A Fervent Defense of Front-running HFTs | Hacker News Reader

A Fervent Defense of Front-running HFTs

chrisstucchio.com

107 pointsspindritf154 comments

I think this article does a good job of illustrating why its so hard to have an open dialog on this subject.

Start with asking "What is front running."? The market's definition would not include what HFT do. But bring this up to someone without knowledge of the public markets and their first reaction is to say, hey this is front running, it must be wrong. "Front Running" has a specific definition and it only relates to a broker and their own clients. You trading before me because you are faster is not front running. You understanding my flow is not front running.

You can then ask "What is public information". The fact that everyone can see any tape they pay money to see so there doesn't seem to be any one acting on "insider knowledge."

Now tell people that HFT's will use their fast machines to change their orders due to a change on one exchanges tape before the main NBBO tape is updated and some people will claim that this is obviously wrong.

The other argument I've seen made here is that trading on "insider knowledge is obviously wrong." Well it isn't obviously wrong and the entire commodities market assumes that anyone can trade legally on insider knowledge. Imagine you are the biggest producer of oranges. You know that you are going to have a bad crop so you but some orange futures so you can meet your demands. This is insider information you've traded on and its the way the market is intended to work.

This is great - it hits major topics that should be part of this debate. It's long, and it's a bit complicated... but so is the issue.

Some things you should be thinking about after reading this:

* What exactly constitutes front running? Does trading based on public data (albeit in expensive feeds) constitute front running?

* Large trades are almost all traded through algos. Are those algos better than proprietary "market making" algos? Why?

* What is adverse selection? How do dark pools contribute? Who benefits and who suffers?

Read more articles like this. Be suspicious of "simplified" discussions.

I have some questions based on yours:

* What constitutes public data?

* How likely are the types of front-running HFT algos that are discussed in this article to be the old, traditional players?

* What are the ethical (lol) rules against front-running your own customers if you're a market-maker? How could your customers even find out? What happens when the proprietary information is that a customer has just placed a large trade, and you drive up the price before it even hits the market? How is this fundamentally different than the commission these firms already charge?

What are the ethical (lol) rules against front-running your own customers if you're a market-maker? How could your customers even find out? What happens when the proprietary information is that a customer has just placed a large trade, and you drive up the price before it even hits the market? How is this fundamentally different than the commission these firms already charge?

Market makers are generally proprietary firms that trade their own money, and don't have customers.

Brokerages (ie: Scottrade) have customers and it illegal for them to front run their customers.

I'm not thinking retail brokerages -- I'm thinking investment banks like Goldman. Often the big i-banks have both prop trading operations and the ability to fill large orders for institutional clients (e.g. a pension fund looking to buy $1 billion of Apple stock).

For them, they have a fiduciary duty to their clients to act in their customers' best interest. So, if their clients asks to purchase, for example 100,000 shares of AAPL, it would be illegal for them to first drive up the price.

Good questions.

* Along with order routing, market data is heavily legislated under RegNMS as well. Both the creation of the SIP feeds (the slower consolidated data) and the rules around exchange proprietary feeds are legislated there.

As part of the Fair Access Rule, exchanges cannot favor a certain participant with preferential pricing. Therefore, even if proprietary exchange data products are expensive, they are equally expensive to all participants. I consider that fair.

An argument could be made that the price of the feeds is exclusionary. I do not buy this - there are many types of data available in the market that come at a high price. The next question (if you assume that the price makes it effectively non-public) is if there are effective substitutes. I think for non-professional traders (moving less than, say, $10mm notional per month) the SIP and similar feeds is acceptable (just as many retail traders accept 15min delayed market data as acceptable). For more serious traders, there may not be an acceptable substitute, but given their usage the higher costs are more justified.

* Ethical rules around front running of orders is covered in the Manning Rule. In short, it prevents placing a firm's trading interests in front of a client. The details can be found at FINRA: http://finra.complinet.com/en/display/display.html?rbid=2403...

I've been following (sort of) the back and forth on this and find it quite interesting. Here's a question though: what happens when the "whale" is really something like an index fund that, ultimately, is composed mostly of retail investors? Aren't they getting ripped off in that case? This isn't a rhetorical question, I'm curious to know how it plays out.

Yes. But you get ripped off less in an index fund since in general, they are also run by algos within other algos that just rebalance to match whatever they're tracking. The idea if you're an investment firm is that index funds can hide risky investments: they're often large and they're often not highly leveraged.

In reality, index funds are the safest way for individuals to make money in the market because you're placing a bet on the economy as a whole.

Here's the CIO of Vanguard (who run some of the biggest index funds in the world) saying that HFTs cut costs:

http://www.cnbc.com/id/49434073

I think it really depends on what you mean by ripped off. I think that institutional investors looking to place multi-million dollar moves shouldn't be able to just place an order and cry foul when it's not completely filled on all the exchanges either. From another point of view, that's the slippage you get from an improper order placement strategy.

>Here's a question though: what happens when the "whale" is really something like an index fund that, ultimately, is composed mostly of retail investors? Aren't they getting ripped off in that case?

Damn right they're getting ripped off.

The defense in the OP is essentially "yes, that can happen but it's very rare". Which is about as believable as it sounds.

> Predatory traders detect information and split the profits with the counterparties (taking a cut in the process)

No. No they do not. They detect the information, and extract part of the value without improving the situation of the seller.

The seller was going to get filled at $21 in either case, the only difference is that the front-runner bought and resold those shares to the "whale" buyer.

This intellectual backflip is premised upon two mutually exclusive things happening:

1) the predator trades on information that there is demand coming and 2) in the counterfactual for the seller, that demand may never have come.

But because the front-runner is cutting the line, they only place trades once the demand is in the order book.

As a work of acrobatics, this is impressive. As an intellectual work, it is saddening.

But because the front-runner is cutting the line, they only place trades once the demand is in the order book.

There is no "cutting the line". If the demand were already in the order book the trade would have occurred.

Please go read the tutorial before commenting further - you demonstrably do not understand how a matching engine works.

I re read your article, and it appears I took information from your headline and assumed it into your examples. I think you're talking about plain vanilla market making and speculation. Nothing in there is what I would consider predatory or HFT or front running.

These things exist, per my best reading of the wsj, and you said you were defending HFT but as best I can tell merely defended computerized market making and speculation.

The thing that is being called "front running" here involves multiple exchanges. There is no cutting in any single line. There is more then one line, and you can be in multiple simultaneously. In some cases, traders may go through one line and then complain that HFT traders went and got in the other line. In order to call that "cutting in line" and be well founded, you need to come up with some framework for how that "line" works - it does not fall trivially out of the actual lines in the two exchanges.

Why isn't HFT front-running? Let me attempt an explanation without relying on legalistic constructs.

Customers pay brokers a commission to execute their orders. This involves a customer trusting a broker with their confidential order information. Until an order goes to the exchanges, only the customer and broker know about it. The order is material non-public information.

Brokers have a fiduciary obligation to look out for their customers' interests. This applies even when the customer's interests conflict with the broker's. For example, suppose a broker holds Tesla stock. A knowledgeable customer calls the broker, seeking to sell 2 million shares. This would depress Tesla's stock price. Front-running would involve the broker selling his shares first, and then the customer's. This violates the broker's fiduciary obligation. That is why it is fraudulent and thus illegal–an explicit trust relationship would be ruptured.

Across the trading floor from the brokers are us market makers. We trade our own capital. We also have no customers and thus no fiduciary obligations. Our income comes from the bid-ask spread (and liquidity-provider rebates from exchanges). For example, here is how a phone call might go:

COUNTERPARTY: "2 million Tesla?"

MARKET MAKER: "209 at 210."

COUNTERPARTY: "Buy 2 million Tesla for 209."

The counterparty is looking to buy or sell 2 million shares of Tesla stock. They do not specify which in advance. The market maker says they will buy at $209 or sell at $210. The customer then confirms that they want to buy, and will buy at $210.

An order, when properly executed, does not betray its owner's intentions. This applies as much in the meat space as in HFT. For example, here is how one would not place an order:

COUNTERPARTY: "I am looking to sell 2 million shares of Tesla stock at whatever price you'll give me. My wife just left me for a Brazillian stripper and I'm halfway through my handle of morning vodka."

This guy won't get 209 at 210. He might not even get 200. This isn't the market maker front-running a customer. It's a liquidity provider protecting his book and bottom line. This adversarial relationship is efficient - it keeps markets from getting too clubby.

There are valid critiques against HFT. (My pet is that HFT has no obligation to continue providing liquidity in adverse market conditions. This means they can pull out when the seas get rough, i.e. precisely when liquidity is needed. Traditional market makers cannot do that.) "Front-running" is not one of them.

Yeah, and isn't it true that the traders managing those large orders never enter them through traditional means anyhow? They either submit them to "dark pools" where the huge blocks can trade with other large participants without impacting the market as much, or they enter them as algo orders with their broker and they are split up into many smaller orders throughout the day with the goal of transacting at the average daily price.

>Why isn't HFT front-running? Let me attempt an explanation without relying on legalistic constructs.

That's quite funny since your defence of 'HFT front running' relies upon a fine legalistic distinction --- that the person who fucked you has no fiduciary responsibility towards you (HFT) vs. the person who fucked you having a legal responsibility towards you (broker).

Bottom line, though - they'll both fuck you.

That's not a fine legalistic distinction! That's a HUGE distinction!

One of the people is someone that you've hired to work for you. The other is someone you have no previous relationship with.

BOTH are siphoning off money from your trades.

It's the difference between an employee of McDonalds embezzling money from the company and an employee of Buger King doing a really good job on a marketing campaign that causes McDonalds profits to go down.

Now, if you work for McDonalds you're certainly entitled to not like either one of those people. But the rest of the world should decry the first and cheer on the second.

No, it's the difference between a CEO insider trading and a guy who looked over the CEO's shoulder at his laptop insider trading based upon what he saw.

No, it's not looking over his shoulder at his laptop. It's actually seeing his trades on a public exchange at the exact same time that everyone else sees them.

Except not:

>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.

http://www.washingtonpost.com/blogs/wonkblog/wp/2014/04/04/a...

Computers and data center space cost money. You think the exchanges should just give that sort of thing away for free?

Until an order goes to the exchanges, only the customer and broker know about it. The order is material non-public information.

The problem with your argument is that it doesn't address that certain companies have paid money to co-locate their servers in the same datacenter as the exchanges. This is unethical because:

T + 0.000 seconds order is sent to an exchange

T + 0.001 seconds order is received by colocated companies

T + 0.090 seconds order is received by non-colocated companies

For the first 90 milliseconds, the exchange has engaged in "selective disclosure" which means the order is still material non-public information after it has arrived at an Exchange. For colocated firms to then act on that material non-public information is unethical at best.

Citation on "selective disclosure":

http://www.investopedia.com/exam-guide/cfa-level-1/ethics-st...

Selective disclosure? When information is disclosed selectively, i.e. just to a handful of investment analysts, or perhaps on a conference call, or in an email, the information may still be regarded as nonpublic. Companies are bound by specific procedures designed to make the information truly public and to ensure a system of fairness in which all market participants are given a chance to act on the information.

If people couldn't pay to co-locate with the exchanges they would still compete for latency reductions. They would try to get in the building across the street. Or the one two blocks away. Or the one with a direct fiber connection.

Being able to pay to co-locate with the exchange actually serves to democratize things because it puts everyone on a level playing field where they pay the exact same cost for the exact same access.

The big problem is that the human definition of "front running" is bigger and more complex than the strict one that the computers (probably) obey.

To the computers the milliseconds of lag between the orders arriving at one exchange and the other is an eternity, it's plenty of time for the information to propagate and make price changes happen. As far as the computers are concerned the whole counterparty/market maker exchange above happened in totality at one exchange before it got anywhere close to the next exchange.

But to the human beings which by definition operate at human time scales it's seems as though the counterparty says "buy 2 million" and at that exact instant someone else cuts in line, yells "buy 2 million" and gets his execution price and causes the market maker to up the price that he has to pay.

I realize that TECHNICALLY that's not what happens. But to a human being it can easily seem that way. That's why the HFT folks argue so vociferously -- they're technically right -- but it makes them look like giant assholes to everyone else. It doesn't matter if they're technically correct, it's indistinguishable from "we're all smarter than you and you just need to trust us on this one" which people don't have a strong affinity for.

Here's that idea fleshed out:

COUNTERPARTY: "2 million Tesla?"

MARKET MAKER: "209 at 210."

COUNTERPARTY: "Buy.."

HFT: "BUY 2 MILLION TESLA!!!"

COUNTERPARTY: "...2 million Tesla for 209."

MARKET MAKER: "Sorry bud, now it's 210 at 211"

COUNTERPARTY: "WTF?!"

I realize that's not ACTUALLY what's happening. But when the time-scales of human beings and computers are so incredibly different it's not hard to understand why people FEEL like it is.

> I realize that's not ACTUALLY what's happening. But when the time-scales of human beings and computers are so incredibly different it's not hard to understand why people FEEL like it is.

The guy getting screwed by HFT isn't the chap looking to sell 2 million Tesla at 209. It's the guy on the other side who was hoping to pick up 2 million Tesla for 209 (to flip it at 211). Now the HFT buys it for 209 and sells it at 210, compressing the margin the flipper would have earned from $2 to $1. That's not front-running - that's competition. There is no privileged relationship between the HFT market maker and the other market makers or brokers looking to buy stock. In fact, there is an adversarial relationship. That adversarial relationship is what allowed the original chap to offload his 2 million Tesla at 209 in an instant. It is also what allowed the next guy to buy it for 210, versus the 211 the other market maker wanted to flip it to him for.

I think you mis-read what I wrote.

Nowhere do I mention a guy actively wanting to sell 2 million at 209 (the market maker was willing to, but didn't necessarily desire to) nor do I mention a guy (an actual human being, not HFT) who was in fact able to buy it for 210 because neither of those happened.

Furthermore there is no such thing as an HFT market maker (at least that I'm aware of) because the definition of a market maker is someone who has to provide liquidity continuously. The HFTs all go offline when things get dicey ergo they're not market makers.

What I described is how it SEEMS to a lay-person and how it SEEMS like HFTs are jumping the line.

A human being can't want to buy or sell stocks much faster than the blink of an eye, which is about 80ms. So everything that happens faster than that, or the click of a key (which might be 100 or 200ms) is going to SEEM like some serious bullshit. Technically it might not be but the entire world isn't going to get educated about HFT to make "smart" decisions.

I totally agree with you about the SEEMS.

But that's exactly why the Michael Lewis book is so frustrating. He's a paid professional who should be able to see through the SEEMS to get to what is actually happening. He's also a talented and popular enough writer that he probably could have done a lot to help explain to the world what's really going on here.

But instead he took the lazy route and just played into everyone's fears so he could make another 5 million (or whatever) on his latest book.

It's so lame.

This is all a matter of perspective. Some people think that markets exist and whatever happens, happens. It seems to me that a lot of the HFT folks fall into that category.

Others say "the stock market is supposed to exist so that large companies can raise funds for growth" The market isn't a thing that exists unto itself, it's a thing that humans created for human purposes. If something is happening in that market, due to a particular set of incentives that causes human beings (which are the only reason said market exists) to feel that sub-optimal outcomes are happening, well then the rules can be changed. The market exists to serve humans and if humans aren't being served they can change it.

So once you have a market structure that exists on smaller time scales than human beings are capable of comprehending everything about "what's really going on here" goes right out the window.

To human beings water is essential for life and largely speaking pretty harmless. But to flies water is hugely dangerous. Surface tension is a joke to a human being but it is much stronger than most insects. That's why so many insects have proboscis. http://irl.cs.ucla.edu/papers/right-size.html

What we have here is one side trying to argue the technical side of things and being 100% correct. Technically their arguments are quite good. The other side is arguing philosophically and their arguments are good as well. The question then becomes, which is more important? Professionals involved in finance are split on the tradeoffs. It should not be surprising that those not professionally involved in finance don't care to learn why a non-intuitive outcome is better than an intuitive one.

A lot of people apparently think that vaccines cause autism. But what if it was even more people? What if 100s of millions of people thought that? Would you make this argument:

"People's trust in the health care industry is really important. If they don't trust it, then they won't go see doctors and take medicine when they should so more people will die and/or get sick. So we're just going to get rid of vaccines because of people's false belief. We know that vaccines are actually a good thing, but because people are confused and trust is important it's better overall to cave on this issue in order to increase the faith people have in the overall system."

Because that's kind of the argument you are making here.

No, no I'm not.

The rules for markets are man-made. No markets would exist without humans. Humans created markets to serve themselves. As such the rules that govern how markets operate can be changed to serve humans. This is very easy to understand, wouldn't you agree?

Now comes the question: does HFT serve humans? Some people say yes, others say no. Some argue that they add liquidity and thus earn their fees. Others say no, they don't add liquidity (since they tend not to trade during rough times).

Still others say they add negative liquidity: when the markets are plenty liquid they rob market makers of deal flow (thus reducing market makers ability to earn a living) and then when things get tumultuous they shut down first taking the extra liquidity with them and also having the secondary effect of fewer market makers thus reducing liquidity further.

Market makers are able to make money because of the uncorrelated order flow that they receive as market makers. But there are HFT firms which are inserting themselves between brokerages and market makers, and paying millions for the privilege. That means they take profits from the market maker and after receiving their cut, provide some of it to the brokerages originating the orders. Is that good or bad? I honestly don't know. I might lean towards it being bad since the HFT firms have no obligation to keep trading. But they might very well reduce spreads. And if they are reducing spreads there is value to that.

http://www.businessinsider.com/brokerages-make-millions-sell...

So let's assume for a moment that they do reduce spreads (good) but they also reduce liquidity during crises (bad). That is the very definition of what is called an engineering tradeoff. What is your design criteria? What are your goals?

Engineering tradeoffs are at the heart of why basically everything is the way it is. Why are some cars faster and why do others get better gas mileage? Why are some bridges built with steel and others with concrete and others with wood? Why do some phones have a lot of battery life and other phones have a lot of features?

So I've heard plenty about how HFT firms reduce spreads, and many argue that it's a good thing. But they're not an unmitigated good! There are downsides to HFT as well. Which should win out? That's more a matter of opinion than fact.

> As such the rules that govern how markets operate can be changed to serve humans. This is very easy to understand, wouldn't you agree?

I agree with this.

> Now comes the question: does HFT serve humans? Some people say yes, others say no.

I would say that the "others" in this statement are incorrect (except in some isolated and relatively unusual circumstances). Since upthread you said "Technically their arguments are quite good." I had assumed that you agreed with me here, but perhaps not?

> but they also reduce liquidity during crises (bad).

They don't "reduct liquidity during crises." They might provide less liquidity during a crisis than they do at other times, but that's not the same thing.

> I would say that the "others" in this statement are incorrect (except in some isolated and relatively unusual circumstances). Since upthread you said "Technically their arguments are quite good." I had assumed that you agreed with me here, but perhaps not?

You can say that they are incorrect, and they can say that they are correct, and neither side will concede to the other. Mostly because they have different goals.

When I said "Technically their arguments are quite good" what I mean is "from a technical and/or technicality perspective" If you fill out your tax forms wrong and you pay the government one cent too few you are TECHNICALLY breaking the law and you might owe thousands of dollars in fines and penalties. But most reasonable folks would say that a $0.01 mistake doesn't deserve giant penalties. Similarly if you're doing 51mph in a 50mph zone TECHNICALLY you're breaking the law and depending on jurisdiction you might well have earned a ticket of some sort. But again, most folks would agree it's not reasonable.

So the technical arguments of the folks doing HFT are good. On an infinitesimal time scale yes they are 100% right. Technically they (probably) aren't breaking any laws and they are propagating price information quickly. And I'm sure plenty of them have great intentions, I'm definitely not accusing anyone of trying to scam.

The problem is that even though they do mean well, and even though they do serve a market function, their presence in the market does make for counter-intuitive outcomes for folks.

> They don't "reduct liquidity during crises." They might provide less liquidity during a crisis than they do at other times, but that's not the same thing.

Okay so there's two ways to skin this cat. But we have to agree on definitions. If HFT folks want to argue that they "add liquidity" to the market I'll concede that. The amount of liquidity that should be in the market is then the sum of the liquidity provided by market makers (MM) and HFT.

Normal Liquidity = MM + HFT

Great. But now a crisis hits and prices start gyrating. The HFT folks pull out.

Crisis Liquidity = Normal Liquidity - HFT

That's removing or reducing liquidity.

Now you might say that I'm abusing definitions. Not really. You can't have it both ways. You can't say "HFT adds liquidity[1]" and then in the fine print say "[1] We only have to add liquidity during normal market operations as we define normal" because that's a hell of an asterisk and fine print.

Furthermore if HFT folks are doing market making during normal times, that's fine. But if they're making profits, they're doing so at someone's expense right? If we hold the order flow constant and we direct it all at a market maker he's going to make X. Now if we inject an HFT into the same order flow and they make Y, that means he's making X - Y. We can say that because everything else is held constant. So that means that on average the HFT folks are going to reduce the profitability of market makers or the number of market makers or both. Then when the crisis hits there are fewer market makers with less ability to trade and thus, less liquidity.

So HFT can reduce crisis liquidity in two ways. First by not providing liquidity during crisis times, and second by reducing the overall number of market makers so that the amount of liquidity that they can provide during a crisis is also reduced.

Now again, I'm not necessarily saying that this is bad. But to pretend that HFT is all upside and no downside and that there are no primary or secondary negative effects seems to me to be either ignorant or disingenuous. I can't say if HFT is 10% downside and 90% upside, 50/50, or 90/10. But I can tell you that the split between upside/downside of HFT does depend in some way on how you interact with the market. Different actors will see different cost/benefit ratios.

I think I get that you generally think HFT is good. That's OK. I personally don't care all that much since I'm out of equities as of ~3mo ago and I've mostly bought & held. But the folks who think that HFT costs a lot and doesn't add that much aren't really WRONG either. People assign different weights to things.

I think there is a lot of nuance being left out in these types of defences which are misleading. For example,

> Note that the market maker at no point had the ability to change any order in response to Big Joe.

But they sort of can, specifically the canonical example in Lewis' book is that HFT market makers change their standing order on other markets faster than it takes the orders of buy/sellers taking liquidity to hit that venue. That behavior isn't what a reasonable person would expect by default.

There is no mention of things like flash orders (which no longer exist in US equities?), hide-not-slide, payment for order flow, maker/taker, etc, all of which are potentially problematic and deserve discussion.

In short these defences are nearly as simplistic as the attacks they attempt to counter.

Agreed. But the difference is that the people defending them are not trying through public perception, or regulation to change the current system. If they are not asking for change, why should they be held to a higher standard than the attackers.

For all of the potentially problematic items mentioned, there is an equally problematic issue on the liquidity taker side. Invisible order books, iceberg orders, preferred router agreements, and large block rebates are all "features" that the markets provide to give advantages to the large institutional investor that harm the rest of the market but they aren't mentioned in the Lewis book, and are never referenced by folks trying to defend "the little guy".

Big Joe is a retail trader trying to move 1-2 lots. His order can be entirely filled at a single exchange. Changing standing orders on other markets is only an issue for big players trying to move many lots.

You are correct that the financial markets are complex and I can't possible cover every topic. Even if I had the stamina I don't have the knowledge.

> If we had no price discrimination, perhaps because of a regulation requiring market makers to leave their quotes out in the market for 60 seconds, then ... [t]he net result is that Big Joe would pay more to trade and Little Billie would pay less.

The debate about HFT is largely about who gets to benefit from new information. Suppose someone does a lot of research and discovers that a firm is undervalued. Should they get to profit from the information, at the expense of current stockholders? Or is it better for stockholders to quickly figure out that their holdings are worth more? HFT helps the stockholders in this case, because it moves the price faster to its eventual higher equilibrium before the researcher can buy up many shares at the (low) current price. The researcher may have expended a lot of time and effort to get this information, and with the existence of HFT their work may not be sustainable.

Contrast this with someone who accidentally discovers public information that could be profitable, or someone who engages in insider trading. In both these cases it's hard to argue that we as a society should create rules that let them profit at others' expense.

In other spheres of life (software patents, copyrights), the law over-protects dubious discoveries and creations. Is information related to stock pricing different? Are we under-protecting it, such that we should let someone with new information collect more profit than they can today?

I'm not buying it. Healthy markets are markets where everyone has access to the same information. HFT by definition means some traders have more access to information than others. This is fundamentally unfair and bad for markets and the economy. I don't see how HFT is any different then insider trading and everyone agrees that should be illegal.

Where do you draw the line? Some retail investors still rely on reading stock quotes in the financial section of their daily newspaper - should we force everyone to only change prices once a day?

HFT does not have more information. They have access to the same public information as everybody else, but they have invested in better technology and are therefore able to parse and utilize that information more efficiently.

Insider trading, by its definition, is insiders trading on non-public information, that outsiders simply do not have access to for any amount of money.

If I tell you that I know privately a piece of news about company XYZ that's about to become public tomorrow, and then you use that knowledge to trade based on how you know its shares will change, that's insider trading.

If I tell you that I know privately a piece of news about company XYZ that's about to be come public in 0.25 seconds and your machine is fast-enough to parse and react to this information before that deadline, that seems pretty close to insider-trading, it's just the "insider" is the exchange itself.

Anytime you act on information that isn't public whether it's a year or a second before it becomes public, your act is illegal. HFT's do NOT have such private information. Everyone has the same information.

If you work for company XYZ, or XYZ has hired you in some capacity only then is it insider trading. And that's because you have a fiduciary duty to XYZ that you have violated by releasing their secrets.

If you release private information on an exchange (by for example, buying up a million shares), first, you just committed insider trading, which is illegal, and second, you just made that private information public (showing that their is a much greater demand than the market believed).

Once it hits the exchange, it is public information, and anybody is now free to act on that information.

People have to have different information or views on a market, otherwise no trade would take place except between gamblers.

HFTs have no unfair advantage. Everything that they use is available publicly for a cost. It's like saying running a retail store in New York is unfair because rents are high.

Is it wrong that some hedge funds or mutual funds are able to build a superior valuation of a stock through hiring more researchers? What about guys counting cars going into walmart parking lots? Everyone can do those things, but most opt not to and are at a disadvantage.

People have to have different information or views on a market, otherwise no trade would take place except between gamblers.

This is wrong. The house is not a gambler.

You could pay Bill Gates a lot of money to wear a wire for you and perhaps if the number was high enough he would do it and you could then argue that anyone could have paid Bill Gates to wear a wire and therefore everything the wire records could be public knowledge you can use to trade MSFT on. But that's illegal and we've all agreed it's illegal and its basically no different then front running in HFT.

Everyone in this story has the same information or rather the same access to information. Anyone with know-how and the money to colocate servers at matching engine data centers has access to the same information. Aka every pension fund, insurance fund, mutual fund, wall st. bank (including Royal Bank of Canada, RBC), and prop-shop. If your definition of HFT is "people/firms who have access to more information on stocks than others" then HFT doesn't exist; notwithstanding illegal insider trading on private information, which isn't what this blog post describes.

If your definition of HFT is "people/firms who have access to more information on stocks than others" then HFT doesn't exist; notwithstanding illegal insider trading on private information, which isn't what this blog post describes.

> Healthy markets are markets where everyone has access to the same information.

This is not true at all! People are working really hard all the time to gain information that they are the only ones they have! If I figure something out about a stock that makes me realize it's mispriced that's only valuable to me as long as that information remains non-public.

I think you are confusing "analyzing public information in a new way" with "getting access to non-public information". The former is what all smart traders do, the latter is illegal.

Getting access to non-public information is, in fact, not illegal. Using non-public information from sources with a fiduciary duty to the company is illegal. You can create non-public information in arbitrarily complicated ways. For example, you could hire a satellite firm to put spy cams over every WalMart parking lot and then count the cars in them, then produce a report about WalMart's quarterly sales weeks before the market heard about it from WalMart. That report is non-public, right? Totally legit to trade off of.

Satellite analysis of WalMart parking lots is, by the way, an actual thing. (It is an actual thing which suggests, among other things, that if you are a retail investor, you should strongly question whether you really have insight into companies which professional investors do not have.)

You completely missed his point about the difference between non-public information and new analysis on public information. Anyone can go and count the number of cars in a WalMart parking lot. This is new analysis on public information, not non-public information.

> Healthy markets are markets where everyone has access to the same information.

I don't want to sound condescending, but did you read the article? One of the points is that this is exactly what HFT accomplishes:

Bob wants to buy a lot of Apple shares. At this point he has more information than all other market participants. He knows that in a few moments, the price of Apple shares will rise. Is the market for Apple shares -- at this point -- an unhealthy market, because Bob has access to more information about it?

If Bob's large order is larger than the current number of open orders, then an HFT algorithm might see Bob's trade -- where he buys some of the stock he wants to buy -- and assume he wants to buy more, so it adjusts its orders accordingly. This very act disseminates information into the market about Bob's large order (if the HFT algo is right, if it isn't it loses money). Information about Bob's future order is now more evenly spread between market participants, though a higher ask price, reflecting Bob's large future order. The information that each participant has is now more equal than it was if no orders were adjusted, because the buying price has risen as a result.

My point is these traders get to know things before other traders, thats not fair, everyone should see Bob's purchase order at the same time and arguing that Bob has an unfair advantage because he knows what he's going to do before the HFT's know what Bob's going to do is just silly.

> My point is these traders get to know things before other traders, thats not fair, everyone should see Bob's purchase order at the same time

How is that physically possible? How can an exchange make sure that I, living in Europe, get to see Bob's order at the same time as an HFT set up in a building adjacent to the exchange?

> and arguing that Bob has an unfair advantage because he knows what he's going to do before the HFTs know what Bob's going to do is just silly.

I'm not arguing it's an "unfair advantage". I'm arguing that your definition of a healthy market as being one where each actor has the same knowledge is not helpful, because this is evidently the case all the time in markets -- even those that seem to work very well.

At the same time I'm arguing that HFTs actually improve this situation (of market participants sharing the same information), instead of hinder it.

> How is that physically possible? How can an exchange make sure that I, living in Europe, get to see Bob's order at the same time as an HFT set up in a building adjacent to the exchange?

Easy, trading cycles occur in (e.g.) ten second intervals synced to UTC atomic time. For instance results of trades propagated for five seconds, orders are accepted for five seconds and then are executed. This should allow enough time for reasonable latency and ensure that everyone has the most recent price on the exchange.

> At the same time I'm arguing that HFTs actually improve this situation (of market participants sharing the same information), instead of hinder it.

I decline to respond as I'm still undecided as to whether this is a good thing or not.

> Easy, trading cycles occur in (e.g.) ten second intervals synced to UTC atomic time. For instance results of trades propagated for five seconds, orders are accepted for five seconds and then are executed. This should allow enough time for reasonable latency and ensure that everyone has the most recent price on the exchange.

Right. But that would constitute a new type of trading -- similar to opening and closing auctions -- so it wouldn't be compatible with the current system.

But yes, it's definitely possible. The question is what the market prefers.

Healthy markets are markets where everyone has access to the same information.

If I want to sell 100,000 shares of Yelp (which is a multi-million dollar transaction), the fact that several million dollars of Yelp is about to hit the market is a really, really important bit of information. I have a reason to hide that from the rest of the market at least until I can complete my sale. HFTs profit by ascertaining my intentions faster than I can complete my intended action and then broadcasting my intentions to other market participants via the ticker tape, whereas previously my intentions were proprietary information locked in my head.

An argument against HFT is, necessarily, an argument that I should be allowed to benefit from material non-public information about the near-term state of trading in Yelp.

Your saying you should be able to front run the market because otherwise its unfair that I know what decision I'm going to make before you know what decision I'm going to make?

No; he’s saying that you have to choose: if you really believe that the same information should be equally available to everyone, you need to admit HFT that reacts to that information as it becomes available.

It’s perfectly reasonable to argue that shouldn’t be allowed, but then you are (implicitly) arguing that either (a) complete market information should not be publicly available or (b) there should be some mechanism which prevents some individuals from acting on that information as quickly as they would like to.

We're talking about different things, actually responding quickly to information is not the problem, gaining access to it before other people can is, which is what Michael Lewis's book was all about. Nobody is saying Algorithmic Trading is wrong, just front-running in HFT that's the problem.

Look more carefully at Lewis' scenario: there are two kinds of entities that have access to secret information: informed institutional traders and HFTs. Lewis is effectively arguing that there should be only one.

That's private information. It is an important distinction. You're saying the market should have a right to know whether I plan on selling my shares next year.

It's private information right up until the millisecond that your trade hits the exchanges. Then it's public information.

Which the HFT firms have earlier access to and greater ability to respond to. Can this legitimately be called fair?

They're paying market rate for that information; you can too if you want to. In the previous version of wall street, it couldn’t be bought—you needed to be part of the old boys club. Are you going to argue that was more “fair”?

They get early access because they pay to be colocated on the exchange. Literally anyone can do this. Can you think of a more fair system than this?

A system where no one can do this or that eliminates the ability to profit off of such a position. Some have suggested a minimum limit on how long one can hold a stock. Seems reasonable to me.

What do you think would happen to spreads if there was a non-trivial minimum limit on how long one could hold a stock?

Obviously they would increase. There seems to be an assumption that reduced spreads at any scale benefits the economy as a whole. On the scale of cents, I don't see how this is necessarily so.

On the other hand, I can imagine there being a trivial limit as far as the wider economy is concerned, but still eliminating the benefit that colocation gives HFT firms. Do you disagree?

If you don't think that increasing spreads by a few cents would hurt the economy than why are you worried about the penny a share the HFT firms are making?

Fairness is a fundamental bedrock of systems like this. Even if the amount of money HFT firms extract does not have a measurable effect on the economy, it harms trust which can have serious consequences.

But people only think it's unfair because people like Michael Lewis have done such a bad job explaining it to them!

They think that HFT makes them materially worse off when it, in fact, does the exact opposite. We should just cave to that misconception?

But if a firm is making a big sell of a stock, as a representative of institutional investors, then it is making regular folks worse off.

Misconceptions should certainly be eliminated, but the fact that HFT firms require colocation does not pass the smell test of fairness. No amount of explanations can eliminate that.

Regular folks aren't buying into firms with proprietary knowledge that deeply care about trading speed. They're buying into index funds or dumb mutual funds. These sorts of funds are the ones that benefit from more accurate and faster updating prices at the expense of the Bill Ackmans & David Einhorns of the world.

I don't know enough to question your point, so I'll take your word for it. But the smell test is still strong here, even if HFT is neutral or beneficial to regular folk. You'll have a hard time convincing people with a complicated argument in the face of this obvious signal for unfairness.

I agree with you about having a hard time. This is exactly what's so frustrating about the Michael Lewis book that kicked off the present round of controversy. See this comment: https://news.ycombinator.com/item?id=7548124

It may be fair in some sense, but it also leads to an arms race that is inherently wasteful.

These aren't bribes to get the information quickly; there are actual costs involved that must be covered to transmit and process the info with high frequency. The alternative would be saying they'll only publish the information slowly (SIP, or say the morning newspaper), in which case there's an imbalance of knowledge between people placing huge orders and everyone else.

Suppose we had no weather forecasts and meteorologists hoarded the information. And suppose store owners could only adjust prices each morning. Before a hurricane, meteorologists could buy up every last emergency supply within an afternoon from the stores and then sell them the next day after the hurricane at 10 times the original price. Is that fair?

I don't think I understand the point you're making in your first paragraph.

For your meteorology example, if such information didn't have life or death consequences, I might call it fair. But the contexts of the two scenarios are different. The stock market is inherently a bet on future prices, and so using information obtained by yourself through your own efforts cannot be seen as unfair--it is an expected property of the system. Using HFT techniques to profit off of frontrunning your demand is unfair. The "market" for items needed for survival isn't analogous.

I'm saying that if anybody can successfully predict your intentions for next year based on your observable actions to date then they have a right to the fruit of those labors, and that you don't have a cognizable interest in "Prevent that person from telling the rest of the world about my intentions for next year", even though that might lead to you making less money than you would but for our friend who reads actions well.

>I'm saying that if anybody can successfully predict your intentions for next year based on your observable actions to date then they have a right to the fruit of those labors

I don't see why this is so. If I have decided through some analysis that I am going to sell X shares at some date, why shouldn't that information be private? Front-running my behavior is essentially front-running my analysis. It would be unethical to hack my computer and read my analysis for yourself, so how is analyzing my behavior to get at that same information any different?

If you're buying a million dollars of Yelp (as posed in this hypothetical), then it's going to take some time (microseconds, minutes, months, etc) for people to realize that. For as long as no one catches on, the person making this large order has a tremendous advantage because supply-demand is misunderstood by everyone else. The market can't fairly price the stock as a result. The HFTs are saying they'll pay the money to get order info in nano-seconds so they can design algorithms to recognize these large orders and react appropriately. They make money being a middleman but the benefit for the rest of the market would be seeing a price change and also for small orders to be filled at a fairer price to supply-demand.

>For as long as no one catches on, the person making this large order has a tremendous advantage because supply-demand is misunderstood by everyone else

Why is the market entitled to knowledge that I'm currently in the process of making a big order? This knowledge being disseminated clearly doesn't benefit me. Should I not be entitled to the sole benefit of my reasoning in deciding to make a big order? Furthermore, how does this knowledge being disseminated mid-order rather than after the full order has completed benefit the market as a whole?

Not that I think any of this outright determines how the argument should go, but a couple points:

Your knowledge that you're placing an order of size X, and why you're placing an order of size X, is always going to be more precise than what's gleaned from observing your behavior, and thus you'll still have an advantage.

"Furthermore, how does this knowledge being disseminated mid-order rather than after the full order has completed benefit the market as a whole?"

For a large enough order in a sufficiently illiquid market, "after the full order has completed" could be days later. More things being priced in means more accurate prices, and that seems to be of some benefit to "the market as a whole." Though to be sure, the longer time frame isn't terribly relevant to the "predatory traders" across exchanges that Chris had been discussing.

Edited to add: Also, the market doesn't learn anything about you in particular - orders are anonymous. What we learn directly is "a trade happened for X lots at $Y", along with possibly which side was the aggressor (depending on the exchange).

Maybe my TCS background and dabbling in mechanism design has biased me, but it seems to be that truthfulness is a desirable property from the perspective of society: It would be beneficial to have a system that is designed in a way that allows participants to state their intentions and desires truthfully, without any incentive to lie.

Auction theory is all about achieving that for simple, single round auctions. Why not redesign the stock market in a similar way as well? I suppose it could make for a nice PhD thesis (or several).

>If I want to sell 100,000 shares of Yelp (which is a multi-million dollar transaction), the fact that several million dollars of Yelp is about to hit the market is a really, really important bit of information. I have a reason to hide that from the rest of the market at least until I can complete my sale. HFTs profit by ascertaining my intentions faster than I can complete my intended action and then broadcasting my intentions to other market participants via the ticker tape, whereas previously my intentions were proprietary information locked in my head.

Let me see if I understand your example. I want to dump 100k@100$ and yet the current book doesn't have that many buy orders (otherwise the order would just complete). The book has buy 1k@100 and sell 1k@105 So I try to be sneaky and just clean out the book with 1k@100, selling 100 shares each to 10 retail investors and wait for more 100$ retail investors to show up by placing another 1k@100 sell order. The HFT sees this quickly and puts in orders for buy at 90$ and sell at 95$. Now the next retail investor sees this and just buys at 95 instead of 100, saving 5. I need to then sell at 90 instead of 100, losing 10. The HFT firm makes 5.

So the HFT firm is taking money from informed investors and taking some for itself and giving some to people who have no special information about the market like retail investors. If that is the case the only problem with HFTs are second order. That (much like bitcoin) they spend a bunch of resources with busywork that could be at least partially eliminated by more decimal points in pricing trades. And that they may discourage some informed investors from adding information to the market because they can't profit from it, reversing their benefit.

The trading pit that electronic trading replaced had far more potential information leakage. You can see which broker is demanding what. Also in order to get the "direct feed" you had to be an exchange member, or rent a seat from someone who was. What we have now is a far lower barrier to entry at the cost of all the existing players. And many of those players are mad.

"Healthy markets are markets where everyone has access to the same information."

If it's not a matter of degrees, then the speed of light means there's no such thing as a healthy market.

TL;DR: Defending HFT’s argues for rewarding market participants who simply jump in front of the line b/c they see other people doing it, at the expense of participants who have worked hard to decided which line to get into.

Here's a more fundamental question to ask:

What kind of behavior do you want to reward in the stock market?

If you view the stock market as a bunch of numbers that wiggle around, where "information" is conveyed by the actions of other people participating in the market (ie, what they’re buying and selling), then the HFT's play a legitimate role in spreading that information around.

If you view the market as a place to buy and sell businesses (equivalently - shares of businesses), where capital is allocated to businesses commensurate with the value they provide to society, HFT's are parasites on the effort of others.

There are participants in the market that spent an enormous amount of time, diligence and thought into deciding allocating capital to businesses according to the value they ascribe to the businesses. For these participants, the signal they send by putting out their orders is currently taken advantage of by other participants who spend enormous time, effort and money into trying to “tap into” the result of the efforts put forward by the first group and rush to another exchange to buy up that company before anyone else gets there.

So: Do we really want to reward all of the effort spent building faster machines, communication links, and algorithms to jump right in front of someone in line? Or do we want to reward those people who are actually determining which businesses have intrinsic value and which do not?

It's easy to hate Einhorn or Ackman b/c they're rich. What's important to keep in mind is that they are custodians of and act on behalf of thousands, probably even millions of other people to improve their financial situation. Pensions, endowments, sovereign wealth funds, etc make up the bulk of the funds that Einhorn, Ackman and others invest. The fact that they're rich an indication of their legitimate hard work at researching and allocating capital and enhancing the financial well-being of their clients. (Note: yes, there are always bad apples that get rich by illicit (read: insider) means, but that is an exceedingly small amount of participants and over time they usually get caught).

Warren Buffett has often said that a perfectly good stock market would be one which is open only one day a year, where participants put up orders based on the value they actually ascribe to a business. If those orders cross, then trades occur - all in one day.

Makes you wonder what would happen to society in that market. Would people would be able to find a way to channel all the frenetic activity currently employed in chasing prices and watching others’ actions into a more productive endeavor?

David Einhorn is a hedge fund manager, not a mutual fund manager. Vanguard, one of the world's most reputable mutual fund managers, is on record as saying that HFT has improved their cost to trade.

That was an easy point in your comment to respond to. The rest of it doesn't appear to have been based on Chris Stucchio's post at all; you could just as easily have posted it in every thread on HN about HFT. I must be missing something; what is it?

If we're all going to cite Vanguard, we should at least get the quote right:

There are literally hundreds of strategies that are high-frequency trading, ranging all the way from those that really perform much of a market-making and liquidity-providing function to perhaps some on the opposite end of the spectrum, where they are abusive and trying to manipulate the market, " he said.

Obviously, we need to get rid of those types of high-frequency traders, but I think the bulk of them are creating liquidity and reducing spreads for us, which has dramatically reduced costs.

They said the same thing about the mortgage market abuses - "Oh, it's just a few bad apples."

No. No it fucking isn't. Furthermore, letting the bad behavior go unpunished means the 'good' behavior gets driven out: https://en.wikipedia.org/wiki/Gresham%27s_law

"Good" HFT strategies are nowadays obvious by one very salient fact: they're not very profitable. Most market making now, for instance, is simply cover - noise trading, basically - designed to disguise the real bad behavior (that the OP conveniently states is just 'very rare'... heh).

HFTs aren't dumb. They know that any regulator or prosecutor will find it very hard to dig through the trading data and discern evidence of illegal behavior from individual trades.

My attempt at a charitable interpretation of Jalopy's post is that he is saying it's actually a bad thing to transfer wealth from informed traders. This is because David Einhorn has demonstrated great competence at trading, and if HFTs predate him it reduces his incentive to continue transmitting useful information to the markets.

I find this to be an argument I can't dismiss easily.

I've added a link to your comment to the original post. It's important to spread this idea as well.

Thanks - you captured a good part of my argument. I'd make a small correction though. I don't consider it "trading" as much as "investing".

As a former quant trader and a current (and forevermore) value investor - there is a big difference.

I think the counter-artument to jalopy's point is to compare the relative degree of investment by "informed traders" vs "efficiency providers" (market makers, HFTers, etc). I think you'll find that investment by the former vastly outweighs the latter indicating that investment in efficiency providers is very unlikely to be too high.

Why should we expect the investment in the two to have any relation to each other?

You find this is an argument you can't easliy dismiss? David Einhorn is personally worth $1.25 billion and Bill Ackman is worth a similar amount and you think that they're going to pack it in over an HFT making it slightly more difficult to place an order? The rise of HFT hasn't stopped Bill Ackman from making huge bets on companies like Herbalife and JC Penny. I won't even get into the fact that he probably paid less to execute that large order than he would have in the previous pit trader environment.

Yes, but Greenlight Partners (Einhorn's fund) is a Limited Partnership that can include Pensions, school endowments, etc, in addition to "other rich people".

Vanguard's CIO (Gus Sauter) has mentioned in a CNBC interview (see http://www.cnbc.com/id/49434073) that the liquidity providing aspects of HFT tech are valuable - ie, the tools that help the real market makers fill orders on the other side. In the same breath he says the abusive practices (predatory trading) need to be reigned in.

Chris Stucchio's post seems to be defending the "predatory" side of HFT's as "spreading around" the information advantage conferred by hard work and due diligence into the workings of a company.

I'm refuting that by describing the actual effort that goes into attaining the information advantage obtained by Einhorn, Ackman, etc he describes and contrasting it with the effort involved in HFT predatory trading.

Which effort is more important and should be rewarded?

Do you deny the article's claim that the predatory trading is part of what enables them to keep the spread low? Or do you think it would be worth the bigger spread (and the associated costs to retail investors) to better reward the big investors?

I really like your TL;DR summary. It's spot on.

One of the debates that seems to underlie a lot of these discussions is probably more reflective of the values of the individual than the actual issues at play. It seems like some people value justice above all else and others think that--at least in some arenas--justice is not necessary, and may be detrimental. So that the final question could be:

How do we balance fairness in the market with the need to provide liquidity?

The line of reasoning you've taken seems reasonable, but I don't think it works. So let's step back a little and take on an even more fundamental moralistic argument. The workers of the companies whose shares hedge fund managers trade may say, wait a minute, we're doing all the work and there's somebody out there creating models of our work in some dinky little spreadsheet and making more money than all of us by trading units of our work! From some moral standpoint, they are not really wrong - hedge fund managers are disproportionately well-compensated and they don't directly add value.

But what happens when you stop hedge fund managers (or really any informed traders) from arbitraging based on whatever research and analysis they do? Prices get out of line. And if prices get out of line or disappear, transactions either go away or are made on uneconomic terms. That's the problem with getting rid of hedge fund managers. This is why financial speculation is tolerated.

Now how does HFT affect this equation? Well, it's quite simple - they accelerate the social benefits of the actions of hedge fund managers while reducing their profits. When you're looking purely at the interaction between HFT and hedge funds, it seems like hedge funds are doing all the hard work and HFT is taking a cut for no reason. But when you realize that the product sold by these hedge fund managers to the rest of the society is better prices, HFT is bargaining with the hedge fund managers on behalf of the broader society and delivering the product quicker and cheaper.

The key to understanding this is that while the social value of hedge fund managers comes from efficient markets they help create, they themselves don't want efficient markets because they can't get paid as well in efficient markets. What HFT does is it brings about efficient prices a little quicker than they would otherwise.

Edit: The above does not preclude the possibility that HFT is harmful, but it limits the possibility largely to a world where hedge fund managers as a group are too poorly paid to be properly incentivized to do their work well. I don't think anyone's gonna go there.

Edit2: Another way to think about this is that hedge fund managers expressing outrage are trying to have it both ways - they want to get paid for their work but don't want to move prices in the process, even though price movements are their only contribution to society. And don't forget their access to liquidity comes from noise-traders who are willing to accept prices as they exist and HFT helps even the playing field between noise-traders and informed-traders, allowing the former to trade in sufficient volume to keep the spreads low.

But for the most part, it's not the buy-side complaining about HFT, because there have always been gate keepers and paying them has always been part of the game. Almost all actual complaints about HFT seem to come from people whose work is being replaced by HFT - the old school line-jumpers whose art no longer seems to translate to the brave new world.

Interesting exercise, yet I feel a little detail is missing. In the two presented "views" of stock market functioning the first "informational" function is an integral part of price discovery, and so of the second "capital allocation" function. With that in mind the question turns into - who is an "authorized" entity to decide, how to proceed with price discovery?

reading about the stock market is always kinda disgusting to me. "If a speculator believes AAPL is undervalued, he buys a bunch of shares of AAPL. This drives up the price until AAPL is no longer undervalued - then the speculator can sell his AAPL and reap the profits." -- the part after the dash shocked me :) seems like the entire purpose of the market is speculation? does anyone actually invest in companies any more? :D

i did like reading this, informative. gave me a nice other perspective on HFT.

however: (a) Goldman Sachs does not have it's own HFT outfit? they are the "helpless victims" here? sounds a little unbelievable. (b) why is it exactly socially beneficial that some HFT company performs this "robin hood" act (lol)? particularly if it exposes us all to the risk of market volatility due to mindless algorithms performing enormous, senseless trade volumes with each other?

all in all, i'd vote for that very small tax on trades, just to get rid of this as-yet-unseen level of speculation.

p.s. how does moderation on this site work? i have been downvoted, and i wonder - is this an act of some admin moderating, or do users with sufficient karma get a downvote button and one of them simply dislikes my comment?..

Sometimes downvote means "I disagree". Since you proposed a transaction tax, most likely a libertarian apologist pounced on you.

ah, ok. i guess that's their right ;)

> ..., or do users with sufficient karma get a downvote button (...)?

Yes, they do. I always forget the threshold, but there is one. Check the 4th point in the FAQ: http://ycombinator.com/newsfaq.html

thanks!

The threshold when I crossed it was 500 karma to downvote. Not sure what it is now, but I got the impression it doesn't change that often.

Speculators are people or institutions who purchase an instrument (stock, commodity, etc.) in anticipation of price movements in order to later sell the instrument, without having an underlying business need for the instrument. [1] In the case of common stocks, unless someone's intent in buying the stock is to take over the company, use the voting rites to influence the makeup of the board, or otherwise use the voting rights, you are a speculator. You may be a long-horizon speculator, but you're still a speculator.

Now, if you're a long-term speculator and the reason you dislike people who typically speculate over shorter term horizons than you do is that you believe they adversely affect your prices, consider that short-term speculators are often the people with the highest bids and lowest offers are shorter-term speculators.

[1] http://www.nasdaq.com/investing/glossary/s/speculator

As I understand it, the main issue with HFT are two fold:

* some cases of insider trading at under-a-microsecond rhythm, that sound like faster-than-light favoritism but are actually covered by existing legislation (you just need to update judges and the SEC on basic technological feasibility);

* dangerous unmanned behaviour -- flash-crashes.

Front-running has always been presented as controversial at best, i.e. taking cents from people who could spare dollars; more often illustrative of finance’s excess (spending the GDP of a large country to establish even faster lines between cities already well connected, not that makes any more sense than blaming Formula 1 racing for going above the legal limit).

I understand his passion, and the “I’m a geek and I work for a small company facing Goldman” inferiority complex must be crushing -- he writes himself ‘A fervent defense’. However, that seems to be missing the key issues most people have with such technology left unmonitored.

If HFTs liberate access to price information, then does that make them the "open-source software" equivalent of our current economic operating system? That is, in the same sense that OSS delivers bundles of information about how to do various computational tasks efficiently via source code, HFTs deliver bundles of information about how to value companies efficiently via the ticker tape.

In the same way that the source code reveals the genius of the programmer's understanding, the excellance of an HFT is revealed by the report of the ticker tape.

I'd be more impressed by a "fervent defense of HFT" from somebody who isn't in the business.

Do you disagree with my arguments or are you appealing to the genetic fallacy?

Not that it matters - I left HFT a long time ago.

TL;DR: Stucchio thinks that front-running people is fine in circumstances where it's not prohibited by law. It's legal, therefore morally right, is his argument.

Other people (including very many securities regulators) think that the problem here is that the law is missing a prohibition.

You'll find this attitude (it's legal, therefore it's morally right) is very prevalent in the investment finance industry. It's as if these guys lack a moral compass of their own...

That sort of smear may or may not be true, but it isn't what is happening in this case. What is happening in this case is that 2 groups (large liquidity purchasers and liquidity providers) have a natural antagonistic relationship with each other. Purchaser always want to lower the price and providers want to raise it. This is good for the markets operation.

But there is a PR/Power imbalance currently in the market. The large purchasers have tons of money had influence. They are using it to smear the sellers of the product they want. The sellers happen to be an easy group to smear (they are highly technical, secretive, and operate in a world that no one seems to understand).

If anything is immoral in all this is that they are actively trying to obfiscate what is happening in the markets and thereby spreading fear.

> The sellers happen to be an easy group to smear (they are highly technical, secretive, and operate in a world that no one seems to understand).

Once you understand what it is that they are doing, it's pretty clear that it's wrong.

Unfortunately, they like to muddy the issue. Hell, the OP does that every time it comes up on HN by asking people to explain what their problem with it is using obtuse industry jargon (e.g. "which part of FIX/OUCH enables front running?").

This is a really late reply, and probably futile in any case, but your comments on this subject make me think you don't actually understand "what it is that they are doing". When people try to explain it to you , you accuse them of using "obtuse industry jargon". Yet you've left them little choice.

An analogy (flawed as they all are) is if you came onto these forums and claimed that udp networks were evil and a tool whereby network consultants got rich on the back of "regular internet users". To back this up you pointed to some articles in People that claimed "Don't trust your UDP network, it might delete your traffic!" When anyone who actually understood networks said something like, "well it's nuanced, error checking is valuable in some cases and not valuable in others" you said, "DON'T MUDDY THE WATERS WITH YOUR JARGON!"

At this point, because networking is such a widely dispersed information set, and there aren't any high profile authors backing up your assertion that "UDP IS DANGEROUS IT LOSES PACKETS!" members of this forum would start down voting you into oblivion and making cogent arguments about why you are so very, very ignorant.

The only reason this hasn't happened yet is that knowledge of electronic trading systems is not as widely disseminated and every one with a 401k and a DSL modem thinks they know what electronic trading is about.

I will tell you this much, everyone who has ever actually traded electronically sees your comments and thinks of you as the "UDP is evil" guy. That we are in the minority means that we can't just laugh at and/or ignore you like we could if you were claiming nonsense about networks. For all I know you are a senator. So with that said, ask a straight forward question, I will answer it without any equivocations given that they aren't covered by IP agreements.

You will find the attitude almost everywhere you look. "If it is legal it is moral". Saying it's exclusively in the finance industry is absolutely delusional.

Replace investment finance industry with silicon valley and you would be just as correct.

Stucchio thinks that front-running people is fine in circumstances where it's not prohibited by law. It's legal, therefore morally right, is his argument.

This is completely not the argument presented in the OP. "Front-running" is fine because it leads to quicker inclusion of market information in price and makes large players pay for their own large trades.

Also because it is not front running. Front running has a technical and legal definition that someone looking at a public feed does not meet.

Using the same logic, if we were to make a law that forbade it, then he would agree that it was wrong? Perfect!

And you think it's morally wrong even if it leads to better functioning markets with lower costs and better prices for everyone else.

Also, what specific prohibition would you change in the law? And who do you think that would help?

> And you think it's morally wrong even if it leads to better functioning markets with lower costs and better prices for everyone else.

Citation?

Citation for what?

A) that jellicle thinks it's morally wrong? He certainly seems to think that.

B) That costs have lowered? Spreads have dropped 10-20x in the last 10 years. Here's the CIO of Vanguard talking about how that's benefited everyone who buys one of their index funds:

http://www.cnbc.com/id/49434073

> And you think it's morally wrong even if it leads to better functioning markets with lower costs and better prices for everyone else.

But it doesn't lead to any of these things. It leads to worse-functioning markets with worse prices for everyone else.

Where do you think the profits made by HFT come from? The air? Ghosts? Fairies?

Market makers have always made money. They now make DRAMATICALLY LESS money than they used to due to automation.

Here's the Vanguard CIO saying the same thing: http://www.cnbc.com/id/49434073

You realize that spreads used to be 12.5 cents or 25 cents and now they're generally 1 cent right?

How much of that is genuinely down to HFT, and how much is down to changing the "protocol"? Keep in mind that in the bad old days, it was simply impossible to place orders at a cent-level granularity for most stocks.

You could probably get the same benefits by (a) forcing exchanges to allow something like a 10^-9 granularity of prices, (b) restricting matching engines to operate on something like a 15 minute heartbeat, (c) regulating the crap out of exchanges to lower the barrier of entry.

You'd get reasonably low spreads while eliminating the waste of resources caused by the high speed arms race. At the same time, for individuals who actually invest (rather than speculate/trade), the spread is a distraction. Access to markets and fees are the real hurdle.

What waste of resources? HFT revenues were estimated at 1B for last year. That's nothing in the grand scheme of things.

Someone deriving a profit doesn't necessarily imply worse prices for everyone.

For instance, consider a middle-man between a wholesaler and a retail consumer. The wholesaler sells widgets in lots of 1000 for $1 a widget, and individual widgets for $2. A middle-man steps in, buys the lots of 1000 widgets for $1 a widget, and sells direct to consumers for $1.50 a widget.

Consumers are getting a better price, and the middle-man derives a comfortable profit.

One of the single biggest problems with discussions on HFT is a lack of rigour in the use of terms that mean specific things.

Front-running is a specific thing, someone who has a duty to you to execute on your behalf instead executing on their own behalf. Large market participants have started co-opting this term to mean, "not allowing us to hide our huge information advantage and thereby screw the rest of the market".

They do this because they know the idea of a market run by computers scares people and most people have heard the term front-running and know that it is wrong. They are trying to bypass market dynamics for their own gain, to the detriment of everyone else through public relations/regulation.

The only difference between front running and what HFTs do is that they've found a loophole whereby they don't have to be your broker to figure out what your trades are in advance.

They can guess at what your trades are. They necessarily still have less information than you do.

One of the problems with this whole issue is that people are prone to looking at tl;dr's. Your comment assumes that front-running is occurring, which is not what's happening. Would you rather the debate go to: whether everyone should trade based on the SIP? But then:

- What happens when the SIP goes down? Should the US markets shut down? - What is the motivation for innovation if everyone uses the SIP? One advantage of multiple markets is that they are also competing with each other to improve in terms of technology, and rates. - Why is it better to trade in a world with less information?

In what other context is using indications of a big buy or sell to bid up the price ahead of the big buyer or seller considered wrong? If my observation of Disney suggests they're going to buy up some land in a neighborhood to build a theme park, is it morally wrong for me to buy up the land and sell it at a higher price?

Why would it not be? You're taking money from the original owner [edit: and costing the buyer more] through asymmetry of information. You are providing no service to either of the parties.

For one piece of land, yes. But if we're talking many plots, your intervention will raise the market price and other sellers will get the benefit of the higher price.

but the machines in the story do not actually know anything about the plans of the buyer. they are guessing. and a lot of them are involved in this guessing now. it seems logical that this would create instability.

At the expense of the buyers--those who are actually attempting to "invest" in the land (rather than speculate). If Disney decides they are going to build a theme park in some area, they should be entitled to buy the land at current market prices, not at an inflated price (solely based on information of their intention) that essentially robs Disney of profits from their own efforts. It is Disney's actions, and their expected future profits, that create value in the land. Frontrunning their purchase is unethical any way you look at it. The market will adjust as it sees fit after Disney's purchase succeeds.

The land analogy is a bit strained, as those who buy stocks are necessarily betting on future earnings rather than investing their own labor into its growth. But I think the analogy holds for those who put in effort to analyse an industry and thus make buy/sell decisions based on their efforts. Frontrunning or behavior analyzing is essentially robbing a company of the fruits of their efforts. The market will adjust based on their buy/sell transaction, it does not need another middle man to adjust market price a millisecond sooner.

Wait -- so you're saying that Disney has a moral right to buy up land at a fixed price, because they had the bright idea to build a theme park there? That Disney should be able to freeze the valuation of all the lots they want to buy, after the neighbors find out that Disney is buying?

Or is it just that you believe that ONLY the landholders should be able to profit by raising their sales price, and not some third party who may have "invested" his/her time and money in figuring out what Disney's future plans are and starts "front running" Disney on land acquisition?

It feels like the more we discuss, the grayer the situation gets.

A third party should not be able to profit at the expense of both buyer and seller without adding some service to them.

The seller should be able to sell for whatever they want, and if they know Disney is selling and they raise their price accordingly, then so be it.

I'm assuming you're drawing an analogy between this scenario and trading on the stock market. The difference with the market these types of deals are expected--people with different levels of understanding will make trades in their own interest.

In this case the service that the third party is providing is telling the land owner that Disney has arrived on the market. That's, potentially, an extremely valuable service!

How is it any different from arbitrage? If I see the price of ES move in Chicago before others and trade SPY in NY based on that, is it front-running?

Somebody will make that trade, so we're really just arguing over who gets the money.

>Predatory traders break this information advantage. Instead of Goldman, David Einhorn or other informed traders gaining the full benefit of their information, predatory traders detect that information and split the profits with the counterparties (taking a cut in the process). Predatory traders improve market efficiency by turning information about market demand into price movements. They are simply criticized because the price movement happens before the whale actually wanted it to.

This is the exact same defense used against insider trading and front running in general.

There is nothing special about HFT in this respect, other than the fact that it is currently still legal.

Edit: downvoting without responding. classy.

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