Comment by gaika | Hacker News Reader

Comment by gaika | Hacker News Reader

Parent Full thread

Don't ask who is losing on the other side of your trades but think instead who is your customer. What is the service that you provide and how it helps them.

If you're making a profit it means you bought inventory when the price was below fair value (your customers didn't need it and wanted to sell as fast as possible) and you sold it when the price was above (your customers really needed the shares right now). The net benefit to everybody is that the volatility is lower, as you moved the price down when it was too high and moved it up when it was too low.

The market efficiency is higher too: a lot less capital is required to establish fair prices as market reacts immediately to any imbalance.

It also makes the spread lower and makes buying and selling stock cheaper for your customers. Only a few years ago market makers and specialists would chicken out at the first sign of trouble and would widen the spread between bid and ask prices. Crossing the spread is a huge part of your overall expense of trading. Unfortunately very few investors understand full impact of it on their returns and don't appreciate your contribution.

Execution time is better now. Even during flash crash it was possible to buy and sell with retail brokers, where's I still remember times in 2001 when retail broker market orders sometimes took minutes to fill.

"If you're making a profit it means you bought inventory when the price was below fair value (your customers didn't need it and wanted to sell as fast as possible), and you sold it when the price was high (your customers really needed the shares right now)."

It's a bit more complicated than that, because it's fully possible that the seller in a trade is selling above his fair value and the buyer in that trade is buying below her fair value. Supply/demand certainly plays into it (a trader with a very large position is definitely willing to take some price hit if they are able to quicky their position), which will invariably lead to a discussion of utility functions and slowly bore everyone :P

> invariably lead to a discussion of utility functions and slowly bore everyone

But that's the crux of the matter - both sides of the trade are getting some utility gain (otherwise the trade would not happen) and thus it is not a zero sum game.

It is still zero sum in short term dollars, which just obscures the subject for the people who equate utility with dollars.

No, they are not getting utility gain.

Recently I was selling an netbook, aiming to get about £100. A friend told me she was wanting something, and looking to spend about £150. We split the difference and went £125.

It would not have been a utility gain if someone had quickly jumped between us, given me £100, sold the laptop to her for £150 and kept the £50 for themselves. We would both have ended up out of pocket.

The whole point of exchanges is that they connect buyers and sellers. Parasites living making a living by being faster than anyone else are not helping anyone.

If there was a level playing field, and everyone went at the same speed, and they could still make money, then I could believe they were adding some utility.

It's more subtle than that. If you wanted to make the sale now and your friend wanted to buy next week when she got paid, then an intermediary would be adding value, purely by being willing to act more quickly. The difference would cover them sitting on the laptop for a week.

It is yet more sophisticated for some HFT trading.

Continuing the analogy: Some trading is as if there's a person standing between the two people trying to make a deal and can hear the offers before each party can react and then make their own offers to each party to capture some of the difference (re: HFT profit).

Explanation: In some forms of HFT the key advantage is that they can buy the market data faster than other people so they can see upcoming trades before other participants (undoubtedly there are better citations but here's a decent NYT article): http://dealbook.nytimes.com/2010/06/11/opening-up-the-market...

High-speed traders are living in the millisecond range. Do you think the people doing trading on the order of seconds are pleased they are paying to save milliseconds or not? I suspect not, but would be happy to be proved wrong.

What would really happen is that a second trader would enter the market, offer to buy the laptop for 110$, hold onto it and then sell it on for 140$. Actual prices vary and with enough competition, will settle to something that gives the trader still a nice profit and enough cash to insure against the risk of such an operation (the trader doesn't know up-front when he can actually onload the goods and how far the price might move meanwhile).

Of course, if you're not desperate on selling right now and or the risk for the trader is too high (i.e. the minimum price you'll sell right now is higher than what the trader is willing to offer you right now), nothing happens.

Concluding, traders do add utility to a market. And as others have already said, with high freq trading it mostly results in massively reduces spreads (and the temporal utility as outlined in the laptop example essentially disappears).

These high-frequency traders are not parasites. They are providing liquidity. Essentially, they are providing you a service. If your friend had not come along, perhaps you would have been holding onto your netbook for a lot longer, or it may not have sold at all.

If you want to see what happens when liquidity dries up, you only have to look to the Flash Crash. Yes, the whole thing started due to an erroneous trade, but the fall was greatly magnified when all of the computers were pulled from the market when they couldn't make sense of things. If this type of trading were to be banished tomorrow, the market would tank so quickly that people would be begging for the computers to be flipped back on. The genie is already out of the bottle, and it can't go back in without considerable pain to everyone around it.

Dont forget that a lot of trades didn't clear.

I read somewhere that something like 30% of trades used to fall through because of paperwork mixups and other problems before electronic exchanges.

How would you like to think you sold at a profit only to find out that the trade didn't clear and now you're in the hole because the stock bottomed out?

The worst part was May 6 2010 (the flash crash). The exchanges and SEC arbitrarily threw out a number 60%, and people who managed to buy at 59% discount got to keep their (very) profitable trade and people who managed to buy at 61% discount lost only one leg of the trade. The process was not transparent, at all :/

I know some people who made a boatload (all trades cleared), and others who lost a boatload (one part of their trade was cleared, but the other part was broken, and they had to go back and buy back at a very disadvantageous price)

Reply on news.ycombinator.com