Daniel's review of Flash Boys: A Wall Street Revolt
amazon.com
amazon.com
Specifically, we're looking for 1-2 core devs (hacker/generalist types honestly). Python's our main language now & I'm trying to incorporate Haskell as well. Green card/Citizen required + NYC only (sorry, not up to me), salary 120k-190k/yr, 40hr/wk, awesome team run like a research arm.
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http://www.slate.com/articles/business/books/2014/04/michael...
Can you explain how the smaller spread is better for the entire system? I'm not convinced that anyone really gains much from these very marginal gains in liquidity other than the HFT entities.
Personally, I'm fine paying 2% more for something if it means that the person I'm buying it from is keeping the money as opposed to some middle-man taking a cut.
There seems to be a lot of unquestioned dogma in the financial world about the efficiency of the marketplace on a macroeconomic scale.
But again, please correct me! I'm honestly trying to learn more about this.
If I want to buy a security, don't I have to buy it at whatever price is being offered? Sure, some dude can cover the spread on both sides, but if the guys selling it to me just passed it through 50 hands going from the firm that issued the security to get to me, what's the point of all that? Like, I get the point of the liquidity offered by market makers, but I'm just questioning the marginal utility.
How much less likely am I to buy or sell a security based on the marginal decreases in the spread? It doesn't seem like it would be linear. And what effects are caused by having so much complexity between the issuer and the investor?
If you can't get worked up over a 100+bp difference in cost of trading, you shouldn't be worked up over HFT, which is operating at much smaller price deltas.
Let's pretend that the marketplace only sells securities with dividends. The people buying them are not interested in their liquidity, only in their ability to store value as well as ofter a steady return.
Why would I want to buy shares in companies in any other type of marketplace?
Can you explain how this hypothetical market would function differently than how our current markets function?
"Type of company" and "marketplace" are orthogonal concerns.
What would make me want to go with a market that offered lower spreads and more liquidity? How would it affect a long term holder?
Isn't there a cost to all of these transactions occurring?
Like, why do I need the spread to be as small as possible? How much is actually saved? How much are the infrastructure costs for maintaing a marketplace that supports these high frequency trades? Isn't there room for a much simpler, low frequency marketplace that had fractions of the operational costs? Couldn't savings be passed on to retail investors with a cheaper marketplace?
There is the opposite of a cost to normal investors of "all these trades" occurring. The volume of trades makes the pricing of stocks more competitive and increases the odds that when you want to trade, someone who agrees with you about the price of that stock will be available to take the other side of the trade.
This discussion keeps waving the term "spread" around like a totem, but in reality the term just captures that paragraph.
I'm not convinced that all of these marginal gains makes up for these costs.
I don't get the jump from describing an illiquid real estate market to this hypermarket with millions of trades a second. Are you telling me that it is a linear function? We will always need more trades, and more volume? What about the underlying economic activity? How does this follow any sort of market fundamentals?
Are you really saying there is no upper limit? How could that make any sense at all?
But even if you stipulate that we are, it doesn't follow that interventions to suppress trading will do more good than harm, because we also know that prior to the advent of electronic trading, we had "not enough" liquidity.
Surely the current system is imperfect in many ways, and I'm sure Nash has something to say about the competition among market makers of varying degrees of competence.
The difference is what the market maker takes for providing liquidity (in exchange for providing money now and for taking a risk that the price may change out of the spread range). Spread == price of liquidity.
The spread is just the difference between what one person is willing to sell and another willing to buy.
If it's Monday and I'm trying to raise money for a venture by selling shares at a certain price, and some other dude has extra money laying around but wants to buy it for less, that's the spread, right? I either sell for less directly to the retail investor or a market maker happens to come in to the picture and I happily get to sell to him at the price I wanted to. He thinks my price will go up by Friday and that these other dudes will definitely be willing to pay more for the shares that he did by then. At which point he will profit, right? But that never changed what I was willing to sell and some dude was unwilling to buy at on a Monday. How does HFT affect all of this?
Not really. The spread is the difference between the lowest market sell price, and the highest buy price. What the market maker (be it a HFT or a human) provides is the ability to sell and get money immediately. If you have the patience to wait (and can afford to take the risk that the market moves in a direction that is not good for you), then you can put a sell order at a specified price. At that point, you are a market maker.
However, most people don't trade like that. Instead, they put a buy (or sell) order at market price, at which point the exchange will match the current orders in a way that is as favourable as possible to the guy that placed the order. The affect of the market maker is that the seller and buyer don't have to be active at the same time, or even in the same exchange. The spread is simply the price the market maker takes for arranging this. Less spread is the same as less cut for middlemen.
First, resting a limit order on the book makes you a liquidity provider, but not a market maker. Market makers are consistently willing to buy or sell, regardless of where prices are; they are long-term neutral with respect to the instruments they trade. They're able to trade constantly without losing their shirts because (a) they deliberately avoid holding a long-term position in what they're trading and (b) they are constantly adjusting their prices to stay in the middle of the "true" bid-ask prices.
It's easy to see that entering a single limit order doesn't make you a market maker; you're willing to trade only if prices match your preferred valuation, which means you have a long-term long or short position for that instrument.
Second, "most" retail investors do enter market orders (orders fulfilled immediately that cross the spread, buying at the best ask price or selling at the best bid price). But sophisticated investors do not do that. Market orders charge a premium for the liquidity they demand, and so sophisticated traders use different order types.
The best way to explain this is by analogy to other kinds of markets. For example: consider housing, which is the canonical example of an illiquid market.
I know the value of my house (it's around $300k). Say I want to sell it. The more liquidity I need, the worse price I'm going to get. Anyone with any intuition for the housing market knows that if I have to sell my house tomorrow, I am going to get a god-awful price for it; the "tomorrow" price for my house is many tens of thousands of dollars off its true value.
This creates huge problems for homeowners. The obvious standard advice for sellers is to wait patiently for the best price, counting on many weeks or months before a reasonable offer arrives. But I have to pay money every month I hold on to the house. If I need to move immediately, for instance for a job, or because my financial circumstances have changed, I might need the house to sell quickly, and because houses are illiquid I have to accept a crappy price. Or consider trends in the market: by forcing me to hold the house for months rather than days, I'm maximally exposed to swings in the market. So if Chicago housing prices crater while I'm trying to sell, the extra time it takes to unload the house takes that price swing out of my hide.
(You can easily see how the same thing happens in reverse in "hot" markets like Palo Alto, with the buyer now assuming the role of the hapless Chicago seller).
The exact same thing happens in the public markets; it's just not as intuitively obvious because we're working in smaller deltas of time and price.
But the public markets have a huge advantage that the real estate market doesn't: market makers.
Imagine if houses traded (were bought and sold) so frequently that a smart company could make good educated guesses about the current value of any given house. Imagine if that company would on any given day snap up a house offered for sale. That company wouldn't pay my asking price for my Chicago house, but it would pay something much closer to it than the "true" market would. After buying my house, the company would immediately offer my house for sale at any price greater than what it bought the house for. I wouldn't care, though: either I'd be thrilled for the opportunity to sell my house quickly and painlessly, or I just wouldn't accept their offer and instead do what I do now, which is to wait for the best offer.
Assuming the housing market makers were smart, the money they'd get by forcing me to accept a lower bid would be "free money" they get simply by being smart about valuing houses and having capital available to deploy. We'd all be a little irritated at them for scalping distressed buyers and sellers. But something else will inevitably happen: other smart firms will smell the free money, and they will compete for it. To capture a share of the premiums, all they have to do is offer a slightly more favorable price, so that's what they'll do. Over time, the money the housing market makers will get less and less "free", and the price penalty for immediate liquidity will get lower and lower.
In my fantasy real estate market, I now have the opportunity to avail myself of a reasonable "market" order, or to buy or sell on a "limit" price. I could do that if there were housing market makers, but in their absence I can't, because the price hit for selling tomorrow is too great; it might be a 25% discount on my asking price, or even something close to 50%. That's the cost of illiquidity, or, stated more directly, the value of liquidity.
It's probably also worth saying that liquidity is a presumption of the public electronic markets. Because it's taken for granted, there are whole trading strategies (hedging, for instance) that depend on its presence. These trading strategies face execution risk: if they can't bail out of a position within a specific window of time, they incur losses for the trader.
The public markets are a series of zero-sum games. When you fully understand this, it becomes apparent that almost any profit-making strategy for engaging with them can be described as a form of "rigging". Every dollar Virtu makes has to come out of someone else's pockets.
The important thing to know is "whose pocket".
People on HN love to play six-degrees-of-Mom's-retirement about this issue. That game doesn't actually work. Consider two scenarios:
(a) By increasing the cost for billion-dollar broker/dealers to shop blocks, electronic trading systems are making it more expensive for mutual funds to trade and thus extracting rents from the hides of pension funds; the pockets picked are ultimately those of ordinary Americans.
(b) By preying on naive market-making strategies, electronic trading systems are disrupting an entrenched cartel of billion-dollar market players, and in the process driving trading spreads to historic lows without measurably impacting volatility in the market; the pockets picked are those of other, more brazen pickpockets.
The difference between (a) and (b) is crucially important. If the status quo ante is bad, and the new situation is better, then organizing against that change is a positive action taken in favor of unfairness.
Significant evidence points to (b).
But (and I say this after having read both the Lewis book and Dark Pools), I'm not entirely sure what to think about HFT (or more broadly, electronic trading in general) and market volatility.
It kind of seems like there is going to be some popularly accepted government regulation of electronic trading that my gut tells me will be more acceptable for the "other, more brazen pickpockets" than the new, despite the fact that we think choice (b) is better for investors.
HFT is complicated in large part because it's not one thing. The best response to criticisms of HFT is to be wary of anyone who would try to lump a bunch of different entities with different motivations and different business models together based solely on the technology they're using.
Unfortunately, that is in a nutshell what Lewis' book tries to do.
Implied volatility is computed base on the difference between an option's selling price and an algorithmically-determined price. That's exactly the sort of information any trader would rely on to place bets. When the calculated value is higher than the price, there is profit to be made. Any decrease in trading latency will allow traders to buy up instruments selling below their estimated value a bit quicker, driving these numbers closer together.
Let's say we didn't have HFT and we had a larger spread... That means that one of the parties is overpaying, right?
But, aside from the burdens of the individual overpayer, doesn't it make more sense for the overall ecosystem to at least keep that money in the pockets of people who are interested in the long term value of the equity?
What are the overall economic marginal returns on squeezing the spread so thin? Is it possible that it might make more macroeconomic sense to NOT have some other entity profiting off of having created a minutely more liquid marketplace?
It's not particularly surprising that the loudest anti-HFT voices are guys whose profit margins have been killed by it.
Disclosure: my profit margins have been killed by HFT...
If you want to disincentivize active trading (more than the market already does, by awarding outsized returns to funds that don't rely on active trading), a tax on trades performs this function more effectively than high spreads do.
Worth noting: during the times when spreads were as high as 0.25, that was in large part the result of collusion between the market makers, who were eventually taken to court over it.
Basically, what I want to know is, how does this reduce the spread between some dude trying to sell shares in his venture and some dude wishing to invest his money? I get the role of a market maker in this situation. But what does HFT do to somehow make the two parties willing to either sell for less or buy for more?
"The" spread is the difference between the best bid and the best ask. A market order "crosses" the spread, requiring the buyer to pay the best ask price or the seller to take the best bid price.
The function of a market maker is to bridge the prices of buy-side investors.†
Without market makers, spreads are much wider, because they depend on which particular long-term investors might be willing to trade today and what their limit prices are.
Market makers are willing to buy or sell in the middle of the spread --- presumably not all the way down at the best investor bid, and presumably not all the way up at the best investor ask. By briefly jumping into the middle of the spread, in effect finding compromise prices, market makers collect what's effectively a small fee in exchange for improving the "resolution" of the market's current price --- from, say, "XYZ costs 10.00 plus/minus a dollar" to "XYZ costs 10.00 plus/minus 2 cents".
In the 1990s, market makers were humans, and they were only required to quote prices to the nearest 1/8th of dollar. The price delta between the true market price for an instrument and the nearest 1/8th was a rent captured by the market makers. In practice, the situation wasn't even that good: market makers colluded to avoid quoting "odd eights", in effect offering only "to the nearest quarter dollar" resolution.
Electronic market makers (a/k/a HFTs), though not operating out of the good of their hearts (nobody in the market does) impose serious, fierce competition on market makers for different instruments. Instead of charging 0.12-0.25 cents for the service of discovering the clearing price of an instrument, they charge pennies. The 10-20 cents the HFTs shave off the spread is money into the pocket of anyone who trades, which very much includes "some dude wishing to invest his money".
In fact: if you read the responses to Lewis' book, the one consistent thing you'll see is the notion that if HFT harms anyone, it is not the retail investor. Even the people making the case that HFT is evil are making that case indirectly, by suggesting that HFTs impose costs on large sophisticated investors that act on behalf of ordinary people. (But then, Vanguard disagrees with that, too).
† The "buy" and "sell" in "buy-side" and "sell-side" refers to the intent to transact in liquidity , not the actual shares; the buy-side isn't "people who want to buy shares", but rather "people who want to trade now", or perhaps more accurately, "people who want to maintain long-term positions". The buy-side is "customers of the public markets" and the sell-side is "people who make the public markets work".
I believe it is more on the order of $0.00005 per share traded.
From what I can tell, these issues come into play primarily in two scenarios:
(a) market orders with traders demanding immediate liquidity at the expense of optimal pricing, and
(b) complicated hedged trades in which traders are depending on the synchronization of two different sets of correlated limit orders.
If HFTs want to be hailed as more efficient market makers, they should operate under the same obligation.
"• However, the most commonly cited debt-to-income statistics in Canada and the U.S. are not directly comparable. There are differences in the methodologies used to calculate both debt and income. There are also differences in how health care is funded in Canada and the U.S. that should be fac - tored into the amount of personal disposable income households have to help service their debt. "
This claim seems dubious. This CCPA report is saying the majority of the "bail out" was from the CMHC (our FNMA) buying mortgages (which were already insured by them) from banks. Thus, assets were exchanged for cash at a fair market value. Is that a bail out?
A fishy anti-business report quoted by a supposed wall-street trader. Michael Lewis' book has brought some strange groups on the same side of the issue I guess.
1) most of the arguments for call auctions instead of continuous trading assume a centralized call auction that in and of itself adds no cost above our current decentralized exchanges. This seems like an extremely troublesome assumption given that we have seen the negative impact of centralized monopoly exchanges.
2) If it isn't a centralized auction there needs to be some price sync. mechanism. The most obvious one seems to be either latency arbitraging HFT (which for some reason people don't like) or a governmental central auction block the type of which is already causing legislative arbitration in the current markets.
3) Call auctions in and of them selves do not solve the major issue with our current prioritization system. If the auction algorithm has several prices that match the same amount of participants, or if the price it determines has an uneven number of buyers & sellers, who gets priority?
4) Price discovery is currently harder in call auction instruments. That could be because they are only done in illiquid markets and liquidity itself will fix that, but it is an issue with the current examples of this style of trading.
5) "Market" order mechanism. Many, many market participants are more worried about making sure they buy/sell than about high fidelity price fairness. If I say, "I want out of Goog no matter what", that complicates any auction methodology and introduces opportunities for gaming.
At the end of the day, I can't figure out who will actually be protected in this style of market and to whose disadvantage. That is a lot of added complexity for a very vague benefit.
And since this is a discussion about a book, it's worth pointing out that the book is focused around an alternative proposal for market design.
They are still a price-time priority matching exchange, they still allow colocation (well not directly, but they are themselves in data centers that have colocation), they still offer exotic order types, and their much hyped added latency amounts to 350 micro seconds. They aren't trying to remove HFT from the markets, they are trying to disadvantage one class of HFT in favor of another.
I personally don't have any problem with their goal, but they aren't being honest about it and that seems problematic.
The stock market is a service to provide equity for real production companies to grow. HFT distorts the real value of a stock. There is also 0 chance of any regulation authority to ever check the amount of paperwork HFT produces.
63.36%: "The NYSE had ... built this 4000,000-square-foot fortress in the middle of nowhere ... the moment they announced their plans HFT firms began to buy up land surrounding the fort ... the NYSE somehow persuaded the SEC to let them make a rule for themselves: Any banks or brokers or HFT firms that did not buy space inside the fort would be allowed to connect to the NYSE in or of two places: Newark, New Jersey, or Manhattan. The time required to move a signal ... undermined HFT strategies ... "There was a precedent: They'd let NYSE do it,"..."
So to my unsophisticated eye, this sophisticated reviewer is blowing a bit of smoke. Not all smoke, but a bit of it at least.
75.73%: "A few thought it was important to remember that technology had lowered their trading costs from what they had been decades earlier - and half-turned a half-blind eye to the stunts Wall Street intermediaries had pulled to prevent technology from lowering those costs even further."
I'm beginning to suspect the author is flat out dishonest. The Goldman cock-up is used as a <i>defense</i> of Goldman. Lewis says that unlike other firms they had a legitimate excuse for not trading with IEX - they didn't trust their systems. So, no the cockup had nothing in particular to do with HFT, but Lewis never implied that it did, and it is impossible to read that paragraph and come to another conclusion honestly. The review author is not shooting straight.