I'm old enough to remember trading on US stock exchanges in the mid 1990s when prices where quoted in 1/8s and 1/16s and NYSE specialists were the only ones with visibility into order book. Think about it: you as an investor had no idea of the depth of the order book, but the specialist who took the other side of the trade from you had it in front of him. The specialists were minting money. They would lose money maybe one day per quarter, and their ROEs were ludicrous.
HFT and ECN trading killed them. Labranche, Van der Moolen, Susquehanna, Spear Leeds, all gone. Goldman Sachs bought Spear Leeds for $6 billion in 2000 (it is now no more); Labranche specialist business fetched only $25m when it was sold to Barclays in 2010. Van der Moolen went bankrupt in 2010.
Investment bank trading desks, true champions of customer front-running, are shrinking fast. Cash equity trading has become so tough for the banks that they are starting to think of it as a cost center, a loss leader to promote their equity underwriting business.
These were multi-billion dollar businesses, with tens of thousands of middlemen living high on the hog from the spreads and front-running. They're all (mostly) gone. Good riddance.
If you want to relive the old days of trading before HFT, go execute a large trade on Karachi Stock Exchange. Put the order in and watch in amazement.
I would like to see the data showing total revenues of specialists, market makers, bank trading desks, brokerages, and HFT traders, over time. I would bet they have been going down for two decades. This is undeniably a good thing for investors.
You didn't need HFT for that. You could've gotten the same thing with LFT. If all you want is a penny spread, then nanoseconds don't matter.
Also, it is hard to prove a causal relationship, but with the rise of electronic trading and HFT, price spreads and fees have come down.
I can't prove it, but I believe that insider trading is also much less rampant in modern electronic systems than it was in the older pit based markets.
Re liquidity: it depends how you define liquidity. If you define it by "the average size at the bid or offer and next few price levels" or "volume traded", then yes - HFT has helped liquidity tremendously. If you define it as "the probability that a large order can complete", then liquidity has NOT gone up. With HFT, it's the same 100 shares/futures changing hands thousands of times per day, and they disappear often in times of uncertainty. If you need to execute a large order, you observe that you do not have the amazing liquidity everyone in HFT is talking about.
Re insider trading: I wouldn't bet on it. With electronic trading, it's now easier to do insider trading slowly without attracting much attention. Furthermore, HFT has created new forms of fraud, so far unregulated: see e.g. http://www.nanex.net/aqck2/4329.html
People seem to have this idea that back in the days of floor-based trading you could just call up the NYSE and say, "sell 1 million shares of Citigroup!" and the market makers would just kindly oblige you, without widening their spreads or trying to eke out a bigger gain from a transaction which inherently carries significant risk for them.
It's possible that the situation for executing giant orders in one fell swoop hasn't gotten any better under HFT, but it hardly seems to have made it worse. And as the large flow traders become more sophisticated and start to implement algos of their own, they'll get better at moving volume at a fairer average price.
> With HFT, it's the same 100 shares/futures changing hands thousands of times per day, and they disappear often in times of uncertainty.
I don't know about "often," unless you're talking about trading individual issues where news events introduce a high degree of uncertainty. There's really only been one case of a market-wide drying up of liquidity, which lasted for about 15 minutes during the flash crash.
There's also nothing new about market-maker liquidity drying up in times of uncertainty or severe volatility. Plenty of stocks went "no bid" during the 1929 crash. Floor-based market makers are no more interested in standing in front of freight trains than algos are. If you're looking for someone/something to blame when markets crash and there are no bids to be found, focus on the Fed and its attempts to manipulate the credit cycle, which periodically fail in spectacular fashion.
1929 is an obsolete example. Heck, the SEC didn't even exist in 1929. A more relevant example is 1987 -- how many stocks went "no bid" on Black Monday?
Here's how HFTs operate today. Bid furiously while the going is good. If you find yourself on the wrong side of a trade, you can always hit up the actual market-makers for a penny loss. And if the markets collapse, you pull out. What could be better? Supply liquidity when it's not needed, and stay out precisely when liquidity is most needed.
Meanwhile, the registered market-makers are pulling back, or pulling out. And why not? They used to count on having the good times to balance out the bad. But now, the HFTs are siphoning off their profits during good times. Thus, the cross-subsidy has gone away. In periods of market stress, the HFTs go hide under a rock and don't participate in absorbing losses.
The effect is: There are now fewer market-makers in periods of market stress. That's how HFTs have made things worse.
I don't know who these people are. But many people today see the screens and volumes, and say "see, HFT gives liquidity!", and that's wrong. I'm not saying HFT took liquidity away (it may have, I don't know, but for sure I didn't claim that). But it does not improve the liquidity that matters to most market participants.
> executing giant orders in one fell swoop hasn't gotten any better under HFT, but it hardly seems to have made it worse.
I agree. I'm just countering the oft repeated meme that "HFT provides liquidity". Essentially, it doesn't.
> I don't know about "often," unless you're talking about trading individual issues where news events introduce a high degree of uncertainty. There's really only been one case of a market-wide drying up of liquidity, which lasted for about 15 minutes during the flash crash.
There's been tens of "flash crash" and "flash smash" events in the last couple of years. Not of the magnitude of the one blamed on Waddell and Reed, but it's still happening.
> There's also nothing new about market-maker liquidity drying up in times of uncertainty or severe volatility.
I agree. I just disagree that HFT are providing any kind of service or benefit to the market. They only benefit themselves, at a cost to the market that goes way beyond the profit from arbitrage/scalping action that they do.
And it is easy to put a stop to: Adopt the rule Eurex and LIFFE had in 2001 that requires 10:1 order:execution ratio.
Actually not true. There was plenty of liquidity during the flash crash. It's just that the people who were selling ended up not liking the price they got. During the flash crash, the market was quite in order, except for a few stocks where all the bids were got (too much sell pressure) and the remaining bids were at $0.01... For most stocks, the market was just fine, just that the spread widened up considerably to take into account the temporary uncertainty in the market. Also, the flash crash took 5 minutes, not 15.
Flash crashes happen in human-traded markets took. Recently there was a flash crash in Indian stocks, where humans mark the trades. In fact, human-traded markets are worse: in 1987, the brokers just stopped picking up the phones, even if technically they had an obligation to do so.
This isn't the article I remember but goes into detail on most of these issues:
http://www.demos.org/publication/cracks-pipeline-part-two-hi...
This wasn't possible before HFT, and it allows retail investors to get much better trade execution.
The situation you describe is thanks to electronic trading, and is also available in financial markets that are not dominated (not to say "infested") by HFT, such as currencies and CFDs.
It is better to think of these as dials than as hard requirements. Some algorithmic decisions take a very long time to make decisions, other electronic trading systems hold positions for weeks or even months. I've seen very low latency systems that only trade a few times per day.
Finally, your currency trading example is perfect. The reason HFT's are less involved in those markets is that they are known to be dominated by insider deals and old boy network cronyism. It is not a "fair" place to trade. If HFT were to come in that may or may not change. I suspect it would get better.
HFT stands for "High Frequency". That has not meant minutes since 2008 at least.
> It is not a "fair" place to trade. If HFT were to come in that may or may not change. I suspect it would get better.
"HFT" and "fair" in the same sentence, with positive connotation. Now, that's funny: HFT in American exchanges these days is an all out, unregulated war of bits, and fairness is not an attribute you can associate with it - see e.g. http://www.nanex.net/aqck2/4329.html ; The reason HFT stays away from currency is not because of being "fair" or "unfair" (no markets are fair, every market has privileged players).
It's just that in currencies, the people you take money from own the system and will kick you out. They make their own rules. Whereas on ARCA and INET, the HFTs are the landlords and make their own rules (by quote stuffing and stuff).
Neither market is regulated against the privileged players.
Is it the amount of time it takes a computer to make a trading decision? Nearly any modern computerized system in under that time constant, and many non-low latency trades happen in that time frame.
Any electronic trading system (which I think most people agree are good things) will allow for algorithmic trading (how could they not?). The question is should we try to prevent low latency trading? If so, why? And how can we? Will any system we put in place cause more problems than it is worth?
Finally, if you don't think currency markets are fair, why use them as an example where you are getting better prices than you would be otherwise? Currency markets do not provide better pricing to all of their participants than electronic markets with HFT do.
It is time from when information becomes available until order goes out. This is a well defined measurement, unlike things about "decisions", which are not well defined.
> The question is should we try to prevent low latency trading? If so, why? And how can we? Will any system we put in place cause more problems than it is worth?
"Low Latency" and "High Frequency" are not equivalent, even though you seem to think so. "Low Latency" relates to one event. "High Frequency" indicates a rapid succession of events (Frequency is a measure repeating phenomena). High frequency does not theoretically imply low latency (or the other way around), but practically the correlation between low latency and high frequency is 100%.
If you follow the nanex links, you'll see the "low latency" players are bullying the "higher latency" players, and should be prevented from doing so.
In fact, many exchanges do that - e.g. Some european future exchanges will fine you if your order:execution ratio is >10. Meaning, you have, on average, to execute 10% of the orders you give. In the US, some players have an 10000:1 order:execution order. We should disallow that - as everyone else pays exchange fees for a faster system to suit these players, and then pays more to have a system that can keep up with the spurious orders these guys send.
Really, Eurex has this trivially solved. Since 2001.
> Finally, if you don't think currency markets are fair,
I do not think they are fair. But they are as good as the equity markets (liquidity and spread wise) without the HFT players - ergo, HFT does not provide the benefits HFT proponents claim it does.
Fill ratios are not designed to prevent either high frequency or low latency trading, it is there to prevent a particular form of exchange gaming (quote stuffing).
You are not being clear (and you are being condescending) on what you mean by HFT players & what you find objectionable. Is a market maker that trades 40K contracts a day but doesn't quote stuff objectionable? What about a cross exchange latency arbitrage trade that is not spamming exchanges? If so why?
Also, I've traded Eurex. They have very specific interfaces for low latency/high frequency traders. You can order different classes of connectivity from them that are specifically designed for these use cases. They also have predatory algorithms, so I'm not sure what they have solved.
They are very effective against quote stuffing, but they also work well against player that leave their quote active in the market for 1ms with high frequency. That's false price signaling, and is independent of quote stuffing (as I'm familiar with it: the practice of throwing so many orders at the exchange that slower players got a lag in their data).
> You are not being clear (and you are being condescending) on what you mean by HFT players & what you find objectionable.
I am specifically talking about HFT players in the US Equity markets - these are the subject of all the HFT discussions on reddit and HN. These do a lot of false signaling, quote stuffing, frontrunning in between exchanges.
> Is a market maker that trades 40K contracts a day but doesn't quote stuff objectionable?
That's fine, as long he is not false signaling either (that is, putting in orders he has no intention of executing)
> What about a cross exchange latency arbitrage trade that is not spamming exchanges? If so why?
This subverts the NBBO system. I believe this should either be illegal, or it should be legal and the NBBO system be canceled. But traders are under the illusion that the NBBO system is protecting them from wasting money to these arbitrageurs, when is isn't.
> Also, I've traded Eurex. They have very specific interfaces for low latency/high frequency traders. You can order different classes of connectivity from them that are specifically designed for these use cases. They also have predatory algorithms, so I'm not sure what they have solved.
The same things: a) quote stuffing, b) false signaling. Being faster costs money, and should provide an advantage - but it should be "neutral".
Is there any way (e.g. quote stuffing) in which you are aware that the faster players on Eurex can causally disadvantage the slower players, like they can in the US Equity markets?
Very fast player X puts a few (<10) big orders on one side of the order book at a level that has some but not a lot of quantity in front of him (using random quantity to make it hard to recognize) making it look like there is more demand than there is.
This will cause other participants to quote at this same level. Once enough orders have been entered behind him, he will yank all of his orders and then cross through that level (or even through 2). He has flipped a level.
His speed allows for 2 properties that make this much easier: 1. He is taking much less risk with his spoofed orders turning into real orders because he can cancel them fast when the market conditions indicate they might get filled. 2. His targets can't catch his cancels/fill through order fast enough to get out of the way.
He can keep his fill ratios within the correct boundaries with no problem.
This is much better for me as a participant than the single exchange monopoly is or having to build up an exchange presence at every exchange.
The competition in that space is so fierce that the cut they are taking from me is much less than the alternatives. For me at least, it is a small price to pay.
(And no one should trust my assertion either - I'm just as anonymous as the rest of you, and lying for all you know).
Perhaps other order types could allow market participants to ask for something closer to what they actually want - but new order types are often criticized as giving HFT players an advantage, since they can understand and exploit them faster than other market participants.
Alternately, eliminating the sub-penny rule would allow HFTs to compete on price rather than just latency, which would mean better prices for long-term investors and remove a lot of the profit from the HFT industry.
Well I guess I'm very biased but here's my stab at it.
High Frequency trading is at the for front of alot of technology such as ASIC's, Infiniband networking gear,and low latency OS and networking stacks.
You could argue that they help push these technologies forward by providing the first customer for these areas.
Liquidity has gone up with the advent of High Frequency trading but like someone else has said its hard to disentangle all market factors to say this is due to HF Trading.
> Something about it just doesn't ring true to me. If it is in fact true I'd love to hear an explanation.
To be fair, this statement is the equivalent of "I've heard evolution is a well followed theory but something about it doesn't ring true to me."
What sort of explanation would you like that hasn't already been said 100's of times by people more qualified than me?
You haven't said what you don't like or disagree with about the many existing explanations:)
That's not an argument for HFT. If HFT is useless, then it has divested a great amount of research into technologies that no one really wanted otherwise, i. e., that the social cost of HFT is greater. Standard microeconomics.
The question is, what's HFT good for? Do its benefits outweigh its costs? I believe they don't. Low-quality liquidity under the 1s frame is not only useless for traders, it has a great social cost, in the form of research diverted to this inane game. The only plausible arguments I've found for HFT claim that HF traders wouldn't profit if it wasn't useful -- which is really just begging the question; a circular argument.
-lolcraft, 1852
Now, the resources that were going to traditional specialists and a subset of the professional traders, are going to HFT's, with some of that returning to investors in form of lower trading costs (if we buy the argument that liquidity has indeed improved, of course. Most of what I've seen indicates that it has.) As a side effect, we have technology improvement, useful for other things.
Now, there can be an argument made against HFT's, and in favor of more traditional traders, related to a potential decline in market depth. So far, I have not seen any convincing proof of this being the case, but I am open to it.
However, I think a lot of people arguing against HFT's do not quite understand that their position is literally that we need to enact legislation in order to protect Wall Street from competition :)
More specifically, HFT acts like a market maker in that it will take the other side of trades that other players (HFT or not) want to make. Let's say I own 1000 shares of MSFT, but I need to liquidate them for some reason. A margin call, a new car, or some immediate, unexpected cost has arisen. The more potential counterparties I have -- the more players that will potentially buy my shares -- the more liquidity there is.
With more liquidity, I can hold out for a higher price (with a cost in time), or I can sell more quickly (at a slightly lower price -- with a cost in money) than I could otherwise.
Whether or not my HFT counterparty is executing profitable trades (which it is, presumably), the very fact of its existence as such is a net benefit to me.
So you got your order filled in 5 milliseconds instead of 6 milliseconds. So what? You're a person.
And stocks without enough liquidity to get to a penny spread? The HFTs don't like those stocks, because the "F" is not "H" enough for them to participate. The very nature of HFTs is that they prefer to participate when there is already plenty of liquidity.
You're talking to an unabashed proponent of subpenny increments. Smaller spreads, more counterparties, faster execution -- these things cannot possibly hurt.
Note that I am talking about the concept of HFT. It's true that there are shady operators who abuse rules and undertake things like quote stuffing. I'm not here to defend any of that.
> So you got your order filled in 5 milliseconds instead of 6 milliseconds. So what? You're a person.
Still a net benefit even for just market orders. Limit orders benefit much more from HFT, particularly the stop-hunting variety. I think of the randomized price action as similar to quantum noise. No one really knows to the nth decimal what the price should be, but it wanders around where the money thinks it should be.
So that noise can help trigger your limit trade at exactly the price you want, whereas the false placidity of more granular enforcement is less likely to hit your limit.
Now let's look beyond just me and consider that some firms get more relative benefit from HFT than I do, and that these slivers of benefit sum across market participants.
> And stocks without enough liquidity to get to a penny spread? The HFTs don't like those stocks, because the "F" is not "H" enough for them to participate. The very nature of HFTs is that they prefer to participate when there is already plenty of liquidity.
Of course -- this should not be surprising in the least to anyone paying attention. The reason HFT practitioners participate is to attempt a profitable strategy. Liquidity is the side effect, not the goal. So while it's fair to say they provide liquidity to the market, or even that providing liquidity is the role they play, it's neither their duty nor their motivation.
Similar to how commodities speculators provide counterparties for nervous farmers, they are guided by the invisible hand and not by duty.
You think Apple want to make products and improve people's lives without making money? If so, why don't they reduce the prices? You think Google is all about search? No, it's about making money -- you get encouraged to go after... and I quote Sergey and Larry here, "markets of at least 1 billion" and make products that could potentially be worth 1 billion per year. Search my ass... it's all about making money as with most companies, including most of the the non-profit ones (non-profit hospitals that charge more than the for-profit, universities, etc)