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Comment by ap22213 | Hacker News Reader

I know several people who make a lot of money in trading, and I hear the liquidity argument constantly as the justification for their behavior. They describe the millions that they make as payment for all the 'value' that they've given to everyone; But, as an ignorant, I can't see how those millions could have come from anywhere than other (less informed) peoples' pockets.

To me, the worst part (again, as an ignorant), is that the argument seems practically untestable. They say that if we prevent or regulate these complex trading instruments and schemes, then the sky will fall. But, to me, it just smells of religion.

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It's vastly testable, there are thousands of different markets with different sets of regulations.

But your talking about two different issues, the liquidity issue mainly applies to exchange traded assets while more complex instruments tend to be OTC (i.e. custom agreements).

With liquidity you can be a sophisticated buyer and still be willing to pay for it. For example look at when MtGox was lagging by 600 seconds when bitcoin was in freefall, many buyers would happily have paid a hefty fee to be able to trade out of their position instantly without having to worry about what the price would be when the transaction was finally able to get through.

Ok - but, here's where I get lost...

Some of these people are high-net-worth individuals. I sometimes ask them why, instead of trading, they don't take that money and invest it in new research or technology or product development or services. At least then, there would be jobs created, technological progress, more money exchanging hands. But, to them, it doesn't make sense to do that; they make much higher returns, more quickly through trading.

To me, a lot of this money seems to be 'locked up' in liquidity trading, that would otherwise be doing good things for the economy and human progress. Right now, it doesn't seem like the traders have incentive to do other things with the money.

When a friend of mine 'clicks a button' and makes a few million from a trade, how is that adding equivalent 'value' to the overall economy than if he would have taken that money and invested it in a new start-up? Again, this is my total ignorance, but something doesn't seem right. To an ignorant person like me, it just seems like wealth exchanging hands, but how is clicking a button better than employing hundreds of people?

It's "clicking a button" in the same way programming is "typing on a keyboard" - people execute trades of different asset classes for a huge variety of reasons and with different motivations and outcomes.

Let's talk fundamentals: if we didn't have an equity/bond market it'd be much much harder for companies to raise money for growth and investment. If we didn't have an IPO market you wouldn't have company exits - the most common forms of company exits are IPO or sale to a listed company. Without exits it wouldn't be economical for VCs to invest in startups.

All of these things are interconnected, having liquid public markets play a huge part in economic growth by both directly and indirectly financing the growth-makers.

That's how Wall Street works. You give money to Wall Street, and Wall Street in turn chooses to distribute the money to technology or research companies like Google or Merck (or even venture capital funds which in turn invest in start ups). Wall Street adds value by allocating resources.

Trading is a legitimately socially useful business, but it's winner-take-all. Yes, they provide liquidity and, in doing so, capture proportionately small amounts of money that other principals don't care about. If you need to move $25 million, are you going to notice a difference of a few hundred dollars that an arbitrageur collects (by taking the other side of a bid he judged to be 0.37 cents high? No. You want your trade to go off. Principals would lose money to the bid-ask spread no matter who's in the market; arbitrageurs narrow it by competing against each other.

So why do traders make so much money? Because they're better or more useful than software engineers? No. Because they steal it? No, not that either. Software engineers are seen by the business as cost centers, even in 90+ percent of startups and even at Google (closed allocation).

For traders, it's a different story. If Bob is a little better than Mark, Bob will get 100% of the business and Mark will get nothing. At this point, to do arbitrage you need to be thinking about microseconds. If Bob can execute in 75 mcs and Mark takes 100 mcs, then Bob is going to get all the trades. Trading shops must be meritocracies because they have no other option. If they can't hire good traders, then there's no reason to keep working.

Because trading is winner-take-all, trading houses put a lot of money back into compensation: 40 to 50 percent profit sharing (in a way that, outside of direct P&L roles, is subject to politically fucked-up performance just like everything else) is the norm. That'd be like a typical software company paying $250k-500k bonuses.

If we, as software engineers, want to make trading money (not the 5-10m outliers, but 250-1M, then we need to think about profit sharing-- http://michaelochurch.wordpress.com/2013/03/26/gervais-macle... -- instead of this startup equity that pays off in the distance future, and is subject to horrible terms). I believe that we, as a group, could be making what we're actually worth, but we'd have to convince businesses that we're as essential to their operations as traders are to trading houses and, thus far, we haven't done so.

If Bob is a little better than Mark, Bob will get 100% of the business and Mark will get nothing. At this point, to do arbitrage you need to be thinking about microseconds. If Bob can execute in 75 mcs and Mark takes 100 mcs, then Bob is going to get all the trades.

If Bob were to be kidnapped by aliens, would society be poorer for it?

Nope, but someone else would get the money instead of his client. Think about you engage a negotiator for buying a house and he only gets 5% bargain when another one could have gotten 10% - the seller gets the money you'd have otherwise.

No, but the people paying his wages would be, and that's sort of the point.

Bingo.

Not at all, but that's how commodity work works. The provision of the commodity is important, but there's a limited market and superficial or unimportant differences (in traditional marketing, branding; in finance, 75 vs. 100 mcs) determine who gets what share.

What traders do adds a lot of value to society. The difference between 75 and 100 mcs is irrelevant. Ultimately, trading is converging on a circle-jerk of machines throwing numbers at each other, but the world is better off with that circle-jerk, and really doesn't care whether it's Bob or Mark who wins.

Trading is the last commodity job.

However, traders don't make more money than computer programmers or professors because they're more important to society (that's clearly not true) but because of the employer/management filter. For traders, the organization is so sensitive to small differences in individual performance as to justify extreme compensation. Software engineers are worth just as much to the world, but employers still see them as cost centers because, while engineers actually have their employers just as much by the balls, it's not as visceral as it is with traders.

If you think of economic input/output relationships as S-shaped curves (I've dealt with this a lot in exploring convexity and concavity of labor) then trading is an area where the precision/scale parameter has gone to infinity and it looks almost like a step function.

>Not at all, but that's how commodity work works

Then something needs to change so it stops "working" that way.

I am more ignorant than anyone on this subject, I too have similar questions on the stock market as a whole, not just traders. Originally, stock market was created to raise large amounts of capital for big projects/companies. Once the IPO is done, people keep buying and selling stocks - how does it benefit anyone other than the seller who makes a profit? It doesn't add extra capital to the company, doesn't "create" anything (physical, digital or otherwise). Maybe this question is really dumb, but I really can't understand why traders (and other wall streeters) are paid so much

> Once the IPO is done, people keep buying and selling stocks - how does it benefit anyone other than the seller who makes a profit?

The IPO (initial public offering), isn't necessarily the stocks only public offering, so the trade of stock on the market provides the firm the capacity to raise additional capital via further public offerings. (The demonstrated ability of the firm to do this may also influence its ability to raise money through other financing means.)

Investors will generally only be keen to buy into an IPO if they know that there is the possibility of selling the stock in the future in an open market.

Wealth is not fixed. Both parties can benefit from a trade, and often do. A party that wants cash now and another who wants more cash in the future both benefit from a trade (e.g. buying and selling a bond).

If your pension fund doesn't day-trade, you never pay those fees for liquidity.

Liquidity isn't free, and no one is forced to buy liquidity (unless your money is managed by an incompetent/corrupt manager due layers and layers of your employer-sponsored pension contracted to a bank....)

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