Is this a get micro-rich in micro-seconds scheme or something more?
August 2, 2012 9:21 PM Subscribe
Can high frequency trading be justified on any social benefit grounds or other orthodox market theory?
Does high frequency trading provide a useful function in the market place, in the manner that derivatives, hedging, bundling etc can be claimed to do, does it make markets more efficient or something, or is it unequivocally just about exploiting loopholes for wealth creation?
(not looking for your opinion on whether these people are evil, just looking for market based models to support their existence).
Does high frequency trading provide a useful function in the market place, in the manner that derivatives, hedging, bundling etc can be claimed to do, does it make markets more efficient or something, or is it unequivocally just about exploiting loopholes for wealth creation?
(not looking for your opinion on whether these people are evil, just looking for market based models to support their existence).
The more buyers and sellers, the more liquid the market so it probably makes those markets more liquid at many price points. Additionally, it could be argued that these trades are enriching many people, so there is that benefit as well.
Does high frequency trading provide a useful function in the market place, in the manner that derivatives, hedging, bundling etc can be claimed to do
Look high frequency trading happens all the time and it doesn't screw up the market - these 2 or 3 times that it has done some nasty stuff, it could have been done equally just as nasty by regular traders. I would argue that HFT has stabilized / smoothed day prices because HFT trading strategies have been developed to find those *super tiny profits* that regular traders don't bother with. That it makes mistakes is besides the point - people make mistakes trading all the time.
If you really want to look for a problem in the markets - have a look at naked short selling.
posted by Brent Parker at 9:39 PM on August 2, 2012
Does high frequency trading provide a useful function in the market place, in the manner that derivatives, hedging, bundling etc can be claimed to do
Look high frequency trading happens all the time and it doesn't screw up the market - these 2 or 3 times that it has done some nasty stuff, it could have been done equally just as nasty by regular traders. I would argue that HFT has stabilized / smoothed day prices because HFT trading strategies have been developed to find those *super tiny profits* that regular traders don't bother with. That it makes mistakes is besides the point - people make mistakes trading all the time.
If you really want to look for a problem in the markets - have a look at naked short selling.
posted by Brent Parker at 9:39 PM on August 2, 2012
It would depend on their trading ratio or taking or adding liquidity. If they are hitting bidsandtaking offers, then there is a certain amount of destabilizing being done with the adding of liquidity. If they buy on the bidandsell on the offer, they are adding stability and liquidity.
As a former market maker on the floor of the AMEX and CBOE and CBT, you have obligations to provide a two sided market (bid and offer) as well as at times, an obligation to provide stabilizing bids.
The general argument is that they are providing liquidity. Essentially, don't put a bid or offer out there if you are not willing to or do not want to actually get filled.
I think the issue with HFTs is only part of a bigg issue with market structure. I think that there should be a CLOB (Central Limit Order Book). The fragmentation of the market whereby there is incentive to be first and to display your true size and intentions is creating instability. Also, as many of these firms are able to collocate their servers with the various exchange servers while the average investor trader are not able to, gives them an unfair advantage in terms of speed. I think the playing field should be level with all market participants being on parity. They also have a significant edge in their transaction costs. While the average individual trader or investor cannotbe profitable earning the dealer spread of a penny because of commission costs, these guys can and do make money making a penny or even at times scratching a trade based on liquidity rebates.
Also, from my standpoint, in theory, I am not sure that the basis of the question is relevant. I don't necessarily subscribe to the theory that a HFT needs a market function other than making money. They take risk and sometimes they make and sometimes they lose. Ultimately, if they artificially move the price out of where oth market participants think it should be, those other market participants like you or mean always step in and make a bid to buyoranoffer to sell.
posted by JohnnyGunn at 10:02 PM on August 2, 2012
As a former market maker on the floor of the AMEX and CBOE and CBT, you have obligations to provide a two sided market (bid and offer) as well as at times, an obligation to provide stabilizing bids.
The general argument is that they are providing liquidity. Essentially, don't put a bid or offer out there if you are not willing to or do not want to actually get filled.
I think the issue with HFTs is only part of a bigg issue with market structure. I think that there should be a CLOB (Central Limit Order Book). The fragmentation of the market whereby there is incentive to be first and to display your true size and intentions is creating instability. Also, as many of these firms are able to collocate their servers with the various exchange servers while the average investor trader are not able to, gives them an unfair advantage in terms of speed. I think the playing field should be level with all market participants being on parity. They also have a significant edge in their transaction costs. While the average individual trader or investor cannotbe profitable earning the dealer spread of a penny because of commission costs, these guys can and do make money making a penny or even at times scratching a trade based on liquidity rebates.
Also, from my standpoint, in theory, I am not sure that the basis of the question is relevant. I don't necessarily subscribe to the theory that a HFT needs a market function other than making money. They take risk and sometimes they make and sometimes they lose. Ultimately, if they artificially move the price out of where oth market participants think it should be, those other market participants like you or mean always step in and make a bid to buyoranoffer to sell.
posted by JohnnyGunn at 10:02 PM on August 2, 2012
Let's frame the complaining about HFT. Most of the vocal critics of HFT are short-term day trading types - why? Because computers are better at arbitraging away the small price differentials those guys live off of. Do those guys serve a social benefit? No.
The other group being directly damaged by HFT is market-making. Again, basically the HFT guys are better at it than the traditional market-makers are. In theory the issue here is that market-makers are compelled to provide liquidity, whereas HFTs are not, so when things go crazy in the market and the HFT models breakdown they just exit the market, removing liquidity at inopportune times. Now who does this damage? Again, people who have to trade - speculators. If you are a long-term buy and hold investor do you really care if you can't trade one day? Not really. If the lack of liquidity becomes bad enough you can even profit from it by providing liquidity yourself. Also I would argue that market-makers were overpaid relative to the risk they took, especially pre-decimalization. The HFTs are arbing this away.
So I would say it does not serve a social benefit, but the people it is taking money from also don't really serve a social benefit.
And of course, like all other "innovations" on Wall Street the HFT world is following the classic lifecycle - so many market participants and so much capital being put into the space that the volatility levels where its a reasonable ROE business has doubled or tripled over the last five years.
posted by JPD at 6:09 AM on August 3, 2012
The other group being directly damaged by HFT is market-making. Again, basically the HFT guys are better at it than the traditional market-makers are. In theory the issue here is that market-makers are compelled to provide liquidity, whereas HFTs are not, so when things go crazy in the market and the HFT models breakdown they just exit the market, removing liquidity at inopportune times. Now who does this damage? Again, people who have to trade - speculators. If you are a long-term buy and hold investor do you really care if you can't trade one day? Not really. If the lack of liquidity becomes bad enough you can even profit from it by providing liquidity yourself. Also I would argue that market-makers were overpaid relative to the risk they took, especially pre-decimalization. The HFTs are arbing this away.
So I would say it does not serve a social benefit, but the people it is taking money from also don't really serve a social benefit.
And of course, like all other "innovations" on Wall Street the HFT world is following the classic lifecycle - so many market participants and so much capital being put into the space that the volatility levels where its a reasonable ROE business has doubled or tripled over the last five years.
posted by JPD at 6:09 AM on August 3, 2012
or is it unequivocally just about exploiting loopholes for wealth creation?
It isn't a loophole. It is trading like anyone else trades. Someone offers to sell at a price, and buyers either take the price or they don't. And at the same time, someone offers to buy at a price, and sellers either take it or they don't. The only difference between high frequency trading and other trading is the length of time the assets are held. Remember, HFT operations aim to not hold any stock at the end of the trading day.
There is nothing immoral or unethical about making a quick buck, as long as you aren't cheating. And it isn't cheating to be quicker than the next person.
(In case it is confusing: adding liquidity to a market means adding more buyers and sellers. It means that when someone decides to enter the marketplace to buy or sell, that there is likely to be someone willing to be the other side of the trade. The more liquid a marketplace is, the more likely the prices are to be correct. As JPD explains, there are fewer opportunities for people to take advantage of disparities in knowledge or access to the market. It means prices are fairer.)
posted by gjc at 7:26 AM on August 3, 2012 [1 favorite]
It isn't a loophole. It is trading like anyone else trades. Someone offers to sell at a price, and buyers either take the price or they don't. And at the same time, someone offers to buy at a price, and sellers either take it or they don't. The only difference between high frequency trading and other trading is the length of time the assets are held. Remember, HFT operations aim to not hold any stock at the end of the trading day.
There is nothing immoral or unethical about making a quick buck, as long as you aren't cheating. And it isn't cheating to be quicker than the next person.
(In case it is confusing: adding liquidity to a market means adding more buyers and sellers. It means that when someone decides to enter the marketplace to buy or sell, that there is likely to be someone willing to be the other side of the trade. The more liquid a marketplace is, the more likely the prices are to be correct. As JPD explains, there are fewer opportunities for people to take advantage of disparities in knowledge or access to the market. It means prices are fairer.)
posted by gjc at 7:26 AM on August 3, 2012 [1 favorite]
The Economist had a good article about the pros and cons of HFT in their Financial Innovation Special back in February that might be of interest to you.
posted by urbanlenny at 7:27 AM on August 3, 2012
posted by urbanlenny at 7:27 AM on August 3, 2012
Yes, it provides a "social benefit" - a term that is pretty subjective anyways.
First, as others have pointed out, they provide liquidity to the market. This is real, and in fact most of their revenues come from rebates from exchanges for providing liquidity, not from actually 'buying low and selling high'. This liquidity helps people buy and sell stocks, but it also removes a lot of the pitfalls from our currently fragmented market structure. For example, in the US, you can buy IBM on NYSE, Nasdaq, Bats, ... lots of different market venues. In the 'old days' if your order got routed to a bad exchange, you could get ripped off. With Reg-NMS and lots of HF trading they are all pretty much the same.
Second, lets look at what the *vast* majority of the HF trading actually is - its not prop trading for their book its algos for clients. For example, Vanguard (or some other well respected pension/mutual fund company that everyone gets warm fuzzies about because its their money) says they want to buy 100,000 shares of IBM - they dont just go out and buy 100,000 shares of it with a market order. They will take that 100,000 share order, and send it to an algo provider (like a bank), and say "do your best, buy me these shares before the end of the day". The algo provider then will run that order through their algos, submitting lots of orders, cancelling them, and generally working hard to fill the clients order. This will almost always include pinging dark pools, iceberg orders, cancel/replace orders, etc - all the things people like to harp on. In the end, Vanguard might save say .10/share versus a market order, so at 100k shares thats 10k savings, but they give the bank some fee for filling the order. So now the end user (you), owns IBM for a better price.
Lastly, and this is a bit more speculative but I think real - the amount of money/people/time/research spent to build the infrastructure to support low latency trading is pretty amazing. New fiber lines get laid, research in microwave networks, switching technology enhancements, new programming languages get developed, jobs are created etc. In the same vein as NASA and other big-govt-big-budget science projects pays lots of dividends its hard to argue that lots of this tech does not provide a social benefit.
Full disclosure - this is my thing.
PS - the breathless rolling stone articles about the scope of profits in HF trading are complete bullshit. Ultimately this is a space that conforms to a fairly nice,tight set of laws (math laws, not regs) that simply limit the amount of capacity (and thus profits) that can be achieved. There are tidy sums to be made, but noone is pulling in $10bil+/yr, or as some reports have claimed north of $100bil. they are just rattling peoples cages with that type of noise.
posted by H. Roark at 9:19 AM on August 3, 2012 [2 favorites]
First, as others have pointed out, they provide liquidity to the market. This is real, and in fact most of their revenues come from rebates from exchanges for providing liquidity, not from actually 'buying low and selling high'. This liquidity helps people buy and sell stocks, but it also removes a lot of the pitfalls from our currently fragmented market structure. For example, in the US, you can buy IBM on NYSE, Nasdaq, Bats, ... lots of different market venues. In the 'old days' if your order got routed to a bad exchange, you could get ripped off. With Reg-NMS and lots of HF trading they are all pretty much the same.
Second, lets look at what the *vast* majority of the HF trading actually is - its not prop trading for their book its algos for clients. For example, Vanguard (or some other well respected pension/mutual fund company that everyone gets warm fuzzies about because its their money) says they want to buy 100,000 shares of IBM - they dont just go out and buy 100,000 shares of it with a market order. They will take that 100,000 share order, and send it to an algo provider (like a bank), and say "do your best, buy me these shares before the end of the day". The algo provider then will run that order through their algos, submitting lots of orders, cancelling them, and generally working hard to fill the clients order. This will almost always include pinging dark pools, iceberg orders, cancel/replace orders, etc - all the things people like to harp on. In the end, Vanguard might save say .10/share versus a market order, so at 100k shares thats 10k savings, but they give the bank some fee for filling the order. So now the end user (you), owns IBM for a better price.
Lastly, and this is a bit more speculative but I think real - the amount of money/people/time/research spent to build the infrastructure to support low latency trading is pretty amazing. New fiber lines get laid, research in microwave networks, switching technology enhancements, new programming languages get developed, jobs are created etc. In the same vein as NASA and other big-govt-big-budget science projects pays lots of dividends its hard to argue that lots of this tech does not provide a social benefit.
Full disclosure - this is my thing.
PS - the breathless rolling stone articles about the scope of profits in HF trading are complete bullshit. Ultimately this is a space that conforms to a fairly nice,tight set of laws (math laws, not regs) that simply limit the amount of capacity (and thus profits) that can be achieved. There are tidy sums to be made, but noone is pulling in $10bil+/yr, or as some reports have claimed north of $100bil. they are just rattling peoples cages with that type of noise.
posted by H. Roark at 9:19 AM on August 3, 2012 [2 favorites]
This thread is closed to new comments.
(I work in the industry and I don't even really understand it.)
posted by phunniemee at 9:36 PM on August 2, 2012