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to me this is a perfect example of how incredibly indifferent capitalism can be to creating value. no one is bad here, per se, but its useless as far as i can tell, and someone gets very very rich. nothing wrong with capitalism of course, but i feel the need to keep harping of the fact that it doesn't necessarily imply anything about value or desert.

edit: every time i make a comment along these lines, its interesting to see... it seems like HN is split about 50/50 on this. is it that this point is trite? or that you disagree?

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I think you're confused about how HFTs create value. They create value because they're the first ones to make a market in something.

They send out limit orders in every product. An investor then sends a marketable order to the exchange that fills one of the HFT's resting orders. If the HFT wasn't there then the investor's order would just fill a bank's order that would probably be wider and wouldn't respond to changing situations as quickly.

The innovation is that HFTs are able to make better markets with fewer people. This means that less money ends up in the pockets of intermediaries and more money stays in real investors' pockets.

Are HFTs always doing the right thing? No of course not, but HFTs are pretty clearly some of the most ethical firms out there.

I think you're confused about the meaning of "value".

HFTs don't provide any value, but they do extract a lot of money from what used to be called a "market".

Beyond the "providing liquidity" argument, another side effect of HFT and arbitrage strategies that one might see as valuable is the promotion of global invariants across the financial network, which is rather complicated distributed system. Would it make sense if there were two very different prices for something at two nearly identical venues? If large block of a stock is dropped on one exchange, would it make sense if there were no effects on the price of the same name on adjacent exchanges?

All that aside, I think I have some larger questions about your worldview: What does it mean to "create value?" By what standards is value assessed?

In the absence of any direct harm to another, under what circumstances should someone be deterred from engaging in profitable activity?

Is the assumption that profits accrue to those who provide value to others utterly false, or just false in this (and possibly other, isolated) case? If merely the latter, why in this case?

>> Beyond the "providing liquidity" argument, another side effect of HFT and arbitrage strategies that one might see as valuable is the promotion of global invariants across the financial network, which is rather complicated distributed system. Would it make sense if there were two very different prices for something at two nearly identical venues? If large block of a stock is dropped on one exchange, would it make sense if there were no effects on the price of the same name on adjacent exchanges?

i dont disagree with arbitrage and liquidity, and a globally invariant price for goods. i just think HFT isnt really improving that in a meaningful way. i ask you- at what timescale does it stop mattering? thats really what im saying. not that liquidity and invariant prices are suspect, but that things are happening on such a minute time scale that it doesn't matter. hey, i could be wrong, but no one has argued why going from milliseconds to picoseconds is improving our lives. thats the thing i would like explained.

>> What does it mean to "create value?" By what standards is value assessed?

tough to pin down, but surely its more than how much money it makes you... right? of course it varies from person to person. but i think its very lazy to say that its "whatever someone will pay for it". then value changes when laws change. i think most people probably agree that some things that are able to be sold for alot are not a value to society. i think its fair to say that there are some basically invariant things that are valuable.

>> In the absence of any direct harm to another, under what circumstances should someone be deterred from engaging in profitable activity

probably shouldn't be deterred. my point was that it looks like this is more like a game people are playing, with no real positive externalities. didn't say it was bad prima facie. i think its weird that people are very strongly clinging to the idea that it has some wonderful benefit to society. seems like a pretty weak argument, and kind of pathetic. its ok to to just admit its a game, and its for the players. poker players dont go around claiming they are providing everyone a service. i just get the sense there is an ingrained idea in our culture that there is some nobility in "finance" that i dont think belongs there in some cases.

>> Is the assumption that profits accrue to those who provide value to others utterly false, or just false in this (and possibly other, isolated) case? If merely the latter, why in this case?

not utterly false, but far from universally true. very difficult, broad topic that i am, or course, not in a position to say definitively. we can all point to cases where almost everyone agrees that someone gets overpaid, or underpaid. seems like a lot of people readily accept the dual premises that success == making money, and that money is a proxy for value. i take issue with both- i think its important to think about success and value more fundamentally. it seems like a lot of people have a tautological idea that you are paid what you deserve because its what you got paid...

>> i dont disagree with arbitrage and liquidity, and a globally invariant price for goods. i just think HFT isnt really improving that in a meaningful way. i ask you- at what timescale does it stop mattering? thats really what im saying. not that liquidity and invariant prices are suspect, but that things are happening on such a minute time scale that it doesn't matter. hey, i could be wrong, but no one has argued why going from milliseconds to picoseconds is improving our lives. thats the thing i would like explained.

This is a little more complicated than it would initially appear, I'll try to explain from a market makers perspective why the speed race exists and why being faster (as a liquidity provider) is better for the market, at least the way it's currently structured.

Market making 101 is basically that you want to come up with a fair value for the product you're trading, and then put out orders to buy for a little less than FV, and sell for a little more than FV. If you buy and sell at those prices you're providing liquidity to the market and capturing a small spread for your effort, great. Do that repeatedly and you have a business. But how much should your "a little less" and "a little more" than FV actually be? The smaller the better for the market, and this ideally should be the primary vector on which market makers compete with one another.

Okay, so in our optimal scenario you'd always quote as tight as possible (limited by the granularity of pricing on the exchange) around the fair value. (I'm glossing over a lot here, calculating the fair value is non-trivial and your level of uncertainty about it will also determine the spread you can quote, but ignoring that for the moment). The problem with this is that if the fair value moves then some of your orders become mispriced, as they represent an opportunity to buy below or sell above fair value and if they execute will be a loser. Smart participants will recognize this and race to pick those off before you can reprice them. If this happens too often, you're not making money anymore, crap. Really only two options here, #1 is to widen your quote so that you are less sensitive to such movements and you are capturing a fatter average spread which compensates you for the losing trades. #2 is to get faster than those other guys.

#2 yields a better outcome for the market, but necessitates a speed race as an additional vector of competition. Exchanges recognize this as well and have long played around with various schemes to give liquidity providers a systematic advantage, e.g., via rebates, or otherwise. It's a tough problem.

> but its useless as far as i can tell,

That's because you, as well as 99% of people accusing financial firms of being useless, don't know what you're talking about.

One of the reasons planned economies usually fail quite spectacularly is that individuals are very bad at predicting global market behavior. It's too complicated. Local stochastic optimization (free market economies) works quite well, even if it's maybe not globally optimal; doing better than free markets via central planning requires an unfeasible level of omniscience about all market actors and interactions.

This refrain of "traders do nothing useful" is a great example of that; most people are too myopic and/or economically illiterate to see otherwise.

Here's what traders do; they communicate price information (extremely important) and charge a small commission for doing so. In the absence of regulation on "Wall Street" (or whatever your regional synechdoche), there would be more competition among people communicating price information and profit margins would probably be a lot smaller. If you can do a better job communicating price information (possibly by predicting future prices), you can make more money.

Another auxiliary job that traders do is provide liquidity, which is very important but (in my opinion) less important than the first.

My apologies for being a bit blunt, but I think people deserve a bit of admonition for attacking that which they clearly don't understand enough to even criticize coherently.

This refrain of "traders do nothing useful"

That was not how I read the comment at all. Maybe slow down and reconsider it in the context of a specific discussion about this specific approach to HFT, rather than assuming the GP is dismissing the whole underlying principle of market making.

wasnt attacking that. was arguing that the marginal/imperceptible improvement in liquidity isnt really doing anything for anyone except the people profiting off it.

Trading firms create value by providing liquidity.

If they can buy low and sell high, they will be buying when there are relatively fewer other buyers, and sell when there are relatively few other sellers.

This activity creates value for other people who want to trade in those circumstances.

If no value was created, there would be no value to capture.

And the prima facie evidence that they are creating value is that they are capturing value from willing market participants.

This is fundamental economics.

nah. its on such a small time scale, i really dont think it does.

If a company provided X amount of liquidity to both sides of the market, even if the company itself only entered a position for a millisecond, it still provided necessary liquidity. It did so in a very efficient manner and turned a profit on that.

Saying that you dont provide liquidity just because you enter both sides of the trade is like saying that a cab going into and a cab going out of manhattan cancel each other out and provide 0 net value to their passengers.

sorry, i guess there was an ambiguity. i didnt mean to say it didnt "provide liquidity". i meant that what it provided was pretty worthless, in the non-monetary sense.

if you look at the market as a whole, there is a thing called the "efficient market hypothesis". It assumes that markets are perfect and you can not make money trading securities, because all information is already priced in.

This is obviously not true, because HFT makes money, but you could say that HFT contributes to getting markets closer to being efficient.

Having efficient markets is worthwhile for society because an efficient, liquid market provides a more accurate picture of the "actual" value of things.

If you buy this argument, then HFT would be contributing to finding truth, which is inherently valuable in the eyes of many people.

At the end of the day, HFT is one of those things that people just get jelly about because someone makes money on something they dont understand and gets insanely rich "doing nothing".

What people get mad about is completely arbitrary. Everyone hates google because ads, but without google, their world would barely operate. Everyone hates facebook because fake news but nobody has the balls to actually not use facebook. A social network.

Everyone hates uber because "scandals" and poor drivers not being paid but still uses it because comfortable.

I'm not really in the stock market but when I want to sell stock, I'd rather there be some market maker who is obligated to buy it. Maybe he makes more money off of me than I ever will selling stock to him, but that one time when nobody else wants the falling stock and I potentially use a large chunk of my savings, I really need them.

Consumers sit on some amazingly high horses sometimes.

You are not in a position to talk about people on high horses after posting that. There is quite a lot of research from the behavioral economics field (tl;dr: most people are somewhat irrational) that undercuts the EMH.

Also, there's a lot of straw man argumentation in your post. Consumers can and do make sacrifices of utility in line with their values, even if such behavior is a standard deviation or two outside the norm. And while your argument for market making is sound, do you really need to make that trade within milliseconds, or would you be equally happy as long as it closed within a couple of minutes? You seem oblivious to the possibility that your stock might be falling due to a liquidity event caused by a race condition, for example, although in cases such as the 'flash crash' such trades are usually unwound afterwards, presumably at considerable expense.

I'm being called oblivious by people who confuse HFT and market making which each other. That's cute.

There are companies that provide liquidity. They do nothing else. They don't take a position in the market. Its their job to quote both a bid and an ask and to trade with anyone who wants to hit those quotes. They are not allowed to not quote a price, unless trading is suspended. Those are called market-makers. They need to be able to change their quotes quickly, because being taken out on one side of the market creates positional risk for them. The only time they make money is when they can trigger a buy and a sell at the same time. If they cant do that, they have to hedge their position. They have to compete on spread with other market makers, which is possible to do in 2 ways - being fastest to quote or having a narrower spread. Trades at the price are executed in the order of submission.

There are companies that engage in statistical arbitrage. They look for opportunities that are statistical in nature. Think of technical analysis but in a way that works. Think stock A and stock B being more correlated than price reflects. They want to execute fast because those opportunities do not exist for long. This kind of trading smoothens out the curve and smooth curves are nice to have, mathematically speaking.

There are HFT firms who scalp dodginess in price by renting colocated servers. Very tiny but almost guaranteed returns if they can get execution. Nothing wrong with that either. Low margin business model.

Then there are companies, or rather teams inside companies, that send buy and sell orders into the exchange that they never want to execute, on millisecond timescales, to disrupt the market. They are trying, in simplified terms, to create signals for other market participants that do not really exist, and then execute trades that they know will be profitable by exploiting other participants for whom they generated buy signals. This is your evil HFT. The T in HFT is a misnomer, because they dont really trade. They abuse stock exchange mechanics to fuck with other market participants and then try to rob them. This is mostly illegal and not allowed by the exchanges themselves. The problem here is to prove that someone didnt play by the rules. Google "optiver the hammer" for an example of a couple years ago. They have counter-intelligence teams whose entire job is to not trade the market for profit but to ruin other companies profits to drive them out of business. But most of this is illegal, its just difficult to prosecute.

The problem with banning folks is that most trading companies engage in all of these things at the same time. There are market making teams at optiver and there are evil HFT teams at optiver and if you ban optiver, you wipe out a major market maker which leaves the stock exchange exposed.

Another problem with "banning HFT" is that where do you draw the line? Market participants can suddenly not try to get their trades executed anymore? Maybe that's beneficial to the market as a whole, but how do you even execute such a rule?

You're projecting far more into my post than I said. I have not proposed banning HFT, for example.

Also, you really need to work on your manners, which is why I'm not going to bother addressing the rest of your remarks. Perhaps we can have a more constructive conversation some other time.

>> Then there are companies, or rather teams inside companies, that send buy and sell orders into the exchange that they never want to execute, on millisecond timescales, to disrupt the market. They are trying, in simplified terms, to create signals for other market participants that do not really exist, and then execute trades that they know will be profitable by exploiting other participants for whom they generated buy signals.

This is well-known. But for some reason, only kids trading in their parents basement, across the ocean, over a non-fibre connection to the internet, get charged and convicted.

Your points are valid, but not entirely correct IMO. What you are describing as abuse is "quote stuffing". Sending in buy or sell orders to move the market with no intention of fulfilling said orders. When I worked for an exchange operator we routinely reported this type of abuse to the SEC. It' difficult to discern the difference between a fast moving market maker (and many successful HFT firms are indeed market makers) and simple re-positioning of the spread because of shot term volatility. Your "evil" HFT firms may be abusing the system by cancelling an order placed a millisecond prior, but they don't make any money if a trade does not occur. Quote stuffing without a trade on the modified price does not produce a profit. Manipulating the market in this way is not a fool-proof way of making money - there still has to be a minimal position taken by the trading firm in order to realize a profit.

I really think EMH is a red herring here, for what it's worth. This is more a market microstructure issue. You can entirely disbelieve the EMH and still benefit from HFT.

But why is this liquidity necessary? Maybe if you can't find someone to take your trade that's an important price signal, which is being dampened by the liquidity. Forgive me for abusing the metaphor, but just as water is essential for life, consuming too much of it can kill you (by lowering the level of electrolytes and disrupting intracellular signaling). It's rare for people to die from drinking too much water at once, but that's not gonna be a lot of comfort if it happens to you, is it?

liquidity is necessaryy because people need to be able to buy things. not having liquidity is like having empty grocery stores. doesnt sound like a big deal but oh so painful if it ever happens. people in this thread lump market makers and high frequency traders together which is not really correct, but market makers are hired by exchanges to make sure markets stay liquid. market makers guarantee that they will always be in the market for at least "x amount of security", typically 100 lots. that means that at any given point in time, you can at least 100 lots, which covers any kind of smalltime investor who doesn't have access to professional execution traders. this is important because you need to be able to get out of potentially deadly trades.

this is not just for stocks. the potential loss of a stock is the price of the stock. that is finite. some options, even ordinary options, can generate potentially infinite losses and stock exchanges want for everyone to be able to move their stuff.

as far as you are concerned about "signals", there is something called the order book. as a normal trader you dont see this, but the stock exchange lists every position in the market and you can pay to see that. there is literally no difference between no market makers in the market and market makers having their spread quoted on top of the available market, in terms of signals. market makers just make sure that you get a good, if not fair, price for the stuff you want to move.

illiquid markets are extremely painful, especially for those companies that exist in them, because their value can be extremely misrepresented. to make an example, assume you are tesla, but you are traded on an exchange that only publishes spot once a year, in january. in august, you need to raise money at fair value and youve grown 3x since january, but nobody can give you fair price because you are quoted at januaries value.

liquidity is a good thing for every market participant.

you need to drink 5 liters of water over a period of 30 minutes to kill you potentially. thats not going to happen by accident and you will be in ridiculous amounts of pain long before you hit the lethal dose.

I studied economics. Also, I used to install trading systems for hedge fund managers. Your reply is not responsive to the question I posed, and tells me nothing I don't already know.

And yes, people do die from drinking too much water. https://en.wikipedia.org/wiki/Water_intoxication

> Trading firms create value by providing liquidity.

Obviously true when they're added to market with little to no liquidity.

But hard to see as true when you're adding them to market that is already extremely liquid. At least, it's a statement that needs some empirical justification in that case, to show that the value from marginal liquidity being added (which is tiny) offsets the waste of the incredible amount of human effort used to create it.

Just substitute "cost of trading" with "liquidity".

It's true that at this point, now that market making is pretty much all automated, there isn't much more cost to squeeze out of this component of the market. But be careful not to imply that liquidity is binary: the more liquidity you have, the less it costs to buy or sell something.

I'm not implying that liquidity is binary. I'm implying that it does not scale linearly, but rather exponentially towards an asymptote. That is, you can add as much as you want, the total amount approaches a limit.

Said a different way, with your "trading costs" substitution: If x amount of human effort is required to reduce trading costs from, say, 5% of a transaction to 0.001%, perhaps (let's assume) that's justified. But is it then wise for a society to encourage expenditure of 10x more effort just to reduce costs to 0.0001%? (This analogy doesn't really hold, because cost of trading could be 0 and there could still be 0 liquidity, just no other parties interested in buying or selling, but it still seems to point at a real issue when restricted to talking about liquidity.)

I think an interesting point you might consider -- let's suppose there is such a thing as "too much" liquidity, and as a corollary, there's a "perfect" amount of liquidity. What do you think happens when more liquidity than the perfect amount is introduced?

I think a lot of arguments which support the idea of HFT being too much liquidity seem to take, as a premise, that the extra liquidity costs consumers -- namely, non-HFT participants in the market trading against the HFTs, the "buyers" of liquidity. Does it? If you have too much liquidity, doesn't that just mean that the buyers don't buy any of it? They saw as much liquidity as they needed, completed their trades, and went home. It seems like the actual cost of too much liquidity is HFT firms which send orders that don't get traded against, so they have no benefit (to the HFT), but still have a cost (the firm has to run, after all). Yes, there's some cost to society here, in the same way that there's a cost any time someone takes on a speculatively profitable business that turns out not to be.

I'm sure there are some strong arguments you could make that HFTs are unnecessary, but the argument of "too much" liquidity always felt shaky to me (in part, because it's one of those arguments that relies on playing fast and loose with nebulous terms).

But he didn't argue we have "too much" liquidity. The argument is that we have "enough" liquidity and are now expending a huge volume of capital on a literally imperceptible increase in liquidity.

My point is that I don't think it's a huge volume of capital. The extra wasted capital here is the cost of running an HFT firm while you test your strategy (aka. see if your liquidity is valuable or not) -- if it's not profitable, it's not a huge loss (HFT firms, in the grand scheme of things, are relatively small) and the firm shuts down; if it's profitable, then clearly they're trading against non-HFTs that value their liquidity, so what's the issue here?

> waste of the incredible amount of human effort to create it

The size of the HFT space is almost universally overestimated. Virtu recently tried to purchase Knight for 1.3 billion, about as much as it would take to buy Sears. Those are 2 of the giants of the industry, combined they would dominate it.

The estimated revenue numbers for all US market makers was 1.1 billion or ~3x snapchats number.

For something that speeds up & cheapens virtually every trade on the planet that doesn't seem like an outside amount of effort. At least not in comparison to showing ads to teenagers.

I don't buy this argument, whose implicit corollary is that there can never be too much liquidity. I'm not an expert and don't have an opposing theory, nor do I want to do a bullshit refutation by just citing something I found in a few seconds on Google, but:

I feel there must be some ideal level of liquidity, which is after all subject to laws of supply and demand like everything else. Cannot an oversupply of liquidity result in fiscal inflation, as opposed to the monetarist kind? I'm reminded of the Asian financial crisis during the 1990s, when there was a ton of money flowinginto newly-developing markets int eh Asian region, but then a spasm of political uncertainty suddenly led to a catastrophic withdrawal.

Echoing one of the other posters here, I don't feel that anyone at this firm or the firm itself is acting in bad faith, but assuming this mathematical demonstration is correct and it's virtually impossible for Virtu to lose money other than by abandoning its winning strategy, does this not invite an arms race and a stampede of eager traders hoping to also get rich by picking up pennies from in front of steamrollers?

I don't want to say you're wrong, but to question the applicable scope of your premise. Virtu itself may not be big enough to cause market instability, but 100 firms doing the same thing might.

I apologize for repeating a point I just made, but I'll make it here too:

You can mentally substitute "cost of trading" for "liquidity".

It's true that you can get costs down to a point where they don't matter. But I think you'll have an easier and more intellectually honest time engaging with the issue if you avoid the jargon and focus on the impact of the jargon. Cost is why we care about liquidity. As markets get less liquid, spreads increase, and the market takes inflicts more and more of a penalty on us for trading at all.

I get this. I just have an intuition that some friction in a dynamic system is actually a good thing, and also wonder if the growth of HFT might not lead to an unsustainable deviation from an underlying power law distribution of trading activity.

You have reminded me of an excellent article on frictional costs in economics from The Economist [1]. There is a slight snag in that it is an April Fools joke.

[1] http://www.economist.com/news/leaders/21719799-it-time-recog...

I think are pretty large barriers to entry to hft. You need enough capital to develop a sophisticated, heavily error checked trading strategy, set up your own network to ensure low latency, the IT infrastructure/engineers to manage this,.. it's not like a few burnt out traders can open up hft firm in their garage so I think any stampede is unlikely

> prima facie evidence that they are creating value is that they are capturing value from willing market participants.

is this referring to market value or economic value?

The way I think about HFT is:

- one effect of an economy is to find an approximate solution to an important problem: optimising resource allocation with regards to growth

- within this paradigm, markets exist to process all publicly available information and turn it into real allocation of resources

- considering the difference between trades executed once a day vs once a week, the more frequent trades will provide information that is up to date, higher resolution, and will lead to a better solution to the problem

- HFT uses a huge volume of very frequent trades based on very weak correlations, meaning that the information it adds is newer than that of longer term trades, is very high resolution, and may take into account factors ignored by longer-term strategies

- therefore, HFT leads to better overall resource allocation by providing greater visibility into the value of the things being traded

This ties into the comments on the efficient market hypothesis. HFT brings us a little closer to the impossible ideal by making the market a little more efficient.

i dont disagree with the basic framework. but why is going from milliseconds to picoseconds important? im pretty sure its not. thats all

Valuing something is itself valuable.

Yes. People mistakenly think it's a meritocracy. It's not.

But it is good at making the world rich.

i'd say it is a bug of capitalism that HFT is a profitable line of business. it's easily fixed by taxing, but maybe it's already taxed properly, i don't know.

HFT is not necessarily a feature (nor a bug) of capitalism, although something you might recognize as capitalism is a prerequisite for the phenomenon, but of the fact that information sources and financial exchanges form a distributed system, i.e. one that is spread out across space and time.

Of course, in the absence of markets altogether, we have no exchanges, no finance, and no HFT.

But... Why do you see this as a problem to be fixed? Who does HFT harm besides those whose bottom lines they cut into: the big, fat, and slow dealers who wish they could drop a block anywhere and have it fill?

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