Your example does exactly what the author recommends you not to do; cross the order book. In your example, you're supposed to place a limit order at 14.99.
The way not to get scalped, is to place the order in a way where it arrives at all the exchanges at the same time, that way the HFT guys and their microwave data links can't peek at your order on BATS, and then beat you to the other exchanges.
The accusation is they see the 100,000 share order hit BATS, 10,000 get filed, then the HFT guys buy 90,000 shares on the other exchanges before your order gets forwarded, and you are stuck paying the HFT guys $15.02.
That might be a bummer for Katsuyama/RBC but it's great for everyone else on the market who now benefit from a price that updates faster.
If someone wants to buy 100,000 shares, and the market says there are 100,000 shares available at $15, the order should complete at $15.
> If someone wants to buy 100,000 shares, and the market says there are 100,000 shares available at $15, the order should complete at $15.
As long as they submit their matching order while my bid is still on the books that's fine. But why should I be required to keep my order on the books for any longer than I want to?
What's happening:
1) A large block of shares is traded on exchange #1.
2) HFTer notices #1 and very quickly updates the price at which they are willing to buy/sell on exchange #2. No one has any sure knowledge of trades on their way to exchange #2. They can guess. They can infer. But they aren't seeing any actual trades before they hit the exchange.
You're talking about front-running the trade inbetween the "sell" decision and the receipt of the signal at the exchange. In otherwords, your bid/offer is in bad faith. I can advertise a car for sale and then when you walk in remove the price and mark up the trade. You cannot do this in an open outcry market. Because it would be subject to retaliation (of various kinds).
Providing bid/ask indication in bad faith is NOT liquidity. Liquidity is not layering a trade to double the volume.
HFT does not increase liquidity. It increases volume, at best. But so does front-running. The bait and switch issue and the front-running issue not interchangeble, but they are closely linked.
Market micro-structure is difficult to discuss because most people are completely ignorant of the mechanics. Its easy to pass of volume for liquidity and to disquise front-running as "market making" or speculation. It is clearly distinct.
Why do you think those people are trading with market makers if they're doing such shady things?
I don't think you really understand the business that market makers are in. They aren't in the business of trying to front run people. They're in the business of making a penny a share on all the trades that go back and forth. But they face a big risk. When they're busy buying/selling for $50.00/$50.01 what happens when a big & smart hedge fund guy comes along who has new information and knows the price should really be $50.10. They try to buy up as many shares as possible at $50.00 and suddenly the market maker is fucked because they're no longer market making in a stable market.
So the market maker has this big challenge where they have to do a good as job as possible detecting the big & smart hedge fund guy and quickly adjusting the price so they don't get squashed. If they can't do a very good job they have to increase spreads so they make more money in the steady state to make up for their bigger losses. If they do a really good job in this detecting they can lower spreads.
It turns out that HFTers are really good market makers. You can see this because they've successfully competed against each other to the point that they can lower spreads all the way to a penny (a 10x reduction of where they used to be!).
When you look at it this way you can see that market makers aren't trying to screw the big traders, they're trying to avoid getting screwed so that they can better serve everyone else by offering lower prices (lower spreads).
The nice side effect of all of this is that price information gets better communicated to the market faster. If you happen to be randomly selling your MSFT when Mr. Big & Smart shows up you're more likely to get the best possible price due to all the information being correctly communicated to the market.
# This includes both voluntary and involuntary disclosure.
This would be like going to an open house where you here someone say "I'm going to offer $1,000 over asking" then going to the seller and offering $500 over asking. Then going to the first person and saying you'll take that offer of $1,000 over asking.
You could claim that you provided liquidity and that you helped speed up the transactions but at the end of the day you made $500 for undercutting someone who already intended to make a purchase.
This is about 2 parties that are ready to agree to a transaction and a 3rd party injecting themselves into the transaction and taking a penny of the deal.
Imagine that you go to the grocery store to buy some milk and as you are about to checkout someone buys your $5.00 milk and tells you the price is now $5.01. And that the $0.01 increase includes spoilage insurance. Maybe you like that, maybe you don't, the issue is that you had no choice in the matter.
In your current flawed analogy you are assuming that there is a fixed price for the things you are buying when there aren't.
Let me offer my own flawed analogy to explain what is actually happening in the latency/venue arbitrage case.
You are a real estate developer who wants to redevelop a block. On that block are 10 relatively equal properties owned by 10 different people. On day 1 you go to the first owner on the block and offer 100K for his shop, he says yes. On day 2 you go to the second owner and offer the same 100k. Again a deal. On day 3 you go to the third but they won't sell for less than 200k because they've been talking with their neighbors and know that someone really wants these properties. On and on until you get to the last owner who won't take anything less than 900K which you pay. Now you can say that you are being taken advantage of but I'd argue that it is just as morally questionable for you to low ball those original property owners when you know their property is worth more than what you bought it for. Conversely, let's say you balk at that 900K and walk away from the deal. Is that last owner "out" 900k? Are they out 100k?
Now lets introduce these nefarious third parties. Let's say I notice that you are buying those properties and while you are negotiating with the third property owner, I offer 200k to all of the remaining owners at once. If they agree and I offer them to you for 300k, I make profit on the deal, you still get what you want (at a cheaper overall price) and the original owners are all paid a consistent amount for equivalent properties. Also, if half way through you decide that this deal is no longer for you and stop buying up properties, I am "stuck" with those properties that are now not worth as much as I paid for them.
You know that someone else just said they were going to offer 1000 over asking. The seller doesn't know that. You have an advantage.
" you are assuming that there is a fixed price for the things you are buying when there aren't."
When Bob offers stock X for 5.00 that is fixed until he cancels that order. Just like the milk, it is 5.00 until the store changes the price.
Your analogy implies that I need all the properties on a block. That would be similar to a hostile takeover where someone needs to buy 50+% of a company to take control.
Are you aware that HFT are not making their money by detecting hostile takeovers?
Further, your attempt to poke a hole in his analogy is itself flawed, because you have a poor working notion of the scarcity involved. "There aren't just 10 shares of MSFT in the market" is what you're thinking, while ignoring that there is a finite amount of MSFT offered a price compatible with your investment goal. You can't think of the total amount of MSFT that exists. To reason about the market, you have to have a notion of what you're willing to pay for it. Many people who hold MSFT are unwilling to unload it at anything near the current spot price. This stands to reason, because if they were willing to unload at that price, they wouldn't be long MSFT.
The simplest example is like this:
1. Bob sees that 10,000 share of MSFT are for sell on exchange X at $50.00 and also 30,000 share are for sell on exchange Y at $50.00 and 60,000 shares are for sell on exchange Z at $50.00 2. Bob attempts to buy 100,000 shares of MSFT at $50.00. 3. The HF trader sees the 60,000 order get filled at 50.00 and reasonably assumes that someone is trying to buy more than 60,000 shares right now. 4. He buys the remaining 40,000 shares at $50.00 before Bob's trade is executed. 5. The HF trader immediately lists the 40,000 shares at 50.01
Do you understand how the HF trader is injecting himself into the transaction?
(In reality, assuming you're a small retail investor, you don't even have to do what this blog post says. Your transactions are small enough they aren't going to hit the exchanges anyways.)
I wouldn't attempt to sell titanium to the Amish for the same reason that no rationale investor attempts to sell stocks without the existing market maker system.
Maybe you'd rather just skip all the complication of computers and go back to the good old days of monopoly exchanges and pit traders. Then you get to deal with fees that are 10x of what they are now, the joy of dealing with over the phone brokers and the excellent opportunity to get to buy and sell from specialists who are given cartel status by the monopoly exchange, I'm sure they price things with the retail investor in mind right? At least you won't know how bad you are getting screwed cause there is zero transparency into the market. Sounds good? Get some legislation passed that gives NYSE and Nasdaq back their monopolies.
There is probably a third path that involves some sort of governmental agency bid out to a third party for a ridiculous contract that has massive reliability issues and doesn't innovate at all. That might be better, I don't know.
Me, even though I know way more about the dirty pool that goes on in the electronic trading space, I'll stick with sending my personal orders through a large retail broker that charges me minimal fees & expense ratios, and allows me access to the lowest bid/ask spreads in history with instantaneous execution to a broad array of risk management and investment opportunities that only big banks used to get.
I'd really like access to a massive free social network that doesn't sell my data to the highest bidder, but since I'm unwilling to bank roll that, I can either deal with the social network we have, or opt out.
I still take issue with your idea that the HFT is injecting itself into some preordained transaction. Information that there is a lot of demand for something should raise the price for that thing.
Large institutional buyers already have huge information/infrastructure advantages. Why should they also be given assn exemption from market dynamics that no one else received?
What you're saying here is that an institutional investor wants to buy MSFT at a price that does not reflect their new demand for 100,000 shares. That order, absent some external force that will put downward pressure on the shares (which, if so, why buy now?) will naturally raise the price of MSFT for everyone in the market.
The investor, in other words, wants something for nothing: they want to trade at a price that doesn't reflect their demand, and for some other market participant to take the hit for selling below the true demand.
Should the price increase to 4.00 as soon as he stops in front of the pump to 'reflect the new demand'?
In my example the Gas Station is doing a bait-and-switch where the price was 3.99 until you pull out your credit card. HF Traders are not doing a bait-and-switch since they are separate entities than the original seller but they are making money off the same principal as a bait and switch.
In the vast majority of instances the HFT are not buying something and reselling it at an inflated price before another interested party has access to it. They are changing the price on things they themselves had already set the price for.
A closer analogy than what either of our gas stations makes is I own ten gas stations in a line down the high way. At the first one a tanker truck pulls up and takes all the gas I have at that gas station, then at another and another and another so on down the line such that I no longer have any gas.
When I go to replenish my stocks I find out that some big company needs tons of gas and has driven the price well above the 3.99 I was selling for. This means I just took an extreme beating in the selling gas industry. I don't mind, that is a cost of doing business.
Then the next week they come and do the same thing and on and on for years. Eventually, I tell the manager of the first gas station to call all the other managers the minute a tanker truck shows up so we can adjust our prices and not get wiped out.
The big gas company now has to pay a much more appropriate rate for the gas. This drives them crazy so they go on 60 minutes and tell everyone on the planet that the game is rigged because I have this super sophisticated technology that lets me "front run" them.
You hear this and start thinking to yourself, man I can't trust that they are going to charge me more money for this gas as soon as I pull into the station. You start buying less gas and calling your senator. The big gas company then goes on CNBC and says, "See I told you those little gas companies were no good. Now they are eroding the faith of gas buyers in the fairness of the market place."
When in reality all that is happening is that the big gas company can no longer take advantage of me to get cheap gas.
Wall St. has a long history of fraud and skimmers so it is understandable to say the HTF isn't that bad relative to other things.
But we should be trying to make the markets more fair and give people more confidence that everyone isn't getting ripped off.
The HFTer has a problem though. If a big & smart trader comes along with proprietary knowledge that MSFT should really be trading for $50.10 he could take a big loss. If that HFTer buys everything up for $50.00 and then the price moves to far too fast that's bad.
So the HFTer works as hard as he can to detect when this might be happening so that he can update the prices he's offering. A really big signal this might be happening is when someone eats up his whole order book on one exchange all at once. So when that happens he trys to react as fast as possible to updates pricing on the other exchanges.
He's not injecting himself into transactions, he's trying to get out of the way as fast as possible.
But this whole article seems to be written for retail investors. And as much as HFTs may sound scary for retail traders they make their money off institutional trading. So the larger impact to retail flow is from the response Institutional desks are forced to take to ensure they are not disadvantaged by HFTs, which then affects how institutional and retail flows are able to interact.
Ultimately a 1000 APPL.US order will get filled and who pays the $0.01 spread is largely academic as it is an inconsequentially small part of the total settlement $ paid.