Market making in itself provides a valuable service by keeping spreads razor thin and ensuring there’s enough liquidity to satisfy almost any trade at close to the current spot price. HFT is mostly just a way for market makers to gain an edge over each other. In general, it neither helps nor harms ‘regular’ customers. It would hardly be noteworthy if not for the insane lengths that HFT groups go to in order to gain an edge. And, of course, the possibility that a HF system with inadequate controls goes on a trading rampage that significantly moves the markets (see Knight Capital).
How many market makers are there?
> How many market makers are there?
However many the market will support.
How many shoe shops are there?
I’d guess Citadel/Virtuu/Jump capture the vast majority of that business.
https://www.canarywharfian.co.uk/threads/list-of-proprietary...
Then also the associate firms on this list:
https://www.technologyreview.com/s/603431/as-goldman-embrace...
It makes the markets more efficient which is good for everyone.
Do you think there was any benefit from having humans do this work? Was there any subjective analysis used, or were these 600 people just human calculators?
The point I am making is that the order books of markets don't accurately reflect the real underlying demand for the securities.
Let's take a hedge fund, who would buy apple at $5. It's incredibly unlikely that they will actually place a bid on the order book at $5 for apple. Instead, they will monitor the price of apple and buy it if they see a good price.
The value that human traders can provide is that they can tap into this hidden sources of liquidity that isn't reflected on the order book of the exchange. They can call up some manager and say "hey I can sell you something at a good price, you interested?"
Without human traders, there is no way to tap into this liquidity. This occasionally causes problems in thinly traded markets or during after-hours trading.
Now as everything has become more efficient, humans are replaced by algos, which are way cheaper. In turn, they also require less for upkeep, and so charge less in edge, which means you have better bid/ask prices, lower trading fees, etc.
* They are always willing to trade, so if someone wants to sell/buy a stock, they can get it from an HFT rather than needing to wait for someone who wants it long-term. (The HFT aims to sell it later to someone who wants it, they don't want to keep it).
This is called 'providing liquidity'
* They ensure prices remain 'in sync'. If prices don't match in some sense, then people need to worry about where to get a stock, rather than just what stock to get. The same goes for e.g. keeping stocks in sync with options. This way, someone who buys a stock gets an accurate price.
This is called 'arbitrage'
There is more to these concepts, especially arbitrage. But these are the core benefits of HFT.
"Flashboys" is pretty discredited as a marketing exercise for IEX.
Vanguard say HFT lowers their costs (https://www.cnbc.com/2014/04/25/vanguard-chief-defends-high-...). Hardly seems like just "benefitting the bank accounts of the traders".
https://scottlocklin.wordpress.com/2014/04/04/michael-lewis-...
Remember that most retail investor orders never hit the exchange because your brokerage firm is selling the orderflow to a HFT firm.
Overall, you can say the benefit is that spreads are cheaper to cross for investors. But, you could also make the counter-argument that if things became slightly more difficult to buy or sell, this inertia would prevent retail investors from over-trading by taking a long-term view.
HFT is "stealing" from the big guys and giving to the little guys.
1. Think homes. Consider buying/selling a house and how painful it is to keep something on the market hoping to find a seller (often at a hit if you want to unload quickly.) Or a buyer desiring to purchase something only to have a handful of homes come on the market.
2. Imagine if for every book you read, you could quickly unload the book (or buy new ones) without fire-selling and paying an absurd shipping cost. HFT and market making reduce friction. They are market lubricants.
3. Imagine looking for an apartment to rent and there were a perfect curve of apartments a dollar apart available all the time!
It's worth asking what that artificial limitation would actually be, and how it would result in changing the game for market makers.
Continuous limit order book trading (how essentially all exchanges primarily work) is a fairly straightforward concept, and speed is an obvious differentiator for a successful market maker. In general, when complexity is introduced into trading, that creates more ways to exploit the rules for "unfair" gain. Assuming you believe market makers are necessary for a healthy market, you'd have to think of how some other system (like frequent batched auctions) would change the differentiators for successful market makers, and whether those changes are "good" or "fair."
How fast do trades really need to be?
Lets start with a hypothetical 'human speed' similar to how things used to be in the pre-electric world.
What if there were only one trade made per day? If every day buyers and sellers (with price limits in place) were resolved similar to a dutch auction (or some other 'fair' process).
What if that happened every hour? 30 min, 20 min? 10 min?
I think maybe every 10 min could be a good cycle. That would give a human duration of time for a buy/sell blackout (about 60 seconds), plenty of time for everything submitted to be tabulated, signed, and then published, and 9 full min to figure out what you want to do in the next order period.
One big problem with batch auctions as a global solution is that conceptually, trades span multiple markets. You have to figure out how your 500ms futures batch auction is going to interact with the unrelated market for the underlying instrument.
Probably the biggest problem is the problem itself, which, in the case of HFT, probably just isn't enough of a problem to reengineer all of market microstructure to fix. The biggest pure HFT firms are worth just a fraction of the biggest investment firms. Major purchasers of liquidity (pension funds, Vanguard) are happy with the execution they're getting. None of this stuff hurts retail traders (on the contrary, it probably helps them on the whole).
Would love to see some research if it exists.
2. Dramatic lowering of bid-offer spreads and, thus, transaction costs to liquidity takers (eg retail investors).
3. No-arbitrage pricing: safe to assume that virtually any easily-tradable instument is fairly priced, otherwise would’ve been quickly arbitraged. Has not always been this way.
4. Driving innovation by paying for technologies/solutions that nobody except HFTs would buy at the time.
If you are a CS/Physics/Math person who loves to optimize systems then this is a good way to get paid for doing exactly that I guess. Many other problems/industries just require good enough solutions, with HFT it seems that most optimizations are worth it, which makes it so much more interesting.
I personally find HFT kind of a snooze and not especially intellectually gratifying. Most of the work is just wading through bullshit (write in interface to some random exchange , figure out how to remove an instruction here or there).
Imo, things aren't looking so good for HFT. The profits are very slim at this point, and staying competitive is becoming exponentially more expensive. The golden years of super-normal profits and fat bonuses are over.
Note that any answers should be HFT specific. That is, if they apply equally well to trades on a second or minute scale as on a millisecond scale, they probably don't answer the question.
I see the importance of market making etc in general, but I don’t see it for millisecond latencies.
Second is the risks to market makers goes up, which means they need to acquire more edge to cover that risk, which in turn widens the bid-ask spread, which makes prices for retail traders worse and will likely reduce liquidity as well.
Many startups look for money though venture capital, and not the stock market, because the stock market is so predatory.
People like Elon Musk have gotten in trouble with the stock market for simple things, like thinking out-loud. I'm pretty sure he hates the stock market, and only by law was he forced to sell stocks.
The stock market has transformed many times. Currently large institutional investors like pension plans buy safe stocks. Originally in the 19th century it mostly a way to buy government bonds. In the 1920s buying stocks was opened up to the 'everyman', a person could buy one share rather cheaply. Then came the depression. In the 1950s the stock-market wasn't that important, economy was doing good. Starting in the 1970s traders started inventing exotic financial tools, to make the stock-market less boring. That's how we got into several crashes, most spectacularly 2008.
Since this is how his company has been kept afloat for the last decade I'm pretty sure he doesn't hate the stock market, he just hates the agencies that regulate it.
You're alone in this thread, but no one here has given any real defense of HFT other than "providing liquidity", which is sheer garbage in a world where we have giant speculative bubbles forming and bursting and taking out huge portions of the economy all the time - it requires a real fanatic devotion to efficient markets to be trying to race against the speed of light. This is bunk; prices are just wrong anyway, and markets don't need to be that good as a result. What we do need is less financialization of the economy. Transaction tax all the way.
And the reason startups like VC vs public markets is because they can easily get money on the secondary markets. Going public is a lot of work and comes with a lot of rules. The only reason people did it during the dotcom boom was there was a lot less secondary market capital sloshing around. It wasn't because the stock markets were somehow less "predatory" (whatever that means) back then.