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.
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.
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?
They think that HFT makes them materially worse off when it, in fact, does the exact opposite. We should just cave to that misconception?
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.
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?
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 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?
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?
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 $Y", along with possibly which side was the aggressor (depending on the exchange).
Auction theory is all about achieving that for simple, single round auctions. Why not redesign the stock market in a similar way as well? I suppose it could make for a nice PhD thesis (or several).
Let me see if I understand your example. I want to dump 100k@100$ 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.
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.
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.
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.
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.
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.
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.)
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 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.
Once it hits the exchange, it is public information, and anybody is now free to act on that information.
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.
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.
This is wrong. The house is not a gambler.
If it's not a matter of degrees, then the speed of light means there's no such thing as a healthy market.