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Comment by raymondh | Hacker News Reader

This article is long on inflammatory language and short on analysis or evidence.

There are plenty of real issues with HFT as currently practiced (front-running data feeds, gaming with flickering orders, dark pools, etc). However, the article ignores these real issues and suggests that liquidity itself is a bad thing (or something not worth having).

Liquidity means having the ability to transfer an asset quickly with minimal loss of value. Anyone who invests wants a liquid market -- illiquid securities are notoriously problematic.

The article is misleading. It is the absence of liquidity that is a disaster. Market crashes are what happens when liquidity dries up. Just ask anyone who was trying to sell their house last year.

As long as the rules are fair (no front-running, preferential trades, equal access, etc), every market participant adds value. Markets are auctions and auctions run best when there are active bidders.

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It's fake liquidity IMO, since HF traders are only willing to take a position inbetween someone selling at one price and someone buying a bit high. The trade was going to go through without them in the middle. They are just skimming some money from the buyer, who would otherwise have a lower price at the cost of delaying a trade for half a second.

Can you explain that situation? As I read it, it goes like this. Someone is willing to buy at $1.50, and someone is willing to sell at $1.60. If an investor comes along that wants to buy right now, he has to buy from the seller at $1.60. But say a HFT quickly throws out a sell order at $1.59, so the investor is now able to buy at $1.59 from the HFT. The investor saved $0.01, and the HFT made a trade he must have wanted. Where is the money being skimmed?

Lets take your example and extended to two investors. One who wants to buy and one who wants to sell. If Bid is at $1.50 and Ask at $1.60 then in an efficient market you can expect the two investors to meet at the middle and make the trade at $1.55. That will not occur. Instead of trading with each other, both investors would trade with liquidity providers who will step in to buy from one investor at $1.51 and sell at $1.59. As a result the investors will get their orders filled at only $.01 better than the expected bid/ask and the HFT guy would make $.08 in pure profit.

In reality this does not occur. What happens is that another HFT guy would step in to offer $.02 to each investor in price improvement and take $.06 in spreads. The next HFT guy tries to shave off a little bit more until the spread narrows to $.01. HFT guys then try to take little bits of that remaining spread with exotic order types, rapidly putting and taking off orders, and other tricks and squeezing more money out becomes increasingly difficult.

Edit: To clarify as per dchichkov comment, because of the competition between HFTs guys, the investors would only see a spread of $.01 or $.02. Thus both would trade around somewhere around $1.55 though not necessarily with each other.

In reality spread would be $0.01 or 0.02 and these two investors would meet in the middle. Even on different exchanges. Thanks to HFT guys.

Yes, I edited that little bit in for clarity.

The part about squeezing the very last bit of the performance still stands though. Because of mid peg orders and darkpools there could also be fractional pennies which are almost always collected by HFTs. If you watch the trade tape, you may see trades happening with $.009 and $.001 sub penny amounts. These darkpool are trades where someone offers $.001 in price improvement and takes $.009 from the spread at another venue if they are lucky.

If HFT firms buy at 1.60 and sell at 1.59, where is their money coming from?

As a high-frequency trader, I can tell you right now that you are just completely incorrect. I'm staring at a screen right now where we take both sides on every order, not 'skimming some money' from people. It's obvious you have no idea what you're talking about.

I would apologize for harsh language, but I have low tolerance for people who freely speak lies of matters of which they know nothing.

If you aren't making money from having the majority of your trades inbetween two trades you are necessarily losing money. But HFT is profitable for you, which is a contradiction.

tumult: As a HFT do you guys (in the gender neutral sense) ever worry about rogue algorithms? By that I mean an algorithm that could be used to harm the market or essentially "blind" other algorithms.

Except that's just not how anyone trades.

Before computers, its not like people just waited until they got a price match to make a trade. Human market makers sat in the middle making money the exact same way computers do. Except they weren't as efficient, fast, or smart, so they had to charge higher spreads to compensate.

Are you a trader that likes paying low spreads? Then you probably like the market better now. Are you a trader that loves getting paid high spreads? Then you are probably writing articles about why HFT should be banned.

Depending on the market and the instrument traded, it can be very rare for "natural liquidity" to generate trades (e.g. mutual fund trades with individual investor through their brokers) and most traded orders interact with some sort of liquidity provider. In these cases, the HFT firms tend to step in front of market makers who are less technically savvy and take the money from them. In this case, customers tend to get better prices on their orders.

One of the big misconceptions about "flash" orders was that customers were being disadvantaged; many customers actually wanted this feature so that they could continue sending volume to more technologically advanced markets such as BATS and Direct Edge and avoid being forced to send to e.g. NYSE (which was very slow) by "trade through" regulations. I've been in the position of wanting this service, and I suspect that most of the criticism came from older markets that were unwilling to invest in technology and change their rules to facilitate faster customer trading.

>However, the article ignores these real issues and suggests that liquidity itself is a bad thing (or something not worth having).

The author does not suggest that. Rather, he says that beyond a certain point, liquidity stops having any practical value.

> beyond a certain point, liquidity > stops having any practical value.

Hogwash. Price improvement is "practical value".

If you're selling an asset, there always practical value to have an immediate buyer willing to pay you a better price than the next guy. That's why auctions go to the highest bidder rather than the second higher bidder.

I doubt that HFT traders really engage into frontrunning or market manipulation. It is illegal. Supporting HFT infrastructure R&D is expensive. And takes nontrivial effort. It is simply too risky to engage in illegal activities.

Edit: no point -> too risky

"There is simply no point engaging into illegal activities."

There are many major firms such as SAC capital that built a business around insider trading (which is also illegal).

Just yesterday: http://www.businessweek.com/news/2012-10-02/ex-sac-capital-m...

Unlike HFT, insider trading doesn't require investment into infrastructure and R&D.

Investment of someone elses money. To someone out there this is a rational risk to take.

And if you do it right it doesn't leave a paper trail. I've always suspected insider trading is the norm, and the careless people get caught.

When one market participant breaks the market with his crappy program, that's a huge problem for the companies that use the public markets to raise money - the entire reason the markets exist. There was plenty of liquidity in the 90's and before to fulfill that function, even with the huge spreads back then. You are missing the forest for the trees.

Breaking the market with a crappy program costs the responsible firm tons of money, up to a complete insolvency.

This system is mostly self-balancing.

Mostly. Until it isn't. It only takes one really bad screw up to cause a boatload of damage.

To the firm who is responsible. If they are buying up securities at well below-market rates, the problem solves itself.

And anyone relying on that firm. What happens if a major bank pulls a Knight and blinks out of existence? Can this happen? I don't know. The answer to that question should be an emphatic "no."

There are already triggers in place now to stop trading when it gets out of reasonable bounds not right? Say like a x% shift throws an alarm that halts orders until a human looks at the situation, etc. I like the ticking exchanges (like the FTSE does not right?) where it "ticks" on the microsecond or some such so some of the clever hacks (locating near the datacenter) are eliminated.

The real question at stake here is do we want to hold back real algorithmic innovation that we actually want? Of course we need to have alarms to head-off flash crashes, but we want a lot of great people working on getting information into the market as fast as possible right? I mean the end goal as I see it is the replace of most traders to algorithms that bring prices closer to market with better/faster information.

I would disagree. We do not need innovation. We need stable functioning markets, which is a goal that is in direct conflict with innovative trading. The system, and the participants' confidence in that system is of far greater importance than the efficiency of the system, and infinitely more important than the opportunity for some smart computer guys to make a buck doing essentially nothing of value. "As fast as possible" should not be the goal. "As fast as necessary" should be, and we are well beyond that.

YOU are missing the forest for the trees. When the a stock is misvalued for about twenty minutes on the public markets, NO ONE raising money in the public markets (in the form of IPOs or secondary offerings) loses money. Not a single one.

Also, you're just wrong about the reason the market exists. The market is just as much about people trying to raise money as it is about people wanting to transfer risk.

> There was plenty of liquidity in the 90's and before to fulfill that function, even with the huge spreads back then

Are you saying things were great back then? why would anyone want to pay huge spreads?

Why do you assume small, temporary mispricings are the worst that can happen? It's all connected.

>> It's all connected.

is that really the best argument you have?

Yep. I believe that the stability of the markets is of vital importance to civilized society, and computers (among other things) can endanger that system when used recklessly. We have clear evidence that the people writing this code often enough do not give a shit. And that is a problem. I'm just saying that there ought to be some thought put into how much we need to push innovative techniques when the stakes are so high. We almost broke everything in 2008 with derivatives and leverage. We out to think about how similarly scoped problems can arise when mathematicians are allowed to get creative before it happens. It only takes once.

none of the things you said describe a mechanism for how hft can topple society / endanger markets / other non specific harms.

seriously, reread your comment. now apply it to online shopping, telephone systems, satellites, air traffic control, etc. it applies to literally everything involving technology. should it all be banned?

I never said HFT. I said out of control computer algorithms. The point is that the markets should not tolerate cowboy coders breaking things in a way that endagers the whole system. Knight failed catastrophically. There is your mechanism. No go apply that to a larger, more unstable part of the market. What if Knight was BofA? Bad things can happen, and if the best argument for this sort of thing is "liquidity", thanks, but no thanks. We have enough of that already. I'm all for letting people gamble when they are the ones who take the loss. But we know that is just not how Wall St works at present time. That needs to change.

Any electronic trading system is capable of experiencing severe errors that have nothing to do with HFT; some of the most common examples involve manually keying an incorrect price or size for an outgoing order. The sort of safety mechanisms implemented by the exchange (which shouldn't permit errors by member firms from damaging the market) to prevent these sort of problems are similar to the sort of mechanisms that can prevent crashes from faulty automatic trading programs.

I thought all these computer trading algorithms had failsafes so they abandon the market when something goes wrong? Liquidity that disappears like that doesn't seem so useful.

Failsafes are triggered irregularly and are thus prone to bugs. It is also very rare to go back and review data with a separate implementation of the failsafe to see if the normal implementation is functioning incorrectly in certain circumstances, so errors in the failsafe algorithm can be difficult to detect until a major problem occurs.

There's nothing preventing humans from abandoning the markets as well. This isn't unique to HFT. Human market makers can also withdraw their liquidity when things don't look good.

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