Michael Lewis: shilling for the buyside?
scottlocklin.wordpress.com
scottlocklin.wordpress.com
Plus, the interviews he's given on 60 minutes and Fresh Air never once mention the terms "market order" or "limit order". If you don't explain those two basic terms at the heart of the HFT controversy, you're not giving people information, you're only giving them disinformation.
That said, there's obviously lots of shady ass shit happening on Wall Street every day, but Michael Lewis is not helping the situation one iota, from the looks of it.
Lewis has a drive-by mention of bid-ask spreads in the book (he concedes that they've been decimated, while asserting without evidence that HFT has created a new "shadow spread"), and, thus far, no mention whatsoever of the mechanics of large-block trades. In Lewis' universe, a hedge fund can unload 100,000 shares of XYZ just as easily as you can sell 10 shares of AAPL.
To your point: what's missing is the hedging costs. The reason block trades trade out of the market is not just that they are "bespoke", but that there is the inventory hedge risk. It may take some time to build up a position (during which prices can move adversely). And this may or may not need a hedge to protect the holding period (which someone needs to pay for).
Various types of trading strategies have very different risk profiles when compared to required inventory hold/periods etc. And this is a hidden source of economics or cost. Hedging doesn't always scale well, either.
So its very hard (especially as a lay-person) to make inferences about many things unless you are taking into account both profits and risk. As I'm sure you know.
Read reviews of the book from traders and you will see lots of people scratching their heads the same way I am.
It is confusing that a former bond salesman, who wrote several famous vignettes about how Salomon got its clients into jams by selling them blocks of bonds and having the market move out from under them, would believe the things he appears to believe about RBC's role in the market.
In Lewis' universe, a $2MM/yr sell-side broker accepts a 100,000 share block order from a hedge fund, consults a single blotter screen, enters a 100,000 share order, and is startled and outraged when that order isn't as easy to place as an Amazon one-click order. Egads! The broker has to actually work for his money! Kill the HFTs!
I don't understand what inventory hedging has to do with the point I'm making. Hedge trades are trades. Large hedge trades involve block shopping.
The underlying cause is the "perverse incentive" (Lewis's words) of the taker-rebate (reverse of the usual maker-rebate taker-fee). Is there a sensible reason to such a fee structure? Or is it just useful for HFT firms to bait orders and get an informational edge they can exploit against mom & pop's retirement fund?
The same should be asked about esoteric order types (Hide-n-Slide, Post-only, etc). Its cleary a complex landscape with middle ground, but it would be surprising if there weren't cabals and conspiracies hiding in obscure corners.
ELI5 version is that you need to pay for (1) working capital. This scales with the size of the block (capital cost). You also need to pay for (2) some lead-gen fees to get the block (service cost). You also have to pay for (3) a hedge on economics while your lead-gen process play's out. The cost of this hedge scales with size (just like capital cost), but also with vol (of underlying) and time (speed of lead gen process).
If you don't cut the deal to cover your hedge (or put one on) you run the risk of massive losses from mino movemnets in the market (ie, if you have a <1% cent spread on 5 mill position and the stock spikes 10%).
So a trade's profits:
(A) scale+fees = Revenues
(B) capital+hedge = Costs
Both the hedge and the capital are proportionate to time.
TLDR when you talk about HFT you are optimizing on time; and thus talking about (B) as much as (A) in terms of profits. Most of the optimization is on (B).
What's unique here is that (B) is blind to the casual observer and to some extent, the market.
But analytically, it influences profits and drives behaviour/incentive structure.
If you dis-regard it out of hand, you're missing an important part of the picture.
You might think you can fill 100,000 @ $10 and allegedly many people did. In fact if the exchanges were consolidated into one you would be filled.
It seems to me a displayed order should be able to be traded and not behave in a seemingly prescient way by disappearing when the order is made.
In an ideal world would the latency between exchanges serve any beneficial purpose?
The reality is that electronic trading systems have different values for all of those variables. I've worked on a trading system that only traded 4 times a week, had no human operator, but extremely tight latency requirements.
I've also worked on a system that did very high volume of trades every day, that was watched like a hawk by a team of human traders, and didn't much care about latency.
A firm simply unloading thousands of shares in 100 block increments in a number of milliseconds with very low latency technically would be a bunch of "high frequency" trades, but that type of activity is not what is being debated.
Mark Cuban misunderstands a lot of things, including Dennis Rodman and High Frequency Trading.
One side: "HFT hurts the little guy and helps billionaires! Boo HFT!"
The other side: "HFT helps the little guy and hurts billionaires! Yea HTF!"
Reality: "HFT is pretty much irrelevant to the little guy. It helps some billionaires and hurts other billionaires, and this is only a story because billionaires are all talking about it."
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This trade used to be extremely lucrative. I was there. It was awesome. Years ago the ETF and basket NAV would cross one another constantly and you could build a fully-hedged position for a profit if you were extremely fast. People still make money on it, but not as a pure speed arb. Like everything else, the fastest traders and those who execute best win. The fact that it's not as lucrative or easy anymore is indication that the markets have become so much more efficient.
So instead of this rent (amount of money X) getting all captured by a single player who is necessarily a large, wealthy trader, it gets divided up more broadly. That sounds like a textbook case of arbitrage being in the public good.
HFT does that. Does it also do other things which create rents rather than break them up? Hard for me to say. It's a complicated subject.
What do you think traders get paid in, cupcakes?
Michael Lewis is a master of taking something complicated and turning it into a clever narrative. However, this narrative is simpler than, say, Moneyball: bad guys are "stealing" from good guys, there's a detective story about figuring out how it's happening, and there's a build-a-better-mousetrap montage at the end. It's too perfect. Odds are there's a screenwriter crunching this sucker down into three acts right at this moment.
Proper investing, buying a stock in the belief it will go up massively over the course of many years is trivially affected by HFTs. You may pay less than a penny per share extra on trades, but if you're looking for tens of dollars of capital gain do you care?
Instead, Joe Sixpack eats his chilli at another store that is more competent in managing their supply chain, and the Wendy's Corporate takes a hit.
Source: some Matt Levine article.
I don't think it's helpful to anyone's understanding of any situation to try to pretend that tens or hundreds of millions of Americans -- who are on the whole somewhat wealthier than average -- are mega-rich snobs who drink ten-thousand-dollar-a-bottle wine.
1) Indirectly via mutual funds, pension funds, and so on.
2) Directly through buying individual stocks on E*Trade or the like.
The second amounts to an expensive hobby (in risk adjusted terms). Whether some people who aren't ultra-rich choose to indulge in such an expensive hobby is neither here nor there, the underlying fact remains that there's no good reason to care about or optimize for their benefit. Yet for some reason so many articles on this subject instead of talking about the funds that are broadly and rationally held, analyze the situation for the small retail investor.
http://www.csmonitor.com/Business/2013/0508/Dow-hits-15000-b...
The rate of stock ownership (including through mutual funds and retirement accounts) for Americans is around 52%, down from last year. So, while the median American owns some stock, it's probably a minuscule amount. Two percentage points lower, and the median American (Joe Six Pack) owns no stock.
EDIT for more related info:
45% of Americans have no retirement savings [1]
1/4 of Americans have no savings whatsoever [2]
[1] http://www.twincities.com/ci_23505006/americans-retirement-s...
[2] http://www.ibtimes.com/over-fourth-americans-have-no-money-t...
Hasn't the FBI been recently investigating this ?
From acquaintances that knew Katsuyama personally, he was described as a genius marketer, not a technologist. Before even Lewis came along, he had crafted a large part of this narrative: the Thor matching technology succeeded on a compelling story. Lewis got sucked in.
The personal reactions you may have seen (William O'Brian on CNBC) are authentic: HFT participants (and those who deal with them) have been villified in an industry already viewed in a negative light. There are some bad apples, but there are also many who genuinely believe that they are doing a service for the market.
I don't blame Lewis for this. I just hope that there is an author that can create a compelling story that doesnt fall for the tired trope of the evil HFT trader. The story exists - it is just very technical and nuanced at times. Unfortunately, many HFT participants have been shamed away from standing for what they believe in so there are very few left to tell the story.
If you want to read a rebuttal and learn more about the markets at the same time, check out this analysis by Larry Tabb - a market research consultant prominent in the US execution technology market: http://www.scribd.com/doc/215693938/No-Michael-Lewis
You make it sounds like HFT is some sort of non-profit, community service vocation, like teaching, or fire fighters. Do people actually think this?
Regardless of the merits of HFT, that kind of argument seems very disingenuous. I haven't met a single person engaged in HFT who is doing it to smooth the function of the market or "provide liquidity". They may think it has that effect, but no one is in it for that reason. If anything, it's what they tell themselves to justify skimming money from the other market participants.
Liquidity has always, always been subsidized by "skimming". The rake market makers take from trades is the cost of liquidity: ie, of being able to buy shares immediately without getting shafted because the only orders on the market are from large traders who are holding out for very high prices.
Have you ever tried to sell a house? That's what crappy liquidity looks like: there are buyers and there are sellers, but nobody is anywhere near agreeing about the price of the goods being traded, and so it takes months to get in or out of a position, and you sometimes have to do it at extremely unfavorable prices.
That fact that no one will defend this practice while vehemently defending "HFT" speaks to an impedance mismatch. We're not talking about the same thing.
It's no different than McDonalds paying a lot of money to buy a prime corner location to build one of their restaurants.
Before electronic trading, the specialists who executed orders on the NYSE floor ALSO paid shitloads of money for their access.
One difference between today and the heyday of the specialist system is that in the specialist system, middlemen skimmed overtly from investors: the bid-ask spread was gigantic, and all that money went to the middlemen.
Someone taking out/arbing a market needs a source of alpha. I need to protect myself from every source of alpha, at least on average. If market makers weren't collocated and looking at many exchange/products for data to price their markets, they would be driven out by fast liquidity takers, forced to quote lower size or a wider spread until they simply stopped getting trades (other faster, smarter market makers could still quote tighter spreads and would take all your market share).
If you do, you are not providing a service to the market.
All things equal, I would prefer to trade on an exchange that makes an effort to provide equal access, and one that doesn't artificially inject middlemen into transactions that don't require them.
http://web.eecs.umich.edu/srg/wp-content/uploads/2013/02/ec3...
Even if empirically it is non-observed, its illegal. So it is a problem, just one solved by law. Now, IFF your're willing to assume that nobody has ever/will ever transgressed such a law...you could hold this position 'logically'. But Few would be so unwise "in the actual world" to do so (and would likely prove foolish).
I'm responding more to this (and more as a general concept).
If given the opportunity, people would do this. So it's useful to dispel the notion that because its "not seen" it's not a problem. It might not always a be problem, but many it is and others it's also "annoying".
Stepping outside of markets for a second, this is why M&A deals have exclusivity and breakage terms. The theory/practive on why you do this involves assymetric information and something economists refer to as "opportunism". Opportunism[1] is exploiting legal abiguity for narrow self interest.
The more complex the legal/transaction structure the wider the attack surface for "opportunism" (because it's proportional with deal complexity). In slow and complex deals like M&A at a certain point it becomes an issue and so safeguards are taken.
In fast and simple deals like buying stock on the box or what not, the scope is very limited. The glaring example is the broker issue you highlight. But as the deal structure gets more complex, this risk rises.
Now, the attack surface for opportunism is proportional to deal complexity as mentioned above. This is legal/structure but also now needs to consider execution and # of counterparties. Limiting counter-parties (ie, middlemen) reduces this "attack surface" (if you will). Because each of them needs to be monitored/paperwork delath with etc. This is why such uncecessary interventions are structured out of deals. Typically by way of convention/courtesy if not expressly by things like ethics codes & stronger (ie, exchange regs+laws).
This is a long way of saying that the institutional integrity of markets hides a lot of problems. This is a good thing. But not to be taken for granted. The cost of undermining these institutions/trust etc. is not insignificant. Because it means you have to solve all these problems again in new ways.
It's also a system where every single trade is recorded in detail that anyone who wants can look at. No one is pointing at this data showing the smoking gun of the kind of front running you describe.
You're just saying "well, people are shady, so it's probably happening anyways." That's an incredibly weak argument in the face of a stack of evidence on the other side the biggest piece of which is the dramatically reduced cost of liquidity. If such shadiness was happening the cost of liquidity would be going in the other direction.
When talking about crimes people refer to means, motive, and opportunity. You've certainly got the motive part, but you're completely ignoring means and motive.
If MSFT is trading for $50.00 on one exchange and $51.00 on another we want someone to fix that price discrepancy! Even if the difference is much smaller we want that balance to be corrected!
You may even be able to replace the letters HTF with "any for-profit profession" and come to exactly the same conclusion.
I think it's fair to assume the HFT traders are rapacious capitalists (as someone who is pro-free market, this doesn't exactly offend me). But motivations don't matter here. It reminds me of the Adam Smith quote, which may only make sense if you've read the linked Scott Locklin essay first:
http://www.econlib.org/library/Enc/bios/Smith.html "It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest..."
If the HFT guys are willing to hold stocks for minutes or hours or days then yeah I might concede that they're adding liquidity. From what I understand that's not HFT anymore. But for a second? I can wait an extra second for an order to get filled.
Or maybe the price will move away from you and you'll never get filled (at least at the price you want).
I think it is from an interview on The Daily Show, see here: http://www.zerohedge.com/news/2014-04-02/jon-stewart-hft-its...
The quote seems to be 'The HFTs "function on volume and volatility" alone and "they know the prices before you do... which is illegal if it's a person, but as a computer, meh?"'
So my question to you is, i) explain how HFT serves the same purpose as market-making ii) explain how HFT is not front-running the valid trades
For decades, humans did exactly what the HFTs did, except much more brazenly: where HFTs take pennies in compensation, the humans took dimes, quarters, even dollars.
That premium wasn't outlawed. No rule was passed to eliminate the profits the middlemen took. No, the premiums were competed down to where they are now.
(I didn't downvote you).
EDIT: Perhaps this is just a small piece of what HFTs do, and maybe it's limited to a few bad actors, but being blown out of proportion by the book?
For instance, Virtu had 1238 straight trading days of profitability, with no losses.
There are no other firms in the history of Wall Street with such success. Such an outlier deserves a lot of scrutiny.
It might help if you expanded on your views of why Lewis is wrong.
Firms that make markets basically make money trading every day absent technology issues. That doesn't mean the company itself is profitable every day. It costs a lot of money to build the technology and strategies, and for every Virtu out there, there's a dozen failed HFT startups.
When most firms talk about profitability of trading day, they are talking about the the profitability of just their trades. That is, if they bought for 1 million dollars and sold for 1 million and 1 dollars. That is technically a profitable trading day. If the cost of entering and exiting that trade cost them 2 billion dollars they will still mark that as a "profitable" trading day, even though it clearly isn't.
That is to say, it is trivial under this accounting scheme to come up with a strategy that has no losses. Just don't trade.
I apologize for not going into more depth about why I think Lewis is wrong. I've explained it a lot in my comments on HN lately and can't be bothered to do it again. That said, if the linked article was more professionally presented and didn't have the weird racial language the points are basically what I would argue against Lewis' premise.
Edited for clarity.
http://www.sec.gov/news/testimony/052401tslu.htm
Technically, that's an example of a rule that was passed to eliminate the middlemen's profits.
Adam Smith's insight helped launched the enterprise of modern economics because it turned out attention to what matters: results. Benevolence, like self-interest, is neither necessary nor sufficient to produce a social benefit.
So you're right: the motivations of high-frequency traders are irrelevant, except insofar as we can change their behavior by changing the incentives they respond to.
They're doing it to make money, but that doesn't mean they're not helping other people out. My uncle is an importer; most of his time is spent finding something that's cheaper in Korea than it is here and drawing up a contract with a supplier there and a buyer here. Does he do it as a community service? No. Does he take his cut? Yes. But every deal he makes benefits both the supplier and the buyer.
In order to sell books, the story and narrative has to be compelling. Is the story of a Canadian guy making millions of dollars at his trading desk quitting his job and starting a company (we love startups!) that may undermine a controversial trading tactic a compelling story? Absolutely. Is the story of Einhorn or Cohen or Icahn doing things like insider trading or activist investing equally compelling? Probably not, since it's on the cover of the WSJ or on CNBC every week.
Michael Lewis does not have a responsibility to educate main street about the nuances of HFT, although as a secondary benefit of his noble pursuit to sell more books, he does shine a light on the topic. In this regard, Lewis is exceptionally successful. He's sparked a debate, he's created controversy, he's made smart people discuss a topic they had previously less interest in.
Think about what Moneyball did for professional sports? Lewis was hardly the first (e.g, Bill James) but he popularized it so we, the general population, could discuss the topic with some conviction and knowledge. If he can do the same for HFT and trading in general, then good job. And he sells more books.
Why do you put activism in this sentence along with insider trading? Are you implying that it is morally reprehensible in the same way that insider trading is? Activism is in no way illegal and many consider it a counter against corporate cronyism that can infect public corporations due to the principal/agent problem.
This criticism, that Lewis doesn't take a comprehensive view, is inapt since Lewis's book is not a treatise on HFT and its implications. It is like criticizing a scientist for publishing an article on a narrow topic rather than describing everything in the world in one giant book.
You can say that this method of HFT isn't front-running or that front-running shouldn't be illegal (and back up your case with arguments) but you can't say this criticism of one HFT method is wrong because HFT does other stuff too.
Edit: Source: actually read the book
Believing they are doing a service and actually doing a service are two different things. I agree it's important not to tar the latter of your two cases with the brush reserved for the former, but that doesn't mean sparing them entirely. It simply means selecting a more appropriate brush.
While malicious intent and clueless idiocy may be different from a moral perspective, they're indistinguishable in terms of effect. In either case, it falls to the law to limit these effects. Between the lack of ethics and the general ignorance, both types lack the ability to restrain themselves from harming others, not to mention the institutions we all rely on.
Without discussing this particular issue, doing evil and feeling evil are two very different things. People who do evil almost never see themselves as evil people, and they almost always justify their actions to themselves. There are no Bond-villains in real life, and if you look for them to find evil you miss its actual manifestations. Those are often quite elusive.
But there are HFT strategies that are bad for the market where the HFT algorithms are enriching themselves while providing no benefit to anyone else and actually causing the market harm.
Take a look here for more details on "quote stuffing" and other malicious HFT practices:
BATS Global Markets Inc., under pressure from the New York Attorney General’s office, corrected statements made by a senior executive during a televised interview this week about how its exchanges work.
BATS President William O’Brien, during a CNBC interview Tuesday, said BATS’s Direct Edge exchanges use high-speed data feeds to price stock trades. Thursday, the exchange operator said two of its exchanges, EDGA and EGX, use a slower feed, known as the Securities Information Processor, to price trades.
The distinction matters because high-speed traders can use powerful computers and superfast links between markets to outpace traders and trading venues that rely on slower market data, such as the SIP.
Regulations encouraged a fragmentation in exchanges (a good thing, since they used to be monopolies).
For multiple exchanges to trade in the same instrument, some force needs to synchronize the prices between the markets.
The regulations specify a mechanism by which this might work: quotation feeds for different products replicate the NBBO ("current" best bid-ask) across the markets.
But the NBBO feed is only an approximation of the best feed --- and it has to be, as anyone who has ever built a distributed system must know.
Fast electronic trading can synthesize a BETTER NBBO. If you know what the better NBBO is, you can trade against it, in effect forcing prices to synchronize through arbitrage trades.
The net effect is that the markets synchronize on a more accurate BBO, and electronic trading systems get compensated for doing this based on the profits from the arbitrage trades.
In the ABSENCE of that trading, the delta between the SIP NBBO and the "real" NBBO still exists; it's just money in the pockets of a different set of entities.
In neither case was this money likely to be helping firms that hold long-term positions and make money by allocating capital; the previous crappy NBBO profits were just going to a different set of sell-side firms, who are now angry that they'd been obsoleted.
To me, an extremely telling fact here is that Vanguard's Chief Investment Officer went on the record and said that HFT trading, and latency arbitrage in particular, had been helpful to their trading costs. If that doesn't mean anything to you, do some research into how Vanguard works and is structured.
Exchanges aren't allowed to accept quotes that would lock/cross each other, so you'd need something to happen like two guys put crossed orders into a wide book like AAPL almost simultaneously on different markets. They'd have to be crossed by more than a cent since the trader taking them out would have to pay remove fees on both (~$0.006) and the person doing it would have the risk of getting legged if he gets the first order but another takes the second one.
They should fix the SIP but this is not a common HFT technique as far as I know.
http://www.zerohedge.com/news/2014-04-03/bats-admits-ceo-lie...
This is actually very simple. Natural buyers and sellers do not need intermediaries, but intermediaries do need the natural traders. So if the natural traders can coordinate, they should be able to set rules that favor themselves and disfavor intermediaries. I won't say that what HFT does is "unfair" (capitalism does not contemplate fairness), but I think it's highly ironic that HFT and their supporters are complaining how "unfair" it is that natural traders are working together, and yes, marketing their new exchange.
The HFT folks seem to be saying "you don't have a right to add up all the total amount of asks at a certain price across all the exchanges and expect to get execution at that price" and with a bit of thought I might agree with them. But it is very counter-intuitive. If you see 10,000 shares for sale across 10 exchanges at $54.00 your VERY next thought probably isn't "oh that's actually 1,000 shares, but advertised on all the exchanges so it only LOOKS like 10,000" Once you understand how things works, sure fine.
The counter to that, though, is that the HFT folks don't have any right to have access to order flow. If market participants want to route their orders to a particular dark pool or exchange they have every right to. The "markets are always right" sword cuts both ways.
Also, there is a network effect to overcome here. Try to give IEX more than a few months before writing their obituary. They haven't even fully launched yet (they are still a dark pool)
You may not like homeowners and think some of them are or should be convicted, but it's ridiculous to say someone is 'shilling for homeowners' when they point out that real estate brokers are overpaid and skimming.
Some more balanced discussion - http://streetwiseprofessor.com/?p=8333
http://blogmaverick.com/2014/04/03/the-idiots-guide-to-high-...
http://blogs.hbr.org/2014/04/high-frequency-trading-threat-o...
In a nutshell, people who run big portfolios don't want to give away information about what they're doing, and they don't want HFT types to be able to pay exchanges to get first crack at front-running them.
On the other hand there is a legitimate market-making function, and there's a tradeoff between transparent markets and forcing people to share info that lets other people trade against them.
It's not particularly meaningful to say that the market exists "for" the buy-side. The real estate market exists for the real estate buy-side, too. But it takes 5 months to sell a house, because nobody is selling liquidity; instead, you have to work through an ineffectual sell-side agent who takes tens of thousands of dollars out of your hide for the privilege.
markets, trades, liquidity are a means to an end, not an end in themselves. every trade is a friction and a cost, and only happens because the two sides aren't happy with their portfolio.
"more friction in your machine is generally bad and just creates heat."
"oh, but that's not meaningful, people who make sandpaper and grippy tires are needed to create friction"
"..."
bottom line is... greasing the wheels of commerce good, making wonky wheels so some goofball can sell more grease services bad.
Buy-side: mutual fund.
Sell-side: market maker.
Then people shouldn't be investing in these poorly-performing portfolios and use other portfolio managers who are more savvy.
These people act like this stuff is MP (my problem, as an average person) whereas it's obviously YP (your problem, Mr. portfolio manager)
But what if you were buying stock at the same time? Wouldn't you want that information about that rise in supply to be detected and priced into the market as fast as possible?
Perhaps his public statements in interviews haven't been so nuanced.
Also, these rebuttals to the book don't really address the front-running issue. Is it simply an unavoidable consequence of the physical reality of separate markets? Should anything be done about it? Is it even still occurring or has competition among HFTs and savvier buy-side order routing eliminated it? I would like to read a rebuttal that discusses this.
In Lewis' universe, the price movement that happens when an informed trader tries to piecemeal-fill a 100,000 share order is "front-running".
But in Larry Harris' universe†, not only is price movement during block shopping not "front-running", it is the fundamental reason for the existence of sell-side firms; in other words, the challenge of stealthily shopping 100,000 shares of thinly-traded product XYZ is the reason that Katsuyama made $2MM/yr.
Lewis posits that the natural state of affairs is that there's an NBBO for XYZ, and that Katsuyama should expect his equities desk to collect fat fees simply by accepting a block order from a client, pushing a button, and unloading it at the current best bid, whereupon at the completion of this order the price will change to reflect the altered supply/demand condition of XYZ.
But that is crazy. The presence of a 100,000 order changes the supply/demand conditions for XYZ. For RBC to expect to sell 100,000 shares at the current bid, it must expect to get something for nothing: to take the price hit for the increased demand of XYZ out of the hide of whoever is holding it right now.
Before HFT mania, "front-running" meant something very specific: it was a problem of agency. A client/broker relationship existed, and the broker exploited it by trading in front of their client's order. The client had a right to expect the broker to act in their best interests. But the markets as a whole aren't a positive-sum system; in the absence of a contractual relationship, nobody has an obligation to act in the interests of anyone else. A dollar you make on the market is a dollar someone else didn't make.
I don't think RegNMS requires a broker-dealer like RBC to route its order to any particular exchange.
Brokers already have a duty of best execution to their clients. They are allowed to use their judgement to send orders to any given exchange regardless of the NBBO. That's what enabled RBC to implement "Thor".
Also note, if that exchange is not offering NBBO, it is bound by Reg NMS to route onward to the actual venue that has NBBO. The exchanges are also bound by Reg NMS, not just broker dealers.
They're hunting down the orders of informed traders who are trying to exploit their own knowledge of the true price of products, and correcting the price on the market before those informed traders can take their knowledge out of everyone else's hide.
The other big scam seems to be HFT firms buying a broker's order flow - for hundreds of millions of dollars. For example, Schwab sold its order flow to UBS for 8-year contract in 2005, for $285 million. It was massively underpriced, Schwab is said to have left a billion dollars on the table. And UBS, in turn, sold Schwab's order flow to Citadel for an undisclosed sum. Why is the right to execute a broker's order flow so valuable? Nobody seems to have a good answer, but the obvious reason is that its easy scalping.
A market maker can only stay in business if they sell as much as they buy and if the average sale price is above their average buy price. They lose money if they provide liquidity in the way of market moving forces.
Market makers try to avoid informed and "toxic" order flow and broker flow is guaranteed source of small uninformed orders that are most likely going to be crossing the spread.
http://www.elitetrader.com/vb/showthread.php?t=245029
https://institutions.interactivebrokers.com/en/index.php?f=1...
http://www.amazon.com/review/R2HRZNW5661QVR/ref=cm_cr_dp_tit...
Also, as with any discussion about HFT look into the people who are making accusations against it. Most of the time they are ex execution traders made redundant by HFT or failed at HFT themselves.
Basically, I really enjoyed the history part of the book and found the expose part riddled with mistakes, obvious biases and vague terms that could be interpreted in many different ways.
I don't think the distinction is as clear as you think. If I'm making markets on several of the US equity exchanges, and I see my entire order on one side of the market at one exchange get taken, I will adjust my quotes at the other exchanges. That's not front running. It's a reasonable market making strategy.
http://www.zerohedge.com/news/2014-04-03/bats-admits-ceo-lie...
Turns out many natural traders (Vanguard is the one that comes first to mind). Really like trading in the new HFT world as it is way cheaper than it used to be.
It's true that IEX is a dark pool, and that other dark pools exist that purport to favor natural traders, but IEX is moving toward an ECN and full-fledged exchange in a staged launch. Other dark pools are highly conflicted, lack transparency, lack technical protections, and the biggest difference is that people seem to trust the principals of IEX and the incentives of the ownership structure.
The only critique that matters is whether or not front running of buy orders by HFT traders is real or bull. Anything more is just an attempt to cloud the waters.
That is the kind of unintentionally ridiculous anecdote which undermines the moral center of this book. SAC Capital, after all, is the same fund which ran into one of the largest insider trading cases in history, which is also about taking advantage of information in a, let's say, special kind of way.
I know a lot about this subject, probably too much to let the judgment fall cleanly in one camp or another on HFT, but with all the hubub right now, I find it might be useful to get biblical for a second - let the person who is without sin cast the first stone.
Quotation: "He had a good friend who traded stocks at a big-time hedge fund in Greenwhich, Connecticut, called SAC Capital. SAC Capital was famous (AND SOON TO BE INFAMOUS) for being one step ahead of the U.S. stock market. If anyone was going to know something about the market that Brad didn't know, he figured, it would be them."
And did Brad "figure" SAC would know because he knew that SAC pursued informational advantages to the extreme? Did he think that was unethical, crossed a line, so they would know about other activity that crossed the line? That seems like a really strange line of thinking.
It also seems strange that this super ethical guy would attack activity which is legal, but turn a blind eye towards known unethical or suspected illegal business. Did he know about the rumors of insider trading? Did he knowingly solicit business from a firm which he had reason to suspect was engaged in insider trading?
http://www.amazon.com/review/R3PJO6KJGRMWUE/ref=cm_cr_pr_vie...
IEXT has a few main selling points. 1 transparency, 2 simplicity, 3 looking out for "investors". The problem is that they aren't any of those things and it is obvious from a simple reading of their technical documents.
First transparency. Their marketing pitch is that as opposed to other dark pools, they are transparent about what is happening on their markets. Yet the first thing they say in their technical documents is "IEX will commence operation as a fully NON- ---DISPLAYED venue." What this means is that their order books is not available for outside audit. They are meeting the lowest hurdle to regulatory compliance by providing best bid/offer and no more. If you think that is ok, let me ask you. If I told you that there was 1 buyer willing to buy at 10.00 and 1 seller willing to sell at 11.00 what would you think the "real" price for that instrument is? What if I told you that there was 1 buyer at 10, 1 seller at 11, 100 million buyers at 9.99 and zero sellers at 11.01? If you think those markets should be priced the same way, IETX is for you. If not, realize that IETX would tell you those markets are the same thing.
As far as simplicity, Flash Boys and the IETX marketing materials make a big deal about all of the order types that provide advantages to market makers, yet they remain silent on those order types that are explicitly there for large institutional investors. Lewis rages against ALO orders yet doesn't even mention iceberg orders which the sole point of is to hide the amount of shares a participant wants to sell. Then he extols the virtue of IETX for only offering 3 order types (which has since risen to 4), yet doesn't explain that in those 3 order types are many variants that only benefit large investors. IETX has literally removed all of the order types that allow market makers to do their jobs, while leaving all the order types that allow large institutions to hide their order flow. One of the most controversial order types out there is an ISO order, which is literally a legislative exemption for large block buyers that allows them to circumvent regulation about the national ticker. IETX offers those sorts of orders, but you will be happy to know they don't support "esoteric" orders.
The most egregious problem in Flash Boys is Lewis' use of the term "investor". He uses this term to make his readers think he is talking about them, after all anyone who is not an HFT, who is long holding a stock is an "investor". Yet the practices he describes as predatory, are really simple market dynamics. If an "investor" wants to buy or sell an extremely large block of shares, that should move the market price. No other marketplace would think differently. If McDonalds buys all the cows in America, beef should cost more. We all understand that. But the giant hedge funds of the world hate this. They want to use their privileged information of demand to make money, and not change the prices of the things in demand. They used to be able to accomplish this because the markets were dumb. They aren't anymore. Price discovery is an extremely efficient (and cut throat business). IETX does its gosh darn Canadian best to undercut that. Literally every rule they have is an attempt to hide demand and undermine price discovery. It's possible that bad pricing is an overall societal good. I'm not smart enough to weigh in on that. I will ask, if they are looking out for the little guy though, why do they have a special order type that insures that big investors don't trade with them (min. qty orders)? They will respond that it is protection against predatory HFT. I ask you though, if the huge hedge funds of the world don't want to trade in small volume with the rest of the informed markets, at the lowest prices conceivable, who do they want to trade with? The answer is large dumb funds, who don't care about trading at inflated costs. I.E. pension funds.
So here's my question: since the people that are trading do tend to understand these things (if for no other reason that they'll go bust if they don't), won't liquidity providers run away from IEX as fast as they can? How do Brad Katsuyama and his partners think they'll actually scare up enough liquidity to get maintain a functioning market?
I'm a little befuddled by this.
These schemes succumb to 1 of 2 problems
1) they are trivial to game by market makers. That is, the exchanges make their money on fees, the market makers make their money on finding inefficiencies in the markets, who is better positioned to find the places that a market protection scheme falls down? Of course it is the market makers. This is why you see stories of HFT "pinging" black pools, or creating routing tables, or whatever other wild information advantage that they can come up with. At the end of the day, big brokers/ibanks still get to eat if their schemes don't work, market makers don't.
2) If an exchange actually does find a way to limit market maker profits, they simply stop trading there. The liquidity dries up and the dark pool has to figure out some way to justify it's existence. Usually by relaxing their rules and allowing the tricks described in 1) or by negotiating a preferential deal with a couple of HFT firms that have some sort of price protection involved (which may be as shady as, only screw my clients I don't care about).
Brad, Lewis, and the IETX backers have figured out another strategy. Convince enough of the "dumb" money to demand that their trades be routed through IEX that they can create a self sustaining dark pool. They actually don't care about retail investors. If a couple of thousand of them call up and demand that their broker get on IETX that's fine. They've made the barrier to entry cheap enough that it doesn't cause a lot of overhead. But what they are really looking for is the uninformed institutional investor. The East Gary Fireman's Booster Union, needs to unload 65k of GOOG that some shady Morgan broker sold them. They think of IETX first. There sits Einhorn and his fund ready to hit it for all he's worth. No intelligent liquidity provider there to take any of his execution costs.
It's sort of brilliant and shows why I'm a dumb HFT market maker technologist instead of a billionaire (or millionaire in Brad's case) Wall Street type.
PS: You've probably already watched it, but if you haven't you should really watch the YouTube video on the iextrading.com homepage. It's...really something.
(Some people mentioned "Dark Pools" by Scott Patterson. Although also interesting, that books was often quite painful to read because it was quite clear that the author did not understand basic financial and programming concepts. "Flash Boys" is much better, in my opinion. Although if you are really interested in the subject, you should read both.)
Isn't that kind of crazy?
Instead I've spent the last week explaining to people (including my mom) why the opinions of an exchange bought and sold by folks with a vested interest in not allowing price discovery are painting me as evil.
Add to that the very real fact that for whatever reason, incompetence, bias, or laziness, Lewis has literally misrepresented the way the markets work, and the way participants thought it worked for many years and you can under stand why some of us are upset.
I will claim that the proposed solution (IEX) creates a fairer market for the vast majority of market participants.
Yet they are more than happy to sell their order flow to market makers who use HFT. (To allow them to trade against it before going to the exchange - as is customary - nothing wrong with that) http://www.schwab.com/public/schwab/nn/legal_compliance/impo...
Seems like they are jumping on the populist bandwagon by claiming "HFT bad!" but I think what they mean is "HFT bad - unless it's from one of the firms we sold our order flow to!"
He took a public stance on HFT a full year before the book was released.
Taken directly from the release you linked-> As we noted in an opinion piece in the Wall Street Journal last summer.
http://blog.themistrading.com/talk-to-chuck-about-hft/ http://online.wsj.com/article/SB1000142412788732358290457848...
Suppose Alice doesn't want to pay for liquidity. She can just as well say, I'm going to wait for a buyer willing to pay the ask price. She doesn't trade with an HFT and instead takes the risk that a buyer never shows up or that the market moves against her. This is equivalent to an add-liquidity-only order. She won't be crossing the spread, and she therefore she won't pay the bid-ask spread.
It's the same thing if you're buying. If you don't want to pay for liquidity you don't have to. You state your price, say you'll only add liquidity, and when a seller comes along who's willing to give it to you at that price, you'll be matched.
Obviously if the buyers and sellers hold fast then no trades get made: The buyers are offering less than the sellers are willing to accept. If you want to make a trade then someone has to cross the spread -- either the buyer has to pay $100.10 or the seller has to accept $100.00. This leaves room for speculators: When a seller decides they want to trade right now and they cross the spread, the speculator can buy the shares and then hold them until a buyer comes who is willing to cross the spread, and then the speculator profits by buying at the bid price and selling at the ask price. The speculator is taking the risk that in the meantime the price of the stock may go down and they'll lose money, and that risk is what earns the profit.
But HFT isn't that. HFT is having fast computers sitting in Chicago and New York, so that when a buyer crosses the spread in Chicago at the same time as a seller crosses the spread in New York, the HFTer can arbitrage the transactions with the foreknowledge that both trades will clear immediately. The HFTer is not taking a risk proportional to the profit but rather is profiting from trading with superior information. Moreover, the HFTer is only holding the shares for milliseconds. How does that provide any useful amount of liquidity? Why can't we arrange the exchanges so that if a buyer and seller both cross the spread at approximately the same time, they split the difference and no third party takes anything?
Also think about this in terms of what happened, the two counterparties got to interact without being in the same place or product. Yes, they could have traded if they were both in the same place, but they weren't. Surely providing that service is worth something. You could buy your meat wholesale, but the grocery store isn't ripping you off by selling it for $1 more a pound somewhere closer to home.
Think about what would happen to others if the HFT wasn't there, too. Prices would diverge and traders on one of the exchanges would be trading away from the real value. By keeping prices in line, information is transmitted from market to market more efficiently. A trader who isn't concerned with cross-market arbitrage doesn't need to connect to and watch multiple markets to get a fair price.
HFTs are obviously motivated by profits, but the level of profit is extremely low for the amount of service they provide. Virtu trades over 5% of the US markets and made slightly over $100 million. They only have a couple hundred employees. Think about how many people were required to make markets globally before technology. Only a fool would argue that we should go back to that system.
Who is even suggesting that?
Distinguish between the result and the method. Having prices be the same on all exchanges is obviously desirable. But why do we have to reach that result in this way? Why not instead have the exchanges talk to each other and have trades on any exchange automatically go to all the other ones, so that prices are always the same programmatically without having to pay any third party to keep them that way?
Anyway most HFTs are not keeping prices the same between exchanges. There simply aren't enough times during the day when quotes are crossed to make this viable. Most are market makers or are doing arbitrage/psuedo-arbitrage trades like ETF vs. basket, futures vs. cash, etc. that move liquidity from product to product.
It's a distributed system. You want it to keep working (be available) all the time right? Guess what, you're gonna have to lose some consistency.
Moreover, you don't strictly need a distributed system. You could instead elect one exchange at any given time as the primary and clear all inter-exchange trades through that exchange.
Don't miss the forest for the trees.
And you can't hand wave away the fact that the implications of the CAP theorem are minimal on a distributed system with a high level of interconnect redundancy. If you can ensure with high probability that there will not be a partition in the network then you don't need partition tolerance. If against all odds you have a partition anyway then you lose availability, but that isn't a characteristic unique to the CAP theorem or distributed systems -- any system will lose availability if enough redundant components fail simultaneously.
Can you explain this in more detail? How does the HFT know that someone is crossing the spread? How is the HFT able to transact with two market-crossing orders after the fact? What financial instrument is being traded in Chicago and NY?
So suppose the bid for some particular stock is $100.00 and the ask is $100.10 in both Chicago and New York. They could be different between the two exchanges, but the prices between exchanges will generally be the same or very close to each other at any given time because any significant divergence is an arbitrage opportunity.
Now somebody wants to buy some shares of that stock in Chicago, so they cross the spread and put in a bid for $100.10. They immediately buy all the shares in Chicago that are available at $100.10. Now the ask in Chicago will go up because all the shares available for $100.10 in Chicago have been purchased, so now the bid in Chicago is $100.10 and the ask is, say, $100.20. At the same time, in New York, somebody wants to sell some shares of the same stock. So they cross the spread and make shares available for the bid price in New York, which is $100.00. That seller sells to everyone in New York who is willing to pay $100.00, so now the ask in New York is $100.00 and the bid is, say, $99.90. Both the buyer in Chicago and the seller in New York are still willing to buy and sell more shares at $100.10 and $100.00 respectively, i.e. the new bid in Chicago is higher than the new ask in New York.
The HFTer sees the new prices before most other traders because their computers are faster and closer to the exchanges. As soon as the buyer at $100.10 learns there is a seller at $100.00 or vice versa, they would get together and trade all the shares they want to trade at some price in that range. But the HFTer learns the pricing information first and, before the buyer and seller find out about each other, the HFTer buys the seller's shares in New York at $100.00 and immediately resells them to the buyer in Chicago at $100.10.
There is $.10 of surplus here. Who (if anyone) should get it, how, and why?
By all means educate us then.
> There is $.10 of surplus here. Who (if anyone) should get it, how, and why?
That seems like kind of a philosophical question. Who ever should get any surplus? A better question might be, how can non-HFT traders arrange to capture the surplus currently claimed by HFT?
> if there is no HFT involved how would you propose that this situation be resolved?
The situation now is that whoever is fastest gets the surplus, even though being milliseconds faster provides very little utility. If you remove all HFTers somehow by magic but the situation remains that whoever is fastest gets the surplus then whichever of the buyer and seller can adjust their prices faster would get it. But suppose we go a different way and have the exchanges sort it out: Automatically send all offers to buy or sell to every exchange where that security is traded and allow the other exchanges several seconds to match bids with asks. The highest bid is always matched with the lowest ask on any exchange and the price paid is the midpoint between them. That seems inherently more efficient than creating a huge financial incentive for private actors to shave invisibly small slices from the amount of time it takes to trade between exchanges.
What would have really happened in your scenario would have been on of the following:
1. The orders would have been partially filled and the balance would be cancelled (order were Immediate Or Cancel)
2. The orders would be partially filled and the balance routed to other exchanges which are displaying the same price (Orders were routable)
3. The orders would be partially filled and remain active (but undisplayed) at the exchanges (this is dependent on what order type is used and at what exchange).
> how can non-HFT traders arrange to capture the surplus currently claimed by HFT?
By posting their order and waiting to be filled. In a two sided market your options are to pay up and be filled immediately or to get in line with everyone else that wants to keep that extra $.01 and wait for someone more impatient (or informed) to come along and sell to you. By providing liquidity you take time and price risk (you don't know when you will get filled, if ever, and the market may move away from you requiring you to have to pay more later) and by taking it you don't (but you pay the liquidity provider for the privilege).
"Someone will always be faster." That will always be true no matter what new trading format is being considered. There will always be a way for someone to get relevant information more efficiently and act on it. Always. Slowing down markets or obscuring/delaying quotation hurts price discovery and increases uncertainty. This increases volatility, widens spreads, and in all likelyhood actually tilts the playing field in the favor of high-speed computerized trading rather than away from it.
You misunderstand what HFTs are doing. They are in the business of selling liquidity. You have to pay them for that. Luckily the cost of liquidity (due to automation & competition) has gone down by a factor of 10 which is great for you (and everyone else)!
Brad Katsuyama (weirdly the hero of the Michael Lewis book) is in the business of making sure you DON'T get the best price. The HFTs are working against him to make sure you do.
In other words, sure, definitionally it's liquidity, but since the trade would have gone through a sub-second later anyway, it's not meaningful liquidity: the liquidity was already there on a reasonable timespan (again, sub-second) for the seller. Thus, nothing has been gained.
What am I missing here? Do sellers really need additional sub-second liquidity beyond what the market would provide without HFT?
Also very few HFTs have sub-second average holding periods. There aren't many instances where the market trades both sides so quickly. Probably average in the 10s of seconds at least if not longer.
Imagine if you could have the house off your hands, at market price, in a day instead of listing it for months. That's b what liquidity does for you. Almost all HFT is market making, there's plenty of information about what that means...
*There are some highly predatory algorithms that try to do this. The problem is that if you are fast enough to do this routinely, you are sophisticated enough to do legitimate market making and make more money.
Maybe start here to better understand things:
http://www.bloombergview.com/articles/2014-03-31/michael-lew...
You should narrow your question to how the latency arms race provides liquidity, and if it would be different it latency was capped at some amount.
Everyone knows you can get more for a used car if you sell it yourself instead of trading it in. Yet millions of people trade in their cars. Why? Because it's easier and faster.
The difference in price they get from the dealer vs Craigslist is the price they are paying for liquidity in the transaction.
HFT's are very good at providing liquidity (and obviously so), under that definition.
The Blind Side -- the story of how one of Michael Lewis's classmates as an Ole Miss booster, gave impermissible benefits to a high school recruit and got away with it.
Moneyball -- the story of a GM with 0 World Series appearances and a .530 WP.
Disagreement is not censorship.
"On most articles like this it just feels like a bunch of doe-eyed, aspirational men who really want to be rich one day, so don't want to spoil the fun for their future selves."
Yet all the interviews, press junkets, and face time on the Daily Show are saying the exact opposite (to the point that Jon Stewart of all people is extolling the virtues of Goldman).
It says way more about the book selling/exchange building business than it does about HFT.
In addition to long term capital gains, and short term capital gains, there would be "intra-day" capital gains and "sub-second" capital gains.
I was thinking the intra-day gains Federal tax rate would be 50% and sub-second capital gains Federal rate would be 90%, but these values are arbitrary.
For both new types of capital gains, LIFO trade accounting would be used.
If the book was presented as non-fiction "based on a true story" that's one thing, but If the b
If anyone thinks that these side business do not victimize participants you should look back to examples like Knight Capitals glitch that most certainly caused retail investors to lose trust and pull their money from the market, taking a loss. The introduction of non-relevant code is an unnecessary risk that does corrupt the system and does victimize your average investor.
1. http://www.telegraph.co.uk/finance/newsbysector/banksandfina...