https://www.amazon.com/Flash-Boys-Insiders-Perspective-High-...
Lewis' book is not well-regarded.
At the point where you've argued that using a Bloomberg terminal means you're front-running everyone who doesn't have one, I feel like I can end this unproductive discussion by asking: "what's a definition of front-running that would be persuasive to someone who doesn't believe that simply owning a Bloomberg terminal is unfair?"
No amount of speed on the traders side will allow them to beat me on a resting order* I put in 2 months ago, even if I did it on the phone with a human broker. Their speed is a risk management feature. They don't have to have the carry risk for those 2 months that I do. But they don't have any special access to the trade at that price.
*note that there is no such thing as 'the market'. There very well may be exchanges out there that have special order types that can trump mine, but they aren't common (or weren't last i was involved in HFT).
In fact, the vast majority of the new information that HFT participants are getting is the order itself. My order goes in and that itself is the information that causes reactions.
And thats the crux of the reason 'smart' money hates it. They want to take advantage of liquidity without it being priced correctly. Meanwhile liquidity providers (HFT) want to price it based on that order information. But note, the built in information asymmetry actually works against the HFT in that case. By the time the smart money order hits the HFT, the smart money already gotten their desires in at least part of the market.
For me as 'dumb' money its largely all upside. I can get execution right now for as cheap as its ever been if that is important to me, or I can set the price I actually want to pay without being impacted by this at all.
[edited for clarity]
You assume that you can obtain on information before HFT, possibly because you're talking about a different type of HFT than I am.
Can we use a clearer example? Let's say that we submit a limit order to buy 10 shares of AA (American Airlines). Before the order is fulfilled, two AA planes collide (the new information). In response to the new information, any trader would agree that the stock price should drop significantly, and it does. HFT will quickly sell to our previous uninformed trade, which we are not able to cancel in time--that's the unfair advantage. Please explain to me how this is not "fastest trader takes all".
- your example has never happened. Its a thought experiment that is worth exactly that.
- you stipulate that the actual information that HFT systems take advantage of is the market microstructure itself. I'm going to demand that you do this because of my experience in the HFT space and my lack of experience in the 2 plains colliding in mid air space
Even given those stipulations, HFT is not the issue. If I am on the ground observing the crash. I have a unique and privileged access to the information. If I am a air traffic controller observing their flight plans before they hit, I have a unique and privileged access to the information. If I am a hedge fund that have been detailing the long history of AA job boards and notice that they spend waaay less on QA engineering than their competitors, I have unique and privileged access to the information. It is not the point of the markets to penalize those participants. It is the point of the markets to reward them. We want that information incorporated into the price as soon as possible and the markets are how we incentivize that.
That is, having data that other market participants don't is a fundamental state of the markets that generates the outcomes we want. Any external manipulation of that information need have a sufficient justification. In the cases we've said are out of bounds, the sufficient justification comes from an issue of agency. We have said that brokers can't take advantage of your order flow because it will destroy the markets if they did. Insider trading represents one party stealing from another (1 set of shareholders who are beholden to another set).
HFT does not represent any of those things. Quite the opposite. They are placing honest bets on their predictive ability, just like every other market participant, the only difference is their information flows and timeframes. Frankly, the markets hold HFT to a higher standard than other participants. No one bailed out Knight when their advantage became their undoing and no one cares now when they are providing liquidity for basically free and the entire industry is a non-event. If an investment bank or an automotive company succumbed to market pressures like HFT did, a president would step in.
My example would apply whenever an analyst comments on AA or whenever any polarized headlines is published about AA.
> It is the point of the markets to reward [information]
But that's exactly what we're debating: why is updating information a couple microseconds earlier something that is valuable? Conversely, if it doesn't make the market more efficient, it shouldn't be rewarded.
Since you mainly want to talk about market microstructure, how do you think a switch to batch auctions would affect the market?
I think it is an interesting paper but it ignores the reality of the market place, which is that there is no such thing as 'the market'. There are a collection of exchanges, spanning the globe, under many different jurisdictions offering either directly fungible symbols or things that are very tightly correlated.
Even if every exchange in the world agreed to the same schedule and time interval there would be arbitrage opportunities available to 'mechanical' HFT at the time scales mentioned in that paper due to the nature of physics and global communication latencies. You'd need to increase their interval value considerably even in that highly unlikely scenario. If they did that, I'd presume that in the short term spreads would go up as the current market makers reduced their risk exposure as they figured out the new system. In the long term either the existing players would figure out their tolerances or new players would come around and things would largely settle back to where they are now. My intuition is that the games they would end up playing in that world would be largely more goofy than the fairly straight forward latency arbitrage they do now (I think it would look more like dark pools than like our current exchanges).
But thats not even realistic. In any realistic scenario a batch auction exchange would exist in an eco system with other non-auction exchanges. It would still have latency based arbitrage opportunities and would largely be a non-event to the markets. HFT firms would continue to do the yeomans work of making sure the prices on it match the prices on the other exchanges. My bet is that the pricing on that exchange would largely be worse for everyone and that most customers would not care enough to make that exchange more than a curiosity. IEX had one of the best marketing plans of all time and haven't changed the market in any significant way with their goofy speed bump concept.
All of that to fix something that I don't view as broken. HFT is one of the most purely Darwinian capitalist systems in the world. Margins are razor thin. I'm happy to have them invest all that money and pay for my order flow so that I can get free trading and near instant execution. Most of the major commercial players like Vanguard agree with me. That a couple of hedge fund whales don't like it doesn't bother me much.
Is HFT not front-running or insider trading? (I'd agree!) Then what's wrong with it? Otherwise: what's the useful definition of either of those terms that you're working from?
I'm sure HFT does dissuade a class of day traders from participating in the market. But who cares? Electronic trading also killed the human market makers, who simply got outcompeted. The result, again, was an unalloyed good: the human market makers were crooked as a wallet full of 3 dollar bills.