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The issue seems to be that, when you want to buy a somewhat-large amount of stock, regulations exist which:

1. Force you to split up the purchase among multiple exchanges, and

2. To compensate for this disadvantage to the buyer, are supposed to prevent news of the order causing a price change at the other exchanges by spreading faster than filling of the order, so that you don't have to deal with an artificially-inflated price on top of artificially-imposed split of your order.

But while (1) is enforced, (2) is not. Which means buyers and most sellers have to play by one set of rules while people who want to inject themselves as middlemen get to play by a different set of rules.

At least, that's what seems to be being described here, and I certainly can see problems with it.

(not to mention that that "liquidity" and "efficiency" arguments fall flat -- the types of HFT schemes being described here work only by creating artificial illiquidity, and I don't know of any rigorous argument that creating more middlemen improves efficiency)

There is no regulation which forces you to split up your order. People split their order because one venue does not have enough liquidity.

To compensate for this disadvantage to the buyer, are supposed to prevent news of the order causing a price change at the other exchanges by spreading faster than filling of the order,

This is simply incorrect. There is a regulation which requires exchanges to transmit news of price changes to the other exchanges as rapidly as possible. The purpose is to ensure that all fills happen at the NBBO.

In concrete terms, if BATS has a BUY@$20.00 and ARCA has a BUY@$20.01, BATS is forbidden from filling your order.

http://en.wikipedia.org/wiki/National_best_bid_and_offer

Actually, the exchanges are REQUIRED to split up your order, if the bid/offer is better on another exchange.

Example: NYSE order book

100,000 shares offered $10.02

100,000 shares offered $10.00 (quote)

NASDAQ order book

100,000 shares offered $10.01 (quote)

You send a "buy 200,000 shares $10.02 limit" order to the NYSE.

The NYSE is REQUIRED to route 100,000 shares away to NASDAQ@$10.01, rather than filling the extra 100,000 at $10.02.

An HFT intercepts the trade, buys the 100,000 at NASDAQ @$10.01 ahead of you, and also can buy the 100,000@$10.02 at NYSE ahead of you. Now you have to pay $10.03 to buy the remaining 100,000 shares.

Please explain how My. HFT "intercepts" the trade in this case? How does he know your limit price? How does he know your parent quantity?

Imagine an alternate scenario: You send an order "buy 100,000 shares $10.00 limit" to NYSE. Does the HFT spend $4MM buying up 200k on the off chance that you want more than the 100k you already bought? If not, why?

The feed the HFT gets is faster than the NYSE to NASDAQ feed. That lets them trade ahead of you.

You placed an ordinary 200,000 share limit order. You didn't use one of the special order types.

It is riskless for the HFT to buy 100,000 from NASDAQ, knowing they can sell back to you when you buy the other half of your order. Other algos, seeing a big buy, move up the price, so the HFT (may) be able to safely buy and then sell to them.

> The feed the HFT gets is faster than the NYSE to NASDAQ feed.

Assuming for the moment that someone can see an execution from NYSE and route an order to NASDAQ in response in less time than NYSE can send their own order to that Exchange you haven't answered the rest of the question.

How does the HFT even know there is an order in-flight to NASDAQ? How does the HFT know that the buyer is willing to pay $10.02?

> You placed an ordinary 200,000 share limit order. You didn't use one of the special order types.

Is this supposed to be an answer? 100k executed at NYSE @ $10.00, this is public information. NYSE routed the other 100k to NASDAQ. Are you saying there is some way for Mr. HFT to know the particulars of that order to NASDAQ?

> knowing they can sell back to you when you buy the other half of your order.

You seem to be under the impression that at some point along the line someone besides the NUSE is seeing the parent order details (buy 200k @ $10.02). Please explain how you believe this information is transmitted to third parties.

The HFTs get to see the list of orders as they come in. That's the advantage of colocating with the exchange.

If a 200,000 share limit order is placed at the NYSE, the HFTs know that regulation NMS requires the NYSE to route shares to the BBO on other exchanges, before filling the order from their own book.

>The HFTs get to see the list of orders as they come in.

No, they don't. Third parties cannot see orders "as they come in". Only orders displayed in the exchange's book and executions already completed are sent out to data consumers.

In the example you created the 200k buy order is never displayed and as such is not visible to any other user. All an HFT can see is the 100k execution.

Again, an HFT rushing to buy in front of this order cannot know how big it actually is, nor what the limit price is and as such whatever buying is purely speculative and not a "guaranteed win".

If you believe the description is wrong, your issue is with the article.

Direct quote from article:

With Reg NMS, it essentially took x amount of available stock at one place, and made it one tenth of that x at ten different places.

If that isn't a regulation forcing large purchases to split up, then it's on you to explain why.

The most charitable interpretation of that quote is that after RegNMS, multiple trading venues became legalized. Liquidity providers then chose to spread liquidity out because it was now legal.

Here is RegNMS. Find me a place where it says liquidity must be divided between all possible exchanges: https://www.sec.gov/rules/final/34-51808.pdf

If you believe the description in the article is wrong, then as I said your problem is with the article.

Seller(s) of stock are not required to place shares on different exchanges. This is a side effect of the process of trading, as the NBBO price bounces around to different venues.

If I offer 100,000 AAPL at NBO at exchange X, and you are willing to purchase 100,000 AAPL at NBO, your buy order matches mine exactly and the transaction takes place. This is highly unlikely, of course, that an enormous stock transaction like this ($50M) will take place this way.

It's a lazy question, but what mechanism is the regulator using to score the effort of the exchange?

A related topic would be how often they take enforcement actions.

>(not to mention that that "liquidity" and "efficiency" arguments fall flat -- the types of HFT schemes being described here work only by creating artificial illiquidity, and I don't know of any rigorous argument that creating more middlemen improves efficiency)

A lot of HFT is market-makers competing for positions in the book. They're simply providing liquidity and literally the more trades they make the more money they make. Market-making is socially valuable (decreases the cost of trading aka the spread) in a similar way that arbitrage is, and as I understand it this is why people are so hesitant to regulate HFT, despite some of the problems it causes. As far as preferential treatment, consider that exchange fee schedules prefer these kinds of traders for a reason.

Exchanges are for-profit and their liquidity providers don't execute trades for the fun of it, there has to be incentive, even if the incentives are at times perverse

If someone was already willing to sell 50 shares of Acme Corp. at $20.00, having an HFT bot get advance knowledge of an order, buy those shares and then re-offer them at $20.01 is not market-making and is not providing liquidity -- it is injecting an artificial middleman, with the cost of a middleman, for no other reason than "we can make money off injecting a middleman".

My point is that regulating this kind of trading can also damage socially useful trading activity and that's why it's unlikely to happen. There's a lot of rabble rousing about HFT in these discussions on HN (in a similar thread someone went as far as to say arbitrage was not socially useful), I thought it was worth pointing out its more complicated than "HFT IS A BIG SCAM"

I'll admit its funny to see the libertarian bastion of HN get so worked up about HFT. Free markets are all fun and games when it's Uber or AirBnB, but HFT harming retail investors seems to really hit a nerve

That's the funny thing too, retail investors are fucked beyond believe and it has nothing to do with HFT and everything to do with not having satellite pictures of walmart parking lots, etc. They trade at such an unbelievable disadvantage that it's laughable that HFT could make any difference. (Plus retailers dont move big enough blocks to get into HFT issues)

How does an HFT bot get advance knowledge of an order?

The scenario most commonly presented is something like:

1. Buyer A wants to buy 50 shares of Acme Corp.

2. The order hits Exchange A first, and Exchange A has 25 shares of Acme Corp. at $20.00 (currently the best price).

3. The order is partially filled, and then on to Exchange 2 to try to get the other 25 shares.

4. Exchange 2 also has 25 shares of Acme Corp. at $20.00 at the time the order hits Exchange 1.

5. An HFT bot saw the order hit Exchange 1, and, in the time it takes for the order to move on to Exchange 2, is able (due to having much faster access) to buy those 25 shares at Exchange 2 before the order gets there, then offer them to the buyer at $20.01.

The fact that the HFT bot was able to act in Exchange 2 with advance knowledge of an order that would arrive at but had not yet arrived at Exchange 2 is what people complain about. And, more generally, people complain that this provides no benefit to buyers or sellers; the buyer was going to buy those 25 shares, and the seller was going to sell those 25 shares, no matter what. So no additional liquidity or market-making went on, and the buyer's order likely is not filled any more quickly than it would otherwise have been.

(and several articles complain that this practice actually leads to loss of liquidity, in that orders go unfilled because HFT bots racing ahead from exchange to exchange have reduced the previously-available shares)

The workaround that's been presented is to have the actual initial order take circuitous, deliberately time-delaying routes to the exchanges in order to have it hit multiple exchanges within a short enough time that an HFT bot can't inject itself as an artifical middleman.

What you describe is called predatory trading. It will almost never occur with a half-lot order, but can occur with large orders.

Rather than repeat myself, I'll just link to a blog post I just wrote about it.

http://www.chrisstucchio.com/blog/2014/fervent_defense_of_fr...

What you describe as predatory trading is different from ubernostrum's scenario. In your predatory trading example, Little Billie trying to move a large block of shares, there are no existing orders in the book that match the entire block; so once the initial partial fill of Little Billie's order is done, he will have to change his offer for the rest of the block to move it. In this situation, yes, the predatory trader is communicating market information that might not otherwise get communicated.

In ubernostrum's example (which is also the one appearing in the OP to this thread), there are existing orders in the book that match the entire block. So the HFT in between adds nothing; the entire trade would have occurred at the original offer without him.

How does the HFT know the size of the buy order?

Alter the scenario here:

1. Buyer wants 25 shares, buys all available shares at his limit price on exchange A.

2. HFTs 1-n see the entire quote taken at Exchange A and rush to buy all available shares at that price on Exchanges B-K

3. HFTs now own a few hundred shares of Acme corp that they need to unwind.

HFTs are only accessible to a select few. And are only worth doing over large sums of capital.

Is it rigging if my dice has more sixes than yours?

This is incorrect - many HFTs are just one programmer investing his savings. Many of the big guys started this way.

THIS is incorrect. From the article:

>A direct feed from one exchange could be $10,000 to $60,000 a month. If the SIP is no longer real-time, it means that people who want to get real-time data have to pay, well, significantly more. It’s no exaggeration here to say you go from $1 a month to well over $100,000, with your own networking staff and a room full of computers just to get real-time pricing.

$100k a month is now something you can stump up out of your savings is it?

You don't need to pay $100,000 month for access. My NDA forbids from revealing pricing info, but I can say I worked for an HFT fund that was just a programmer working out of his living room.

... Neither of your statements invalidated my statements.

Unless you are saying that programmers are a majority, and their savings are typical of the same majority?

EDIT: (And reading the other response, it seems you are in fact incorrect).

Here's a few examples from at 2010 CNBC story of top HFTs. It's a pretty diverse group but most were programmers and most started (relatively?) small.

http://www.cnbc.com/id/39038892

Yet the price to "play the game" does not exactly say "small guy".

Trading is the only industry on earth where we even debate whether Joe Schmoe off the street should have a chance at competing with huge institutions, and oddly enough it's probably one of the most purely competitive things in the world. Most guys who play ball at the local park can't be Lebron James. A guy sitting at home has no shot at market-making liquid stocks, and low latency is only the tip of the iceberg as to why.

In any case it is not expensive to start a firm like this relative to most things in finance or even other physical market-making businesses like running a retail store. You could do it with a few million dollars and a dozen technologists/researchers. That's why this debate is so stupid. Banks who are mostly the ones complaining about having trouble executing could easily hire up a team to build better routers and execution algos for them. Most of them have, even, which has cut HFT profitability considerably. The laggards prefer to go on CNBC rather than invest in technology to keep up.

So you are comparing startup cost of a ball with the startup cost of a "few million dollars" to start a HFT company?

I have no issue with the market in general or people making money providing investment to others who need it.

Where I am having problems is when the market becomes it's own closed loop and the money is made inside of that loop. I been on the sideline of this industry for many years now and I have yet to see any company who is successful in the long run be so because they play a fair game.

Reading stuff like this:

http://moneymorning.com/2012/10/15/the-truth-about-high-freq...

certainly doesn't help.

"...What they are doing is trying to influence, I call it manipulate, what other traders and investors do with their bids and offers. They are trying to fake or set-up other market participants to react to the quotes the HFT players fire out onto the exchanges for all the stocks they trade.

Only the HFT quotes sent out aren't meant to be acted on. They aren't looking to buy on their bid quotes or sell on their offer quotes.

Instead, they are sending out orders to "ping" markets.

Ping refers to how sonar works. For example, a submarine sends out a sonar beep which hits a target and sends back a sound (which sounds like a ping) which the sonar operator "reads" to determine the pinged object's distance and shape.

HFT players are constantly pinging stocks where their quotes are housed and displayed. They send out their orders to manipulate others to adjust their quotes, which get fed into the HFT algorithms to determine any directionality; then, if an opportunity exists the HFT computers buy or sell shares that someone else has put onto the market.

They aren't quoting constantly as bona fide "market-makers" are supposed to do, which they claim they are acting like. They are simply putting out millions of fake bids and offers which they pull almost immediately, just to read the movement of other market participants who react to the HFT come-ons.

It isn't illegal. But it is manipulation.

The buyers and sellers the HFT crowd trades with aren't forced to trade, they are willing to trade -- it's just that the prices they trade at may have been manipulated..."

Can you explain to me how HFT benefits society in general? What would happen if we didn't have HFT? Would the market crash? Would there suddenly be no money to invest with?

There are not many businesses you can start that cost so little. Even a McDonalds franchise would cost more to start than a small trading firm.

The activity he describes is illegal. Every order you place must be because of a bona fide interest to trade at that time, and not as an attempt to induce others to act or gather information.

If I could get filled on every bid and offer I have in the market I'd be very happy. That's basically what happened to the MMs on the other side of the Knight debacle.

HFT moves liquidity across time, place, and product. It drives down spreads by intermediating trades for a lower cost than human market makers had to charge. The market would not crash if HFT went away, but markets would become less efficient, more trades would go off away from fair values since nobody could correct small-scale mispricings, spreads to customers who immediately want to buy and sell would increase, and short-term volatility would go up since nobody would buffer transient pricing errors. It'd be like if all the grocery stores around you folded and you had to trek up to the meat market and buy things in bulk. It would be very inconvenient and expensive, but not the end of the world.

In the digital space there is.

Comparing it to a McDonalds franchise make little sense IMO both in terms of what the investment is used for and the returns you stand to gain.

With regards to the inconvenience and price of not having HFT around. That again sounds like an issue for the traders not for the companies the stockmarket is supposed to help.

The returns aren't that high though. Even the top firms now barely make anything after costs.

The stock market is designed for traders! The primary purpose of a stock market is to let stockholders transfer risk most efficiently. The capital raising was done when the company issued shares. People buying stocks are not investing.

But then we are back to the original question. What value does it provide then?

You claimed that it would be much more expensive if HFT wasn't around. So surely HFT should be able to reap the benefits of what they save no?

Not in a competitive market, and on-exchange liquidity provision is the most purely competitive market out there. My quote is no better than anyone else's, so anyone can undercut my price.

Imagine the grocery store example I gave. Say meat costs $5/lb wholesale and your transportation costs to drive to the meat market in a car are $1.50. A grocery store using a truck to pick up the meat and freeze it in their store can transport the meat for $0.50. In a non-competitive market, they would charge you $6.49 for the meat, and you'd prefer to buy it there since it's less than your alternative of paying $6.50. However, if there are two grocery stores across from one another, they can compete on price to win your business, and the price of meat will end up being marginally above the costs of whoever can transport/store meat the cheapest, maybe $5.55 or something. The end consumer captures most of the surplus value.

The same thing happens in trading. Professional traders are more skilled at managing positions and trading across markets. By electing to trade with a market-maker's quote, you are effectively giving them your trading problem. Unlike the grocery store example where only a handful of businesses may compete, there are dozens of firms engaged in automated trading all competing for your business by offering tighter prices. They'll continue to do this as long as it's profitable, but competition will erode their profit margins until they're slightly above costs.

HFTs made a killing when they had first-mover advantage, just like if you were the first company to use smart logistics software or any other innovation. Now, not so much.

thats still not showing transcendence. How does HFT help the grocery store, the startup, the autocar dealer, amazon, mictosoft etc. you only showed inner market workings not why we as a society need it.

We don't need much more than safe shelter and a shirt on our backs. We could get by with once a day call auctions or even trading stocks face-to-face without an exchange at all. We don't even need stocks or companies. That doesn't mean intermediation in real-time markets isn't valuable.

Say you have a car and want to sell it to buy your future wife an engagement ring. You could take it to CarMax and sell it instantly, or spend your time researching a fair price, posting up ads, cleaning it up for sale, meeting with potential buyers, etc. CarMax has all sorts of "unfair" advantages: they've developed superior pricing models, they have access to historical auction data you may not be able to get, they can sell their inventory in the inter-dealer auction market, they've invested heavily in their own sales force to resell the car, through economies of scale they can hire their own detailers and mechanics to fix the cars up at a lower price, etc. CarMax is clearly superior to you at the "reselling used cars" game, though all the advantages they have are things any competitor could choose to purchase. They make money doing this, but people still choose to deal with them because it's a net benefit to be able to sell your car instantly.

Some people prefer to sell their car to CarMax, others try their hand at doing it themselves, and through their patience they may save a bit of money. Likewise you can do the same in the financial markets. You can work your own limit orders to enter or exit positions or trade in the opening/closing call auctions on each exchange, but many traders prefer to trade instantly with quotes placed by a market maker. Being able to liquidate your stock holdings to spend the money on something else instantly is valuable to some people, and they pay for it through the bid-ask spread.

You're basically saying people want the wrong things.

no i am basically asking whether anyone besides the people doing HFT benefits from it. If they do then it should be easy to point to the positive consequences of HFT in society and a lot more people would back it up.

If its only beneficial as a scheme to get money out of the stockmarket then many people are naturally going to be against it.

Claiming i am on the wrong side of what people want seem to be a tad ignorant of reality, dont you think

Countless studies point to a lowering in bid-ask spreads (the effective "fee" impatient traders pay to trade) when electronic market-makers entered the market, and an increase in this spread when they leave or are forced out:

http://marginalrevolution.com/marginalrevolution/2014/04/a-s...

For me to win trades as a market-maker, I have to put up prices that are tighter (buying higher and selling lower) than my competitors. Through this competitive process, the rents earned by market-makers decrease and the end consumer of their liquidity reaps most of the benefit. Since markets have moved away from a monopoly specialist model and become more electronic, spreads (and thus compensation earned by market-makers) have decreased dramatically.

Nobody is backing it up because a.) firms involved tend to be secretive so as not to give away any competitive information, b.) there are a lot of slow or inefficient brokers speaking out against it "talking their book", and c.) to the end-user, HFT is like plumbing. I don't thank the city workers every time I hop in the shower, or write a glowing blog post about Visa when I swipe my card to buy goods and services all over the globe. The infrastructure exists and it provides a benefit, but it's faceless and not something most people think about. Most people don't even consider who is on the other side of their trades or where the prices even come from. They just want to click a button and get in or out of a position, and thanks to competing HFTs they can do it instantly, cheaper than ever before.

This perhaps used to be true, but the HFT arms race has pushed the cost of entry up to the point where you are looking $50k-$100k a month in infrastructure costs just for a seat at the table, and many times more than that if you want to play with the big boys. And that is in addition to the money you actually plan to invest.

I had this long reply about how HFT allowing you to execute large trades, etc is a bullshit argument, but then I deleted it. I weighed in on how it affects pricing, how it affects the seller, re-read your post, and realized something:

I'm grandpa.