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Comment by eftpotrm | Hacker News Reader

In all seriousness, I would rather see a market designed explicitly around the barring of high frequency trades. All trades taking a fixed and relatively long period (say, 30 minutes) to complete.

This sort of investment strategy doesn't seem to be creating long-term market value, it's exploiting short-term edge effects in a zero-sum strategy. The arms race to pursue ever more inhumanly fast automatic trades seems to have no net value at all yet is consuming resources to impoverish the algorithmically and connectively poorer at the expense of the richer.

Markets seem to be favoured because they allow prices to find their natural level from supply and demand. How is this facility helped by permitting trades to be completed and then reversed faster than any human can ever perceive? This is algorithmic gambling on edge effects far more than a true market.

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I can see from your post that you're very misinformed about how markets operate and the role of high frequency traders (a.k.a. liquidity providers). Read my response to a previous comment: http://news.ycombinator.com/item?id=2164458

I have nothing against HFT but I don't buy your liquidity argument. Liquidity is needed most when markets are falling outside the norm. Any algorithm with a fail-safe or kill switch will immediately shut off when times get bad thereby ending their contribution to liquidity at a time when it is needed most.

Please help me understand this better if I'm incorrect.

(edited for clarity)

The main point that you're missing is that there is a huge demand for liquidity during a majority of market hours. On average, 7 billion shares of US equities are traded every day. That is a monumentally large number if you think about it. According to the TABB consulting group, roughly 50-70% of American stock trades are done by HFT [1]. Let's assume that 10-20% of trading is non-profit motivated (utilitarian, you could say). That means that roughly 1 billion shares are exchanged every day by utilitarian traders. That in itself should be clear evidence that there is a large demand for liquidity.

HFT market makers play an important role in those transactions. Specifically, they make it cheaper to buy and sell stocks by (1) tightening the bid-ask spread and (2) providing more quantity at each price, so that the average cost of executing an order is less. Not only that, when markets become tighter, they actually enable transactions to occur that would not have happened before. In other words, previously where buyers and sellers would NOT have traded because the transaction costs of crossing the bid-ask spread were too high, those two parties can now trade. Specifically, without HFT, there would be far fewer than 1 billion shares traded by utilitarian traders on a daily basis.

To address the other point of providing liquidity "when the markets need it most", let's take a step back. When you say that "market makers should step in to provide liquidity [for society's benefit]", you're implying that there's some externality to lack of liquidity in financial markets (if so, this is yet another reason that we need HFT on a daily basis). Suppose that this is the case: there is some negative externality to society when markets are illiquid, as is oft to happen when things go crazy in the world. During those times, volatility is insanely high because the risk of being in any position is also insanely high. Remember, market makers get compensated (on average) for holding risk that you don't want. If risk is higher, naturally, the compensation should be also. This is manifested in higher costs of execution: spreads widen and the available quantity at each level decreases.

If you want to force HFT market makers, which are private corporations, to step in to provide more liquidity, then you are forcing these companies to pay for that externality. In effect, they would take on huge risk for far diminished expected returns. That doesn't make any particular sense to me. However, if society as a whole has this view that some private corporations need to pay for public externalities, then that should be a matter of regulation. But if that's the case, why pick on HFT in particular? Why not force McDonalds and Whole Foods to give food to hungry people during famines? Surely, there is an externality to the food industry NOT stepping in during periods of extended hunger, "just when people need it the most."

[1] http://georgewashington2.blogspot.com/2010/10/yes-70-of-us-e...

I'm still in the "learning the syntax" stage of finance so this is great information. thank you. do you think that one reason why people say bad things about HFT is because they see them being unfairly compensated for taking on what they perceive is a small amount of risk? as in - "come on, how hard can it be to grab a block of stock on an upward trend and quickly sell it." Of course, the more I dig into this, the more I realize how hard it is to find those trends and how easy it is to lose your ass. But, people don't dig in themselves.

do you think that one reason why people say bad things about HFT is because they see them being unfairly compensated for taking on what they perceive is a small amount of risk?

I think that's definitely part of it. The issue is that people don't know how much high frequency traders actually make per contract. The amount is pretty small (on average). Typically, each trade takes on "bite-sized" risk and expects "bite-sized" returns. Do that thousands of times a day, and your bite-sized returns grow to something reasonable, but not ridiculous. Certainly, it's not on the order of how much other forms of proprietary trading make.

I think the other issue is that people don't understand that all traders, HFT or not, take on risk when they enter a trade. A lot of people use terms like "skimming off the top" or "making money for nothing". This indicates to me that they don't realize why market makers should even make money (on average). It's simply risk transfer, and that has a price (on average).

You're right though, identifying bona fide trends are pretty difficult. If it were easy, everyone would be doing it and arbing those trends away.

"Liquidity is needed most when markets are falling outside the norm"

True but humans have fail-safes and kill switches too, thus this is not a valid argument against HFT in favor of human market makers. At any time, humans could step in and provide liquidity during the flash crash and during other crashes.

"At any time, humans could step in and provide liquidity during the flash crash and during other crashes."

Humans can, and do. But algorithms can't and won't.

Short answer: there is a large demand for liquidity throughout most of the trading day.

I'll give you the long answer when I get back from work.

They're just piggybacking trend and making profit of it, that how there used. Maybe not why and how they were designed. Still, IMHO, it is not fair and goes against the very definition of stock exchange.

High frequency traders are simply are able to provide the most competitive price in the market. They usually do this with a strong hunch that they will be able to get out of that position in a short period of time at a better price. Are they providing a service? Absolutely. When HF traders are involved in a transaction, risk is transferred to them. No matter how short the interval is that they're trading on, they're still taking on risk. The party trading against them doesn't have to worry about what way the market is going to move after the trade is complete and they are willing to pay for that.

Consider a hypothetical stock currently trading at 34.05 bid, 34.06 ask. Trader A puts in a bid for 100 @ 34.06, matching Trader B's ask of 34.06. Normally, B would then sell to A, but thanks to HFT, institute C has the unique and intrinsically unfair position of being able to fulfill A's order. Assuming a moderate holding of stock, you are then able to manipulate the market up and down second-to-second by selectively fulfilling buy or sell orders and so causing supply or demand to pile up temporarily.

In a zero sum game where knowledge is power, you know exactly who is buying and who is selling - before John Q. Public knows. To compound this, you can fulfill orders using immediate or cancel (IOC) orders before they hit the markets - making it impossible for others to know how much or even whether you are buying/selling.[1]

In itself, there is really not much wrong with this - market makers have been doing this for decades, possibly even centuries. And as long as there is a level playing, where everyone sees orders at the same time, there really is no problem - an invaluable service in the form of liquidity is provided.

Having the advantage of being able to front run the markets is not limited to just market making, however. Limits are one of the ubiquitous features of stock markets - the ability to say, I will buy or sell X shares of this stick up until it hits price Y. This can be exploited easily by HFT/front running - you have 30 ms [2] to probe out where the limit is with small IOC transactions. In this way, you are able to meet orders at prices that are different than the currently trading price - effectively bypassing all competition.

Just to respond to one of your statements from the linked post:

> A common misconception is that high frequency trading is like operating a money printing machine... This is false. Peruse this Forbes article, if you will - http://blogs.forbes.com/afontevecchia/2011/02/15/bernanke-pu...

I am interested in any civil responses to this. I am not professing to be any sort of expert on HFT. [3] Normally I would not bother responding to posts like this, preferring to avoid talking to anyone, but your slightly condescending tone was infuriating.

1. This may not be correct, in any case, the IOC would only be of the required size and so not provide any indication of holding size.

2. http://rusingwithronestar.blogspot.com/2009/07/goldman-effec... Cannot find any mainstream media confirmations that it is indeed 30ms, but this number seems well corroborated.

3. I have used HFT and front running as synonyms because they seem to be inescapably tied together. Why the need to have picosecond advantages if you aren't trying to beat another bottom feeder to the prey?

edit: bah, I really dislike how HN treats newlines - I can't find any way to simply start a new line without a space in between the two sentences. Comes out like a block of text at 1366x768, or ends up looking too spread out.

Explain? Who is institution C? How are they able to violate time priority?

Assuming a moderate holding of stock, you are then able to manipulate the market up and down second-to-second by selectively fulfilling buy or sell orders and so causing supply or demand to pile up temporarily.

This is also very vague...

On some stock exchanges, for example NASDAQ, you can pay a fee to be allowed access to market orders earlier than anyone else. Paired with colo services (literally your servers are next door - nearly eliminating network latency) you have a massive time advantage.

Sources: http://www.nytimes.com/2009/07/24/business/24trading.html http://www.nytimes.com/2009/08/05/business/05flash.html

Note that the SEC has not banned flash trading; it only proposed to do so - as of so far they have not done anything.

The second point - it is the core of how market makers work to provide liquidity, with the added advantage of being able to see orders first. Simple supply/demand dictates that selling stock will drive the market down, since existing sell orders are not filled and slowly pile up at lower and lower prices. Then beginning to buy shares will raise the stock price temporarily, at which point the cycle repeats. Being able to figure out the limits on the buy/sell orders is simply icing.

--- It appears that NASDAQ probably discontinued market front running voluntarily in late '09; I wasn't aware of that. I will have to rethink my positions - HFT as such isn't wrong in my opinion, although being able to make a profit 97% of the time (and having 3 straight quarters of only profitable days) is ridiculous, as is profiting purely from having a connection that is faster than what everyone else has.

You're point that market makers provide liquidity by flash orders is entirely false. You clearly have no understanding of how market makers actually go about their day to day business. Please don't pontificate as if you do, or if you plan to, acknowledge that you're only speculating based on marginal facts and poorly written articles (yes, even the NY Times has horribly inaccurate articles) you've gathered on the internet.

In fact, that entire paragraph is pure specious reasoning. The main point that really drove it home for me was:

Being able to figure out the limits on the buy/sell orders is simply icing.

I can gather you have not actually tried to find a statistical trend in market prices. Simply put, it's difficult to do in practice.

rgarcia already pointed out that your statement about institute C violating price-time priority is false. You then make a defamatory remark against the industry with zero evidence. Market manipulation is illegal. No respectable trading firm does it. Why? It is unethical and illegal.

In a zero sum game where knowledge is power, you know exactly who is buying and who is selling - before John Q. Public knows.

Since when was it the prerogative of every market participant to get quotes at the exact same time? There is a huge cost to colocation--it doesn't come free. The fact that trading has as high barrier to entry is a moot point. Starting a biotech company takes hundreds of millions of dollars in capital. Is it unfair to John Q. Public that Amgen and Novartis have competitive advantages in that field? Of course. Is it unethical? Absolutely not. When the steam engine was invented, was it unfair for guys who drove horse buggies? Of course. The new technology replaced him because it was able to do what he did, but more efficiently. This is no different. Day traders (I'm assuming that's what you're referring to when yous ay John Q. Public) are horse and buggy drivers. It isn't the fault of high frequency traders that they are that way. If John Q. Public wants to stay competitive, he has to change what he's doing.

If, instead, you're talking about your pension fund buying 1 million shares of Microsoft, then you have to realize that HFT is actually decreasing the cost of their doing that. Tighter spreads and more liquidity lower transaction costs for everybody.

Peruse this Forbes article, if you will - http://blogs.forbes.com/afontevecchia/2011/02/15/bernanke-pu....

I find it ridiculous that the article you cite makes no mention of HFT! In fact, I'm pretty sure that those profits are from their prop trading desks that don't do HFT. I can tell you that with certainty, because I know the ballpark of how much HFT firms make, and it's nowhere near that number. Please don't cite facts that are irrelevant to your point and then carry on as if they prove your case. I perused the article, did you even read it?

Flash orders, if they're even used by anybody anymore, must account for some negligible fraction of market volume.

Market makers need high speed mostly to avoid getting picked off by other aggressive HFT firms. The prey isn't day traders, it's other HFT firms. Day traders don't operate on the same timescales as HFT. Just the fact that a day trader is using a mouse to enter and exit positions already precludes that possibility. If day traders are placing limit orders into the market and are upset that they can't cancel fast enough, they need to understand that their edge isn't in cancelling quickly, but purportedly something else (predicting longer term price movement?).

I'm all for a civil debate, but please checks your facts. Most of the sources you cite are irrelevant to this discussion :(

This went about as well as discussing religion/politics online, i.e. anything but constructive.

Thank you for your contribution.

What do you mean? I replied to every point you made.

What information/experience informs your critique of markets/HFT?

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