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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.

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?