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If you submit a buy order for 10 shares of GOOG through a conventional retail website like ScottTrade or ETrade your order is going to be sent to an HFT firm that buys flow from from these retail websites.

If it's a limit order the HFT firm is going to immediately decide whether it wants to take the other side of your order (i.e. immediately give you an out that leaves you whole with 10 shares of GOOG at $1134) or whether they don't want the order in which case they might send it directly to a lit venue like NYSE where your order will rest in the open market.

If they take it, from there the firm is going to try to liquidate the position in the market now that they are short 10 shares of GOOG. It is up to their discretion on when they want to even out their portfolio. The idea is that sophisticated traders are able to better time and aggregate retail orders than the retail customer themselves and here is where they make money albeit with a little risk.

For one simple example since you only wanted 10 shares of GOOG typically you would pay a penalty for executing an odd lot (an odd lot is an order that is not an even multiple of 100). If the firm can collect 10 buy orders of 10 then they can avoid the odd lot penalty.

> If I submit a buy order for 10 shares of GOOG with a limit of $1134 that order is going to show up in the data stream of HFTs only after it has become a valid open order on the exchange, right?

False.

HFTs and other trading firms actually buy up the order flow from brokerages. In fact, retail investors making trades in their brokerage accounts are actually referred to as "dumb flow". Having access to the order flow and controlling the routing of it can allow them to jump in front of your trade.

For example, they could see that your limit order of $1134 came in when the lowest ask price was $1133.90. They could buy that for $1133.90 and sell it back to you at $1134 for a 10 cent profit.

It's not too much different than in the old days when the market makers would delay buy/sells calls to their pits to their own advantage in order to scrape a small profit on the spread.

> For example, they could see that your limit order of $1134 came in when the lowest ask price was $1133.90. They could buy that for $1133.90 and sell it back to you at $1134 for a 10 cent profit.

They cannot do that. They can't fill you at a worse price than NBBO.

In my example, they buy before the execute your trade, thus shoving the lowest ask price up to $1134 and fulfilling NBBO.

You said best offer was 1133.90. If buy order is placed at $1134 with HFT firm they must either fill the order at 1133.90 (the NBBO) or pass it on to an exchange that has NBBO.

If you are arguing something else happens then you need to explain it clearly step by step in a timeline.

1. You send a trade to your brokerage for GOOG

2. Trade gets routed to an HFT who will fill the trade

3. HFT notices a spike in GOOG interest over a few seconds and starts buying at 1133.90 driving the price up to 1134

4. HFT fills your limit order at the best price of 1134 which they themselves hold.

Despite what the other commentators here have said, limit orders are less safe than market orders to market manipulation. HFT's will buy up all that dumb flow with limit orders and then essentially run the prices to the limit orders in their favor.

At the beginning of 3. does the HFT have your order or are you saying that the market moves before the HFT receives the order?

As far as I know the first case is prohibited (actual front running). I don't see an obvious problem with the second case though there might be subtlety that I am missing.

>HFTs and other trading firms actually buy up the order flow from brokerages.

That's interesting. This sounds like blatent front-running though. I wouldn't have thought this to be legal.

> HFTs and other trading firms actually buy up the order flow from brokerages.

I'm going to ask for a citation on this one.

I remember a similar incident at KRX in 2009, and it resulted in a criminal investigation [1], so that ought to be illegal.

[1] http://www.traderdaily.com/07/koreas-elw-players-get-hfc-wak...

"If I submit a buy order for 10 shares of GOOG with a limit of $1134 that order is going to show up in the data stream of HFTs only after it has become a valid open order on the exchange, right?"

Correct.

"If at that time there is a sufficient volume of open sell orders at or below my limit, does my order go through or is there a way for an HFT to overtake my order?"

You will get filled with at worse, your limit price.

"The only way I can see how an HFT could possibly overtake my order is by offering to buy at a higher price than me before my order goes through, hoping that he could sell the shares to me later on for an even higher price."

Correct.

If I submit a buy order for 10 shares of GOOG with a limit of $1134 that order is going to show up in the data stream of HFTs only after it has become a valid open order on the exchange, right? If at that time there is a sufficient volume of open sell orders at or below my limit, does my order go through or is there a way for an HFT to overtake my order?

If there is a resting sell order below the limit price of your buy order, nobody will see your buy order. The cross will happen as soon as your order hits the matching engine. You and your counterparty will get trade confirmations via your order entry port, and market data subscribers will see a trade report (10 shares crossed at $XX.YY) and the size of the resting sell order will change.

If you make a limit order at e.g. $1134, it's entirely possible that the best price is below $1134. For instance, if you enter that order right now, you should expect the order to execute at closer to $1130 (assuming a small order size). Your limit price is therefore a worst case.

Lewis is saying that in the absence of HFT front-running, you'd get the best available price at the time, say $1129.82. However, he alleges, HFT traders can front-run you and you'll instead pay e.g. $1129.92, meaning you overpaid for the stock. Note that this happens even though what you paid and the best theoretical price are both below your limit. So you're getting robbed, even though it's not apparent to you.

I see, so the best strategy in terms of game theory might be to always set a limit below the latest offering price known to me.

The point of the article is that you will lose the game because you're making decisions in macro time with old information and you're competing against robots that make decisions in nano time with newer information.

> If I submit a buy order for 10 shares of GOOG with a limit of $1134 that order is going to show up in the data stream of HFTs only after it has become a valid open order on the exchange, right?

No. Your broker might send order flow to HFT firms for payment. They have to fill you at the national best offer if they want to take the trade.

The other thing that can happen is that if your order is not marketable at the current exchange you are trading at but is marketable at another exchange then the first exchange can sometimes "flash" the order to selected participants to see if they want to fill the order so you can avoid forwarding the order to another exchange.