheses in the first place.

Previously we used CDO's to improve our ability to assess risk. We did this because we assumed that assessing risk was important to the efficiency of the markets. However, CDOs were made possible by developments in financial theory and implementation, as well as statistics, and the politicians in charge of influencing our dependance on ability to improve this sophistication were out of touch with the long term effects that their decisions have.

Why are CDOs bad?

Why are crashes bad?

I think the point that you may be missing is that there will always be booms, busts, panics, euphorias, etc. Those are byproducts of human psychology.

The real problem is when people blindly expect the market to always be stable, to always increase in price, etc. Most of the people who lost money in the recent financial crisis were people who couldn't afford to lose on the bets they made or who had essentially let it all ride without understanding that sometimes share prices go down too.

But (ironically in this context) when bets are available, there will always be people making bets they can't afford to lose. People blindly expecting the market to always be stable is a by product of human psychology!

I don't necessarily think it's irony. I don't think gambling is bad either. The stock market is still way better odds than the casino.

Yep, that's the standard answer. But (a) why does the average investor care about short term liquidity? Mutual funds only let you sell once a day and most people are perfectly happy with that. And (b) what good is liquidity that disappears when you need it most?

It's a self-serving argument at best. I sometimes wonder why the whole thing couldn't be replaced with a giant daily auction.

Mutual funds (along with pension funds and other large institutional investors) move tens of billions of dollars into and out of various positions regularly. Speeding and simplifying those transactions reduces opportunity and transaction costs and (theoretically) benefits all holders of the fund.

Again, that's the standard answer, but it's frequently repeated and never proven. I don't see it as anything more than conventional wisdom.

Keep in mind that we're talking about prices here. What is a stock price?

If I put in an order to sell one share of GOOG for $1, would you start to believe that the market price of GOOG was $1 per share?

A market price is only as valid as the degree of consensus. Increased liquidity means that there is a high degree of consensus about the current price. This means that one can feel additional confidence that one is getting a fair price.

The main concept to think about here is an order book. Think about the psychology behind orders that are a ways away from the best price (both bid and ask). Those parties are willing to transact, but at a premium. In other words, they prefer to hold unless a sweet enough offer is made.

Thus, for a very large order one has to pay that premium.

Most of the funds in the company I work at make position decisions once a day. Some only trade once a week. Liquidity intraday really adds nothing.

The investors get a daily price, and they have to notify us they day before.

It's almost as if high frequency traders are actually providing a valuable service for the rest of the world!

There seem to be two obvious problems here. First, what actually happened was that at the point where that service would have been most valuable they stopped providing it. There seems to be a difference in value between idealized theoretical HFTs that provide liquidity at all times, and real HFTs that provide liquidity when there's plenty of it around anyway.

Second, "they abruptly took X away and the results were bad, therefore X was providing something valuable" is an unsound argument -- e.g., coming off a drug cold turkey can be very bad even if the drug was doing you no good at all. It doesn't seem implausible that a sudden drop in liquidity during a market crash might be a very bad thing quite regardless of the optimal level of liquidity in general.

The way HFTs use leverage is opaque to most margin systems. Intraday margins are allowed to go way outside of overnight margins, and only positions are margined, not orders.

That said, there's also traditional leverage used in many cases because you may have a fully hedged position across different exchanges that don't recognize each other's instruments in margin calculation. For instance, you can be long Jan 11 Brent Crude Oil on CME and be short just as much on ICE. The risk is practically zero, so firms borrow as much money as they can to put on as much position as they can. If you've got more margin than others in these sorts of trades, you win huge when everyone else is backed up to the wall.

HFT is a zero sum game, and these firms just demonstrated that they exist to extract value from the market, not provide it liquidity

ALL companies exist to create wealth for their shareholders. Google does't provide search out of pure altruism, but providing their service and making money go hand in hand.

Incidentally this sort of trading is only zero-sum if you ignore time. Taking a position based on events that have not happened yet is in fact buying or selling risk.

All companies exist because structures are created that enable them to exist.

We do this because by facilitating companies we get employment, goods, services and wealth for owners. Of these the utility from wealth for owners is the least significant.

From the point of view of a retirement saver who invests at a single price per day, high frequency traders do hold positions for close to zero time. So in this zero sum game hft traders are just reducing our income.

It's only a zero sum game if you don't consider all the fees and taxes. Doing so would be total folly. The fees and taxes make up a huge portion of the profits and losses on these strategies.

HFT is zero sum in wealth, but positive in expected utility for both parties (when one part is a market maker and the other is a market "user").

In other words, HF traders are a cludgey hack around stock exchanges that were designed on principles that were developed in Victorian era trading floors. Removing them won't fix the underlying problems.

What are the underlying problems?

I don't mind the speculative aspect of it so much - there's legitimate economic reasons for that to exist, and fills an important market function - but I do have misgivings about trades being filled algorithmically rather than by decision of a human agent.

On the other hand I'm not sure how you police it, because some home-investor with a trading program that kicks in and saves him from losing several thousand while he's in the bathroom is engaging in algorithmic trading too, and I wouldn't deny an individual investor such safety mechanisms.

How much more do the typical "real" investors know about the products they invest in than the computer programs?

In other words, if we rule out insider information, isn't all trading, on some level, "algorithmic"? The real-ness comes from the financial statements of the corporations being invested in.

Er...I think that's a rather strained construction. By 'algorithmic' I mean 'executed by a computer without human confirmation at time of execution,' rather than the general application of a methodology.

Are you serious? The idea that speculation is bad dates back to old and embarrassing ant-Semitic rhetoric.

Speculation is an inevitable property of markets and is indistinguishable from more "concrete" behaviors such as hedging. Suppose a farmer buys rain insurance but not hail insurance. He's hedging one and gambling on the other. Yet he bought no contract for the latter.

Such transactions do help build productive enterprises, as they help with price discovery of the shares and add liquidity (which makes the investment more sound for everyone).

http://mises.org/daily/320 a history of speculation and a rebuttal of many of its disparagements

That does come from mises.org, though, and sort of says what you'd expect the Mises Institute to say about speculation. Which doesn't make it wrong, but does mean you're getting one particular side of a long-running debate in economics (roughly, the Austrian-School side). There are a lot more perspectives in the literature: http://scholar.google.com/scholar?hl=en&q=%22role+of+spe...

Search this doc for "speculators" to see where this is really coming from. The modern arguments against speculation are just echoes of this.

http://www.jrbooksonline.com/Intl_Jew_full_version/ij23.htm

It surely doesn't come from that, which you must know is a kind of lame slander, the usual "the Nazis did [x], so you're a Nazi" non-argument.

General attacks on speculation and finance go much further back than anti-Semitic worries about "Jewish finance", to long before the medieval era when European Jews became associated with finance--- the Jewish scriptures themselves, and writings of the early Christians, both have a bunch of attacks on finance in them. Surely the Talmud itself isn't anti-Semitic?

And a modern quantitative understanding of the role of speculation is pretty unconnected to Jews (most financiers are atheists or Christians, anyway).

I know it's not 100% derived from that, there are similarities in how it's articulated, though, one must acknowledge.

Not to take any sides, but you're wrong on two counts.

First, Talmud itself may well be anti-Semitic in this sense, only this is irrelevant. For example, the Bible says, quite clearly and redundantly, many things that Christians reject. Bible doesn't matter--Christians and their actions do. Likewise, Judaists matter and not the Talmud.

Second, Jews, in the sense of targets of most anti-Semitism beyond the troglodytic variety, are not a religious, but rather a social construct. Hitler wrote this in Mein Kampf, and this is why it's not okay to talk about anymore. The thing that makes it tricky is that while the racial aspect is relevant, it is not relevant in the way that makes criticizing Jews racist. That would have been Jew-by-culture <=> Jew-by-race. Instead, we have Jew-by-culture => Jew-by-race.

Huh?

"Talmud itself may well be anti-Semitic in this sense" In what sense? In the sense of attacking speculation since it's been pre-decided that all attacks on financial speculation are anti-semitic going back to Roman times?? The possibility of the Talmud being anti-semitic was simply assumed and implicitly rejected by parent as a standard rhetorical device so I'm not sure what you're driving at here. (and while usual the homily about actions mattering more than words is appropriate in some context, here it's apropo of nothing given that the overall discussion concerns the origin and implications of various criticisms).

Modern antisemitism may indeed involve the cultural racial equation you describe but this doesn't demonstrate that either modern finance theory and early Jewish scripture, the criticisms of finance mentioned by parent, have any relation to modern antisemitism.

I don't understand your question.

Edit: I see that you've edited your post.

_delirium's post had two things in it that are incorrect. It was highly rated, so many other people are presumably wrong in the same way. I pointed out why they're wrong.

On most other topics, it wouldn't occur to anyone to object to my pointing out why some things are wrong, just because it wasn't apropo [sic] the origin of the thread. This is why I don't talk about this and a few other topics publicly unless I'm anonymous, and mostly even then. People just tell me to shut up, in so many words (and that's if I'm lucky).

The two main point's of Delirium earlier post were: * Critiques of financial speculation go back to times before modern antisemitism. * Modern quantitative critiques of speculation aren't connected modern antisemitism.

When I described your points as "Apropo of nothing" I meant related neither to the thread's topic nor Delirium's post. You should be able to read above why.

Anti-semites link Jews to speculation, therefore all criticism of speculation is anti-semitic?

Congratulations on the lamest troll I've ever seen on HN.

The motives and moral decay historically attributed to Jews by anti-semites is the same as that currently attributed to speculators. Yes, finance is one area where Jews have historically had significant power and influence, and so the "anti-speculation" rhetoric is often wielded against them.

That article really misrepresents the issue in a serious way.

It confuses what is necessary - taking risk, with what is reviled - extracting profit at the expense of others from the deficiencies of markets.

Hyman Minsky distinguishes three rough kind of finance: hedge, speculative and Ponzi. He argues that the movement of the economy towards speculative and then Ponzi finance is one of the motors of economic crisis. The implication is that a certain amount of regulation is useful here.

... and I don't think you can draw any lines between Minsky and anti-Jewish conspiracy theories. Indeed, "all criticism of speculation is anti-semitic" is as much a "conspiracy theory" as any other hot-button generalization.

Speculation is not always indistinguishable from hedging. If you have $100 in fixed rate debt, then a $100 fixed floating swap can be hedging. A $1,000 swap is speculating.

Speculation sometimes has negative consequences for the economy. For example a few years ago oil prices were driven higher than they would otherwise be by speculation and this reduced GDP.

I mostly agree with this.

I do think that there seem to be some problems with the "PRICE TIME" rule. My understanding is that is supposed to mean that if two orders get placed at the same price, then the one placed first gets filled first. However, it appears possible for some players to work around this rule and jump in first. That seems unfair to me.

Tradeworx says this too: Jumping ahead of an order that was placed earlier at the same price by another trader is an UNFAIR practice, because it undermines the principle of PRICE-TIME priority on which our equity markets are premised

Unfortunately, this UNFAIR practice is widespread, due to a deficiency in Rule 611 of Regulation NMS

HFTs should not be blamed for exploiting it – in fact, many HFTs who exploit this deficiency do so unwittingly

Instead, the regulators should work to correct this deficiency in the market structure ASAP ! (page 17, http://sec.gov/comments/s7-02-10/s70210-129.pdf)

I had never thought of this before.

HFT provide liquidity. With enough of them, you really don't need a NYSE any more. After all, they're doing the same thing the exchange does.

Now all the attention to HFT makes a lot more sense. The logic never added up, but the politics obviously do.

Thank you.

What if HFT systems exploit the fact that they have access to the information a few ms before the rest of the market?

The only information they have is about trades that are about to hit their private trading network (before they go out to the market as a whole).

It would seem to me that if this were a problem, private networks would emerge that either disallowed the look-ahead option or allowed the party placing an order to declare it off limits to look-ahead (which would probably result in an increased transaction fee).

So in other words, the only time this could really result in exploitation is if one party lacked the wherewithal to use a different trading network (or a large trade broker) when trying to do a large transaction a few shares at a time.

This seems like the sort of thing that would attract innovation and would be fixed before anyone could blink, as trading network firms realized they could make more money by offering both options. My guess is that the lowered fees available in the sort of ecosystem that exists today would limit the demand for a trading network that disallowed it. After all the feature was added on as a desirable product fairly recently and nobody complained about it... until HFT became the scapegoat du jour for the financial crisis.