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Comment by apaprocki | Hacker News Reader

http://invezz.com/news/alternative-investments/625-uk-report...

"Veteran traders would usually wait in anticipation for the weekly report of gas-inventory figures by the U.S. Energy Information Administration released on Thursday at 10.30 AM and then dive into the busiest trading window of the week. This is no longer true as most traders are now staying out of the market due to the HFTs new strategy - sending floods of orders in an effort to trigger huge price swings just before the data gets released, also known as “banging the beehive”."

edit: Fast algo puts orders out on multiple equity exchanges and then hedges itself with a slow algo in the futures market.

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At what point will HFT drive out the proper functioning of a Market?

Have there been any studies on this? If human traders mostly reacted to "real" news (the Orange juice crop is bad this year) then human trading was mostly linked to actual changes that affect the price mechanism

But if large volumes of trades are speculative, or even worse, are directed at affecting the behaviour of other large Market players, is there not a point where the selling of actual OJ is just noise in the Market?

One can anticipate HFT bots acting like the strange Amazon pricing of obscure books in the millions of dollars, bots competing against bots to acquire more of the rent redistribution. If we can imagine that we can imagine a failed crop with prices being driven down in a frenzy.

Surely some research exists on this? Where is the price signal tipping point?

The HFT boys are creating vast amounts of liquidity and squeezing the spread down to unprecedented lows. The volatility created by their trading is essentially invisible to a retail investor who observes the markets day-to-day rather than minute-to-minute.

It seems to me that people are fixated on volume, which is essentially an irrelevant figure - holding a big position for a couple of milliseconds has no meaningful impact on anyone but other HFTs. If we smooth our data to a resolution of minutes rather than milliseconds, market behaviour looks no different today than a decade ago. Even a supposed disaster like the "flash crash" of 2010 corrected itself within five minutes.

I'd be curious to see if the same debates were happening when computerised trading was first introduced. The magnitude of change was far greater, but there's broad consensus that computerisation led to fairer and more efficient markets. I just don't understand how faster trades can be bad in and of themselves. If your objection is to speculation in principle, then by all means argue for a Tobin tax; I just don't see why it matters very much whether that speculation occurs over the course of days, hours, minutes or milliseconds.

If a flash crash triggers a stop loss order and I lose my position in a stock, would that be considered relevant?

Stop-market orders, which turn into a market order when the stop is breached, are obsolete. Worst case one should set a stop-limit order, which "becomes a limit order that will be executed at a specified price (or better)" when the stop is triggered. "The benefit of a stop-limit order is that the investor can control the price at which the order can be executed" [1].

Your asset manager should know this and broker advise you of it. Then again, I don't think retail traders should have such unrestricted, unsupervised access to the exchanges.

[1] http://www.sec.gov/answers/stoplim.htm

It just means that your stop-loss order is working on unsmoothed millisecond-resolution data when it should be working on smoothed minute-resolution data.

When your stop-loss order executes, it's not going to execute at a smoothed minute-resolution price. It's going to execute at a price that's currently in the book. That means that it's not going to stop your losses if you trigger it with smoothed minute-resolution data. Twenty years ago, it would have. But today it won't, because anybody who took your smoothed minute-resolution price would be giving you an exploitable arbitrage opportunity.

I'm not claiming HFT causes securities market price crashes; maybe it does or maybe it doesn't. I'm claiming that, if a security is crashing, HFT gives it the chance to crash in milliseconds or less, rather than minutes.

Just so I'm not misunderstanding you....so you're saying that flash crashes would not and have not executed stop loss orders? (And also wouldn't trigger far out of the money purchase orders?)

That seems contrary to my understanding of how the market works. If a stock is trading at x and I have a stop loss in at (x-10) and the stock trades down to (x-20), even for a few moments, I would assume my order would execute (this is assuming FIFO execution of orders, and also assuming sufficient volume at that price to exhaust all the standing orders once we are down in that region).

Are you saying this is not the case?

The great-grandparent comment said that the market (specifically stop-loss orders) ought to work the way you thought the grandparent comment said it did work. The grandparent comment, to which you replied, actually described what would happen if the market worked the way it had been proposed to work. You are correct about how the market actually does work, and my comment explains why it works that way.

Holy crap now I'm even more confused. I just want to know if stop loss orders will or will not execute during a flash crash, when the crash price trades below the stop loss price and their is sufficient volume to eat through all the standing orders.

Yes they will trade. No they will not trade (if they will not, then I'd be curious to know why, which perhaps has been explained above.)

EDIT: Rereading your comment above again, you seem to be of the belief that it will execute - which was the entire point of my argument. People talk as if HFT has no downsides, this to me seems like a clear downside. And saying "well just don't use stop loss orders, or use stop limit orders" isn't a valid counterpoint. A stop limit can still execute, the problem is when the stock dips down for a two minutes and then returns to where it was, but now you no longer hold the stock.

Sorry for the confusion. Absent experience, I believe that stop-loss orders will execute during flash crashes, because you don't know if a crash is a flash until it's over, at which point it's too late to stop your loss. Is that clearer?

It won't. High frequency trading slices the gap between offer and purchase into an enormous number of tiny slices, and HFT companies compete to see who can collect the most number of slices. But that does not affect the underlying factors that lead to most offers and purchases of stock.

For example you could offer OJ futures at improperly high prices a billion times per second, but that does not mean anyone will buy them. I'm not aware of any evidence that Amazon's weird million-dollar books have affected the price of popular new books.

In addition, I wonder by what criteria one would evaluate how "properly" the markets are functioning. Who decides what is proper? For example, based on the business fundamentals it seems ludicrous to me that Apple would have a lower P/E ratio than GM--but it currently does.

>For example, based on the business fundamentals it seems ludicrous to me that Apple would have a lower P/E ratio than GM--but it currently does.

Their P/E ratios are very similar. Why does that surprise you? Apple is a very mature company. They're currently making huge earnings (which naturally lowers the P/E ratio if those earnings are not expected to continue at that level), and they're a big long-term risk because nobody knows exactly what's going to happen with Android vs. iOS. It's extremely plausible that margins in the smart phone and tablet markets will take a dive in the medium term as a result of vigorous competition, which is where Apple derives the bulk of their profits. Expecting Apple to be doing five years from now as well as they've done for the past five years is to expect them to come out with something new which is as revolutionary as the original iPhone. Maybe they will, but the market obviously isn't betting on that happening.

On the other hand, GM is not doing great earnings wise, but there is no obvious reason to expect that their existing customers are going to evaporate, or that their margins are going to change significantly from what they already are.

Plus, GM is apparently backed by the full faith and credit of the US Government. It's bulletproof. :)

My point was that the typical criteria for evaluating a market are the prices that it produces--but reasonable people can disagree about what the prices "should" be. (As evidenced by this sub-thread.)

> In addition, I wonder by what criteria one would evaluate how "properly" the markets are functioning. Who decides what is proper? For example, based on the business fundamentals it seems ludicrous to me that Apple would have a lower P/E ratio than GM--but it currently does.

Couple of things:

1. Reference to Apple PE ratio is likely a market driven phenomenon that has occurred before to the other technology company that grew very large very fast (MSFT) ie. sometime around 2000, most mutual/institutional investment funds literally owned more of MSFT (and now they likely do of AAPL) than they were legally allowed to own. At this cap, given that these buyers are the largest "long term" drivers of a stock's directionality, the stock must change direction. The second part of this effect is that now a bunch of them are underwater, and the psychology of holding a bad trade will affect whether they decide to book the loss (likely they wont for a while). TLDR: Apple is simply too large, relative to the tech sector, for its stock price growth to match its business fundamentals.

2. Re: markets functioning properly - we should remember that the "markets" are literally a construct. For all the logical arguments made about how HFT reduce the bid/offer spreads, I'm philosophically opposed to them. Mark Cuban has articulated why better than I can: http://blogmaverick.com/2010/05/09/what-business-is-wall-str...

In a nutshell, if we constructed the markets fundamentally to make it easier for businesses in the real economy to raise and price capital, and HFT starts to account for a multiple of that, then the purpose of the "market" construct has been hijacked.

This leads to all sorts of gnarly questions about how to decide what the right volume is etc, so I recognize its'a thorny area - just pointing out that HFT is not so benign, and oftentime comes with consequences that far outweigh the benefit, and happen too often to ignore.

Playing devil's advocate here: if you believe the purpose of the market is to help long-term investors buy and sell at rational/efficient prices (in other words, price discovery), then why is relative volumes of HFT vs. long-term investment relavent.

I'm not saying it's the best metric, or even a good metric, but there's quantitative evidence that when new news comes out and prices move rapidly, HFT reduces the time it takes for markets to settle down after big price moves. By many measures, this makes the markets more rough, since prices move more abruptly. On the other hand, with more rapid price discovery, fewer long-term investors trade at non-consensus prices during the transition period.

What business fundamentals are they?

The ones that say Apple has the vision and skill to enter and exploit many more massive untapped markets as we've seen them do repeatedly compared to GM's fairly static markets?

Oh, wait...

To oversimplify, there are two kinds of trading strategy: value-based and momentum-based.

Value investors judge investments by the expected revenue from it if they hold on to it for long. HFT does not bother them, except in so far as it increases the amount of uncertainty that you can pick up bargains when you see them due to uncertainty.

Momentum investors, or speculators, judge investments based on whether they think they can soon sell higher than they buy. HFT is supposed to be bad for them, since very high volatility makes the kind of judgements they go in for harder. Usually, HFT is itself a kind of momentum investing, albeit of a strange sort.

If HFT reduces the returns from momentum investing while leaving value investment strategies largely unharmed, it might correct bad incentives in finance and so be a very good thing.

I think that HFT is responsible for over 70% of the volume on the major exchanges these days. Very little of what happens on the exchanges anymore is directly attributable to long positions.

I'm not sure how current this is, but the average time a stock is held is roughly 20 seconds [1] and that's definitely not long-term value investing.

I think we're already a long ways away from Kansas Dorothy, and I don't think we'll be going back any time soon.

[1]http://seekingalpha.com/currents/post/110468

High frequency trader here:

This is only looking at the volume on public exchanges. There are a lot of regulations around public exchanges which prevent them from operating efficiently. For instance, unless the stock has a very small price, you cannot offer sub-penny prices on this exchange.

Most retail trades actually never see the exchange, they are sold in bulk by brokers to places like Knight or Getco who internalize the order flow. They cross customer orders and take on some orders. Since this does not happen on a public exchange, they can give sub-penny price improvements.

The same happen with dark pools where many hedge funds will send their trade to obtain better executions.

When the market makers who handle these order flow start carrying to much risk on their book, or if they don't want to take the opposite side of your trade, they send it to the stock exchange.

This means that the stock exchange is mostly a place where high-frequency traders meet to offset their exposures to one another. In this respect, it is not surprising, nor problematic that 70% of the volume come from HFT.

That all makes sense, but I would argue that we're still losing something very important.

There is a natural tension between intermediaries and suppliers in highly transparent and competitive markets. The threat of disintermediation minimizes rent seeking behaviors. Over the last few decades that threat seems very weak in the financial markets, which I believe will have negative consequences for our economy and society.

Yeah. I don't think it's surprising either, in fact when I was first writing the post I assumed HFT volume was closer to 95% of trade volume but I couldn't find any public numbers above 70%.

I think that dark pools are where the next crash will come from, but I'm by no means a financial wizard. The way I perceive it, dark pools and other nearly-invisible investment exchanges are scary in that the ramifications of dark pool trading can spill over into the light world (as it were) with dire consequences.

We'll see, I'm also thinking that the next crash could just as easily be caused by a rogue algorithm as a rogue trader.

Dark pools sound more ominous than they often really are. Most of the time, it's just trades that are done directly between two instituions (often via a broker-dealer like BGC or ICAP) rather than via an exchange.

Maybe you actually know a lot about dark pools, but by expressing fear without expressing knowledge, you give the impression that you're mostly afraid because the name "dark pool" sounds like some kind of unregulated secret exchange run out of a meat locker by the Russian mafia.

I think Kid Dynamite (a retired trader, non-HFT) has some pretty reasonable articles about dark pools:

http://kiddynamitesworld.com/dark-pools-are-not-scary-shady-...

Disclaimer: my employer helps mutual funds, pension funds, universities, etc. place large orders on the market, using a variety of techniques (including dark pools) to try and smooth out the market impact of these big trades and minimize the the amount clients lose to market participants who are trying to anticipate their short-term trading behavior.

Yes, I am aware of what dark pools are, and I'm not trying to imply fear. It's irrational to fear things you can't change, and it's unreasonable for me to deplore someone else allocating their money in an interesting fashion. I don't mean Dark pools are inherently bad because they're dark. These Dark pools expose society to unmanaged risk because of the implicit guarantees of support from the general population.

It's not so much evil as it is secret, and secrets with public shares are interesting secrets indeed.

As I said, I don't live in fear of Dark pools or any financial instrument, but it's important to understand that there is a significant difference between the normal sale and purchase of securities and the activity which happens in Dark pools. Otherwise there would be no need to draw a distinction.

> over 70% of the volume on the major exchanges these days. Very little of what happens on the exchanges anymore is directly attributable to long positions.

this isn't the same as being 70% of price movement. HFT is comprised mostly of market makers, who have books that, over the course of the day, are close to net zero. they do a lot of buys, but they also do a lot of sells.

most price moves over the course of a day are actually driven by people who take positional views, and buy or sell large positions. so actually, we're not really that far from kansas

That's not the whole story. If 70% of the volume is HFT, it means you necessarily have a lot of HFT trading against HFT, which means a lot of HFT is going to be liquidity taking.

Fortunately, that's only on public exchanges. Most of the liquidity provision happens before trade even hit those exchanges.

"we're not really that far from kansas"

Funny given that one of the largest high frequency trading firm, Tradebot, is based in Kansas City MO (not that far from Kansas)

I read this morning in Nate Silver's new book (recommended by Fred Wilson and published September 2012) "The Signal and the Noise" that the average time a stock was held was 6 years a few decades ago, recently the average is closer to 6 months.

Yeah, I could see a long position being held 6 months, but frankly almost all trades are microseconds now.

This is one of my favorite charts on the subject, also from NANEX: http://imgur.com/DxWer

Check that out, it gave me a new appreciation for the changes in volume and volatility we're seeing.

For the most part HFT just decreases or eliminates arbitrage opportunities, or price discrepancies between what a piece of information says the price will be and what the price currently is. Arbitrage has always been a 'feature' of the market and although there are increased barriers to entry for arbitrage, economic theory says that by eliminating arbitrage opportunities through trading the difference away the market is being made more efficient

I've been wondering if an exchange that prevented HFT would prosper in the current climate. I'm sure that plenty of companies aren't a fan of their market cap being at the whim of an algorithm and the large number of swings it would undergo.

Wouldn't they prefer an exchange that offered liquidity in minutes or even hours, opposed to fractions of a second?

They'll still be traded over the counter elsewhere at high frequency, so I think the end result would be widening spreads on the new exchange to cover the variation over a time tick (whatever length that is), and no one (even long term investors) would actually use the new exchange.

What is your definition of H though? If someone decides to offer a large block of shares for sale, and they break it into 100 lots, are they a high-frequency trader under this definition? What if it's 10,000 lots? 10,000,000?

This is a data structure problem at its core - the fact that someone entered one billion BUY orders at $15.51 should not prevent me from seeing that there's an outstanding order at $15.52. The stock market employs the queue only for legacy reasons.

"This is a data structure problem at its core - the fact that someone entered one billion BUY orders at $15.51 should not prevent me from seeing that there's an outstanding order at $15.52. The stock market employs the queue only for legacy reasons."

(1) I'm not sure I understand what you're saying about price information. You seem to be saying that level 2 quotes don't exist. I assure you that for the major exchanges, level 2 quotes do exist, but they're more expensive than what most discout brokerages/Yahoo/Google give you.

(2) I'm not sure what you mean about queuing at price levels being a legacy artifact. There needs to be some objective rule for deciding who trades with whom when there are multiple participants at a given price level. In most markets, it's first-come-first-serve (a queue). I read that MS POOL was going to try prioritizing based on size, but I haven't heard anything since. So, if it's not first-come-first-serve, and there are two offers at $5.43 and a trader comes in and lifts one of the offers (not enough size to lift both), which of the two offers should get lifted?

several futures markets queue partially or only by order size.

Betfair offers exchange sports betting. There, you always have 5 seconds to cancel an order even after it's match, and they suspend trading near a major event, like a goal in a football match. This seems to work quite well.

So cancellations made immediately before e.g. a goal are rolled back? Otherwise that sounds exploitable, as the probability of a goal increases dramatically before the goal takes place.

You could make the (weak) argument that HFT has created market inefficiencies due to excess liquidity and furthering information asymmetry. Most exchanges (NYSE, NASDAQ, BATS, etc) have "circuit breakers" to prevent a massive sell-off. As far as "noise in the market", you could make the argument that speculative trading is simply that: noise. In this case it is just an algobot doing the noise trading, rather than some idiot that thinks he's found the next best way to "beat the market".

OP is referring to a case of a buggy algorithm in a bot which was setting a ridiculous price on a used textbook on Amazon: http://www.michaeleisen.org/blog/?p=358

HFT has already caused at least one "flash crash": http://en.wikipedia.org/wiki/High-frequency_trading#May_6.2C...

Don't forget the PPT, "Plunge Protection Team" a working Group that was/is being used to prop up the markets during downturns. See http://en.wikipedia.org/wiki/Working_Group_on_Financial_Mark...

Information can cause one of three price reactions: up, down, or flat. Prices stay the same if the market accurately anticipated the information. Chances are, though, that the information will change prices. One thus knows that when an EIA report comes out, ceteris paribus, prices are more likely to spike or dive than stand still.

"Veteran" traders set up limit orders so that if prices rose they'd buy and if prices fell they'd sell. It's a momentum trade. Unfortunately, they were sloppy, submitting orders before the data came out. Arbitrageurs realised that these lazy limit orders could themselves be cannibalised by nudging the price around to see if it triggers any hidden orders prematurely. The order's premature execution would then create a tiny, temporary momentum effect that the arbitrageur could ride. This is called banging the beehive.

The trader pushed out was setting up information-less standing orders before the report released. The trader adding information to the market, e.g. through unique analysis, is not concerned by pre-release volatility.

It is possible, here, that a massive lazy limit was prematurely triggered and subsequently mis-interpreted. It's tough to say. With limited information I'd caution against Nanex's assumption of the low prior probability insider information hypothesis.

This is exactly what happened to a biotech's stock back in 2009.

http://pipeline.corante.com/archives/2009/04/30/dendreons_st...

Basically the company was about to release the findings from a key clinical trial. The stock price would either soar or it would flop.

Tuesday 12pm * stock price is $25

Tuesday 12pm - 12:27pm * massive wave of selling starts the price of the stock dropping

Tuesday 12:27pm - exchange halts trading at $11.81

Mind you, at the exact same time as this was happening, the company was releasing very positive clinical trial data.

So what happened?

The guess is that some large trader did some investigating and found out that a lot of people had stop-loss orders on the stock. The trader slowly accumulated a large position, then rapidly sold off shares right before the announcement.

This caused the stock price to drop, which initiated a number of stop loss orders, which further eroded the stock price. Since it's a small company with a pretty small float, it doesn't take much volume to really swing the price.

The trader then bought back a number of shares (at a very reduced price).

The stock was back over $25 the next day.

"Information can cause one of three price reactions: up, down, or flat."

Then there is no cause. Prices change somewhat randomly whether there is some information or not. The only correct predictive model is something like " there is 80pc chance that the price will be between -10 and 30 of its current value". Anything else is reading in a crystal ball.

I didn't invent any of these, read Thinking Fast and Slow if you have any doubts.

By price reaction I meant deviation from the path without the information. I was qualitatively representing the ensemble, i.e. parametric space, of possible price movements on (-∞, ∞) by mapping them to up <- (-∞,0), down <- (0,∞), and flat <- 0.

Let Px(t) be the price at time t. Px(t+δ) given Px(t), i.e. P[Px(t+δ)|Px(t)] is D = Gaussian(Px[t], vol) in an efficient market. We know relevant information is going to be added to the market at t+δ, but we do not precisely know its content until t+δ. The market can, however, make an educated guess. This information is a kernel with a central tendency* and an entropy, i.e. second moment, H. The price at t+δ is now D' = Gaussian(Px[t], vol + Hω), where ω is the weight of the information. Since H and ω are both positive we can see that D' is platykurtic with regards to D. D'-D, the impact of knowing that salient information will hit the market at a certain time, looks like a short butterfly P&L.

Thanks for the book recommendation; I enjoy Kahneman's work.

*If ω were very low or H very high, e.g. a unitary distributed kernel would have infinite Shannon's entropy, you are correct in assuming that it would have no impact on D', i.e. D'-D would be zero.

Commodity futures is not my specialty but I looked into the lagging quotes from leveraged natural gas ETFs and from natural gas producers.

It's well known that tracking index for gold (GLD) correlates to the tracking index of gold producers (GDX) and they diverge and converge. People would do pair-trading on GLD-GDX pairs to bet on convergence.

Given that there's a binary catalyst event for natural gas, I wonder if there's a viable strategy to identify the thinly traded natural gas producers and exploit the stale quotes by market-makers (if the laggards are not responding as actively as the more liquid traded natural gas companies like CHK).

On the other side, I wonder if in a highly volatile event where a lot of punters would bid up leveraged natural gas ETF (GASL) above its intrinsic value, and you can take the other side of that trade and hedge with more liquidly traded UNG or FCX options or futures market. Just food for thought.

EDIT: Also I wonder if there's a spread between IV in UNG options and in the futures market to do a calendar or ratio spread.

"I wonder if there's a spread between IV in UNG options and in the futures market to do a calendar or ratio spread."

UNG is implemented via futures. They announce roll dates every month http://www.unitedstatesnaturalgasfund.com/ung-rolldates.php and the futures traders definitely arb the fund's roll.

Why is "banging the beehive" not considered to be manipulating the market?

This is such utter bullshit. Markets are being programmatically gamed, and seriously bright young minds are still flocking to the Vampire Squid's embrace, hoping for a chance to help them do that in exchange for a slice of that phat, fraudulent loot.

it's not any worse than using javascript to further the ad industry

Well yes, both are bad, of course.

The ad industry's efforts have led to online privacy being all but non-existent, but Wall Street has turned our economies into shit and saddled the world with massive amounts of debt that will never be repaid.

But you can consider the ad industry far more "innocent" than Wall Street. The latter has known exactly what it's doing and causing all along.

where there's smoke there's fire... unless someone has a smoke machine

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