NJ Server Farms Remake the US Financial Markets

1sockchuck writes "The engine of Wall Street has shifted from the stock exchange floor to data centers in New Jersey, where computer-driven trading now accounts for 56 percent of all trading activity, according to the New York Times. 'While this Tron landscape is dominated by the titans of Wall Street, it affects nearly everyone who owns shares of stock or mutual funds, or who has a stake in a pension fund or works for a public company,' the Times writes. 'For better or for worse, part of your wealth, your livelihood, is throbbing through these wires.' There are also photos of the data centers powering the high-speed trading operations, while 60 Minutes has video of a huge new 'liquidity center' run by the NYSE."

Comments

short term skimming

[FuckingNickName]

And nothing of value was gained.

Re:short term skimming

[purpledinoz]

Exactly. Goldman Sachs and JP Morgan earn a huge chunk of their profit from high-frequency trading. This profit must come at an expense of someone else (like regular stock holders). In my mind, this is legal theft.

Re:short term skimming

[Yvanhoe]

Indeed. Actually, making the market trade with a period of one day, and randomizing the priority of orders arriving would sanitize a lot of things.
I have yet to see a good argument against that. I mean one that doesn't say things like "pschhh, you know nothing about economy, let us manage this thing". Sorry guys. We paid for your dumb errors in the subprime crisis, so now that you are creating speculation on yet another imaginary value (physical closeness to the servers of the stock exchange ? Really ? Changes in the value of a company on the millisecond scale ? Are you serious ? ) you better show your whole scheme.

Re:short term skimming

[raw-sewage]

Exactly. Goldman Sachs and JP Morgan earn a huge chunk of their profit from high-frequency trading. This profit must come at an expense of someone else (like regular stock holders). In my mind, this is legal theft.

I see this mantra repeated often around here, but I'm not so sure it's entirely true. First, what is a "regular stock holder"? On one end, there are small-time, buy-and-hold investors such as myself; on the other end, there are big institutional investors who manage massive portfolios for pension funds, insurance companies, mutual funds, etc. And there's everything in between. From one end of the spectrum to the next, you have very different trading profiles, and thus are affected very differently by high-frequency trading.

For someone like myself, I make maybe a few dozen (relatively) small buys per year. These buys are usually in the neighborhood of 100 shares. If a high-frequency trading program jumps in and effectively front-runs me to to make a few pennies, I don't really care. Overpaying by a penny or two per share means nothing given my buy and hold (long term) strategy. I'm already out $9.99 per trade in commissions to my broker. I'm looking at a horizon of at least ten years, when these relatively small additional costs shouldn't matter.

On the other end of the spectrum is the big institutional investor, like the pension- or mutual-fund manager. This person's job is to constantly rebalance the portfolio to meet some pre-defined metrics; he's generally actively trading huge amounts on a daily basis. While he certainly wants to get the best price possible when he trades, it's practically impossible for him to do that given the volumes in which he deals. Unless he has a highly specialized trading algorithm---that is, something just as sophisticated as the high-frequency traders---he can't help but signal his intentions to the market. Telegraphing his intentions is what makes him a "victim" of the high-frequency traders.

I'm not a fund manager, but my assumption is that, like me and my small buy-and-hold strategy, he also doesn't care about having a small percentage skimmed off of each transaction. To me, it's like buying a big-ticket item, such as a car. Say you budget $27k to buy yourself a new car. Now, some enterprising company goes out and manages a massive, real-time database of every car available for sale in the country. This company can use this database to find you the exact car you want, right now for $27,250. If you're willing to spend $27k, do you really care if you pay an extra $250? And for that $250, you get precisely what you want, and don't have to wait. Compared to going to a dealer, who, if you're lucky, might have what you want at your price... but chances are, the dealer will have something close to what you want, and you'll have to negotiate the price. Or maybe the dealer can get you exactly what you want, but you'll have to wait while he works the intra-dealer process to provision the car. Or maybe he can get you exactly what you want, for even less than $27k, but you'll have to wait for the car to be manufactured. A car buyer can face all these scenarios, but I believe the fund manager most closely mimics the first: that is, he knows exactly what he wants, and he wants it right now.

My prediction is that we'll see the high-frequency trading landscape continue to evolve. Like anything, there will come a day when that kind of business and the skills required to do it are commoditized. And when it reaches that point, it will be much less lucrative. I think we'll see traders of all profiles using ideas and techniques from the high-frequency world in their own trading, meaning that the very people high-frequency traders take from will become direct competitors. The small-time trader like me will implicitly use such techniques, though they will be invisible, as it will actually be implemented by my discount broker (perhaps they'll offer

Re:short term skimming

[Anachragnome]

"The argument of 'providing liquidity' doesn't really seem like it has that much value for a normal investor."

Keyword is "normal". This sort of trading is anything but "normal". Only the largest entities can afford this sort of trading backbone--you and I have no such luxuries and have to rely on brokers to even stand a chance.

When I first scanned the summary I assumed that "Liquidation Center" simply meant an assload of processors to give them an edge in terms of transaction speeds/volumes so that they could "liquidate" soured stocks/commoditites/etc.

In short, they have invested in the ability to duck before the shit hits the fan, leaving everyone else standing directly in the path of said shit.

And another thing! With this sort of volume and speed, how in the hell does the SEC make sure it is all kosher? Are all of these trades being archived somehow, or does the SEC keep up with the trades? Or is this the point?--keep the SEC hopelessly back-logged that by the time they catch something it is far too late to really hold anyone accountable?

Re:short term skimming

[pyite]

We paid for your dumb errors in the subprime crisis, so now that you are creating speculation on yet another imaginary value (physical closeness to the servers of the stock exchange ? Really ? Changes in the value of a company on the millisecond scale ? Are you serious ? ) you better show your whole scheme.

Whose dumb errors in the subprime crisis? Those errors were made by multiple parties. First and foremost, the people buying more than they could afford. It's taboo to demonize "Main Street," but let's face it, if people could, or chose to, do basic math, they would have realized they couldn't afford what they were buying. Second, stupid mortgage companies who relied on people's word that they could afford things. Third, those who thought tranching baskets of mortgages and pricing the tranches using default correlations for each tranche that were advantageous just to that tranche rather than rooted in reality.

These three groups of people have almost nothing in common with those who trade equities and equities derivatives. So, please, don't put two things you don't understand into the same bucket simply because both are products of "Wall Street."

Re:short term skimming

[Yvanhoe]

I have no problem considering a part of "main street" has some responsibility. But people who can't pay their debts is a problem known since millenniums (yes it is). Banker is a profession that is as old as this problem (yes it is). Having bankers unable to evaluate at least approximately the risk of a debt is like a farmer who forgot to plant seeds one whole year. Unforgettable. They showed grave incompetence, we now have to look behind their shoulders for their every move because no politician has the guts to make them pay.

Re:short term skimming

[Anonymous Coward]

While the average investor was partly to blame for not checking his actual buying power, remember that the banks' go to extraordinary lengths to hide the real cost of a loan so that a) home owners don't actually know how much they're going to end up paying in the long run and b) to make the loan look easier to pay than it actually is.

Don't cut the Wall Street mob any slack. They don't need, nor do they deserve it.

Re:short term skimming

[TubeSteak]

I'm not a fund manager, but my assumption is that, like me and my small buy-and-hold strategy, he also doesn't care about having a small percentage skimmed off of each transaction. To me, it's like buying a big-ticket item, such as a car. Say you budget $27k to buy yourself a new car. Now, some enterprising company goes out and manages a massive, real-time database of every car available for sale in the country. This company can use this database to find you the exact car you want, right now for $27,250. If you're willing to spend $27k, do you really care if you pay an extra $250? And for that $250, you get precisely what you want, and don't have to wait. Compared to going to a dealer, who, if you're lucky, might have what you want at your price... but chances are, the dealer will have something close to what you want, and you'll have to negotiate the price. Or maybe the dealer can get you exactly what you want, but you'll have to wait while he works the intra-dealer process to provision the car. Or maybe he can get you exactly what you want, for even less than $27k, but you'll have to wait for the car to be manufactured. A car buyer can face all these scenarios, but I believe the fund manager most closely mimics the first: that is, he knows exactly what he wants, and he wants it right now.

Talking about cars and manufacturing completely mischaracterizes the fluid and fungible nature of stocks.

The problem with your long winded analogy is that [enterprising company] and [fund manager] have access to the same database and the same stocks.
The only difference is a hundred mili/microseconds or so.

Whenever there's a technology revolution in any industry, we always see questions of "is it too soon to use this?" For example, vaccines in medicine.

No, not "for example, vaccines in medicine."
The first vaccine was created 214 years ago and we've had plenty of time to investigate and regulate.

High frequency trading, as we know it today, has barely been around for 5 years.
If you think that's long enough for the market players and the regulators to really understand the effects of HFT on the marketplace... well, not many people agree with you.

Re:short term skimming

[Antique Geekmeister]

It doessn't. Recent regulatory changes at the SEC, and promises to "review" the situation, have carefully avoided striking at the heart of the larger investment companies and groups that both engage in this sort of behavior, and have enough spare cash to fund politicians and arrange their own "reports" for the SEC on how disemboweling thihs sort of high-speed trading would "hinder the market".

It's insider trading with a high-tech cover. The data is not avaialble to ordinary investors in time for them to take keaningful action: the millisecond of having their servers right near the NySE overwhelm the reponse times of any ordinary trading entity and prevent their meaningful responses.

Re:short term skimming

[Dhalka226]

First and foremost, the people buying more than they could afford. It's taboo to demonize "Main Street," but let's face it, if people could, or chose to, do basic math, they would have realized they couldn't afford what they were buying.

While that's not untrue, it's somewhat disingenuous. If people knew basic auto repair, they could save a lot of money on oil changes and auto mechanics. If people knew basic home improvement skills, they could save a lot of money on handymen and repair guys.

But most people don't, and in that void of ignorance, fear or indifference exists entire industries who we collectively tag with the sometimes laughable title of "professional." A person doing some basic math might have figured out they couldn't afford what they were buying (and you're grossly oversimplifying the problem, by the way), but instead they relied on a series of "professionals" to do it for them -- professionals who are paid handsomely, not only in terms of their own salaries but in terms of commissions (real estate) and interest (banks/mortgage companies). Both of these parties nodded their heads emphatically and declared "of COURSE you can afford this, don't worry about it! Sign here!"

They did it from simple greed, and from a misguided belief that eh, even if we have to boot these freeloaders out of their house we have some of their money in pocket and real estate prices keep going up so we won't lose THAT much when we sell it to the next sucker. Through their greed, and their staggering unprofessionalism, they essentially collapsed two entire industries with a trickle-down effect that collapsed even more; industries that survive today only through the intervention of the federal government, right or wrong.

Some extra personal accountability is certainly a good idea to protect ourselves, but when we hire or deal with professionals I don't think any sane person expects them to be so wholly unprofessional as to tank their entire industry. They don't deserve to be let off the hook for that, not to any degree, even if peoples' ignorance is what allows them to operate that way. Ignorance, and more importantly knowledge of their own ignorance, is precisely why people hire professionals in the first place (not that there is much option when we're talking about a mortgage, I admit).

That these idiots are distinct from equities traders I do not deny, though I also don't think they're quite as separate as you make them out to be.

Re:short term skimming

[pyite]

In fairness to the tranche modelers, all historical data indicated that foreclosures in geographically distinct areas were in fact largely uncorrelated. The housing bubble broke this assumption rather badly, but that was on those who made the bubble, not the quants.

My point was a bit more subtle. Those holding equity tranches want defaults to be highly correlated. Although high default correlation means if one fails, they all fail, it also means if one doesn't fail, none of the others do either. So equity tranches were priced using that correlation. Senior tranches want little default correlation, because it means that defaults are random and will be absorbed by the equity tranches. Those tranches were priced using that correlation.

Where High Frequency Trading really makes money is from trusts missing out on fractions of a percent - HFT is sort of a more legit version of the "steal the rounded off interest" scheme from Office Space - on an individual level it is meaningless, you may lose 1 cent per share, but doing this enough makes it profitable to the brokerages.

Making fractions of a cent on spreads is a market maker's reward for providing liquidity and taking risk for a large price swing in the period of time in which they are still holding the securities (in the case of an underlier) or haven't yet hedged (in the case of some derivative).

Re:short term skimming

[AcidPenguin9873]

So only big banks are supposed to taking these risks and making huge returns, while Joe Taxpayer is not supposed to do that and just "live within his means"? Why should Joe Taxpayer be locked out of potentially big returns in a hot housing market? And why shouldn't Joe Taxpayer get a bailout when things inevitably go south? Banks take risks all the time to maximize their profits, and they were making huge profits (which turned into huge bonuses for executives) during the housing bubble. Joe Taxpayer was just trying to get in on the action.

Let me quote from this outstanding article by James Kwak:

But, let’s say I’m a guy who makes $15,000 a year. I realize, wow, I can get a $400,000 mortgage and I can live in this house for a few years, and if housing prices go up, I can flip it and I can actually make a couple hundred thousand dollars. And let’s say I’m really clever, and I say, if housing prices go down, I’ll just walk away and I will have gotten to live in a really nice house for three years at no cost to myself. I mean, that’s the worst, most cynical spin you can put on it, right? But this is exactly what people on Wall Street do. The person who is criticizing the janitor for doing this is the same person who thinks that businesses should exploit every legal opportunity to make profits. So even if you attribute the worst possible state of mind to the guy making $15,000, he’s still just doing what any businessman should do under the circumstances. But our national ideology somehow doesn’t allow us to think about it in those terms.

in-equity

[alphatel]

Not only are you completely powerless to do anything about it now, but when some glitch causes your pension fund to suddenly be worth 10 cents, you won't be able to sue anyone.

Re:in-equity

[SuricouRaven]

It wouldn't even need deliberate manipulation. When there are thousands of programs all making the same decisions on the same input, even a natural fluctuation can trigger a disaster. A stock falls a bit, programs see it, and within milliseconds are selling - triggering a further fall, a feedback cycle of collapse.

Re:in-equity

[biryokumaru]

This kind of thing always makes me wonder why you see so many homeless people. They could just smash someone's head in with a rock and have a nice, clean, warm home with three squares a day and plenty of time to read or watch TV.

The reason is, those homeless people, unlike the bankers, aren't heartless sociopaths. I think when the bankers rob you of everything you've spent your life saving, you may find the same is true of you, unfortunately.

Re:in-equity

[Pinky's Brain]

That's 72 hours of liquidity gone, there is an opportunity cost there ... an opportunity cost measured in true dollars going into the pockets of speculators. Basically we have traded wider spreads for higher instability, is it a good trade? Maybe, dunno.

Personally I think bids and offers should be matched up only once every hour ... I don't see any need for this stuff to happen at wire speeds.

Re:in-equity

[SuricouRaven]

Where would the profit be in buying a declining stock?

I oversimplified the example for clarity - in realise the algolrythms used are far more complex, and include some safeguards against this type of collective behavior, otherwise it would happen all the time. Still, the possibility is there. The 2010 Dow mini-crash was caused in large part by high-frequency tradeing which amplified a minor variation into a severe one - and came dangerously close to progressing into a full-blown crash. It was only a combination of a final emergency safeguard closing the market for fice seconds and a lot of blind luck that averted disaster. High-frequency tradeing, espicially of the extremes seen today, is just inviting another such incident - and with the frequency of tradeing constantly going up, next time there might be no stopping a crash until it's too late.

Re:in-equity

[Anonymous Coward]

If you match bids and offers once per hour, you're going to widen the spread pretty dramatically. It's no coincidence that the spreads have tightened up as trading speed has increased. If you force market markers to hold securities for at least one hour, they're going to have to widen their spreads pretty dramatically in order to compensate for the risk.

You would also see significantly higher volatility in the market. The way things currently stand, you can get a very good idea of what a security is worth at any given instant. If you have to wait an hour before the market updates, it's going to be hard to predict what the next trade price will be. That's going to result in a lot more price volatility, which will also increase spreads.

Another consequence is that you're likely to put smaller shops completely out of business. Holding a security for a minimum of one hour in an environment where pricing information is not available is just not something that smaller firms will be able to do (if nothing else, net capital regulations will foreclose it, due to the enormous risk). For the big firms, it will be like a return to the good old days- all those pesky HTFs gone, and only 2-3 market makers for any given security. This, more than anything else, will increase spreads and spell the end of the exchanges and a return us to the days of market makers. "You want to buy 100 shares of MSFT? You'll pay what we say. What are you going to do, go buy it from someone else? Good luck with that!" "You're ready to sell your 100 shares of MSFT? You'll get what we're willing to give you. What are you going to do, go to someone else? Try to trade it on an exchange? Har har har!"

This is a complex situation. The rise of the HFTs was one of the biggest shakeups in Wall Street history- the large firms lost huge chunks of their control of the market, and are still reeling from the shock of lost profits. They would be more than happy to see the end of HFT and a return to the days when they controlled the market. HFT's may cost the market $0.01/share, but that's nothing compared to the bad old days of monopoly market makers extracting $2/share or more.

Re:in-equity

[Gorobei]

Personally I think bids and offers should be matched up only once every hour ... I don't see any need for this stuff to happen at wire speeds.

Numerous markets had, and do have, this "feature." For example, trade-at-close aggregates all the orders at the day's close, and everyone gets the same price if the close price is within their limit.

The effect of this feature was to benefit the technologically sophisticated traders (I was one back in the nineties.) You waited until a few seconds before the close, then slammed limit orders onto everything that moved: the poor retail guy who had put in an order 1 minute ago was your counterparty, and he had just given you a free option for 58 seconds.

Re:in-equity

[LordNacho]

And what's wrong with speculating? We all do it in one way or another. Taking a degree in the hope of getting a job. Buying a house. Holding cash instead of hard assets. Changing jobs. Speed dating. Many of life's decisions are made in the hope of an uncertain gain.

I Can't Help But Think...

[sycodon]

...that automated trading has and will cause more trouble than it is worth to the overall economy.

Re:I Can't Help But Think...

[biryokumaru]

"That's funny... all our HFT algorithms keep investing in our own datacenter technologies..."

So, where are the VAXen?

[Tackhead]

Oh, that's right. Even 22 years later, VAXen, my children, just don't belong in some places :)

Re:Throbbing money

[migla]

>Can pennies throb?

Sure. It's a widely used idiom, popular in phrases such as "The sweaty lumberjack lustfully thrust his throbbing pennies deep into the moist slot of the pink piggy-bank."

Humans in the loop.

[blair1q]

“Markets are there for capital formation and long-term investment, not for gaming,” [Michael Durbin] says here

Amen to that. The markets should operate as though there are humans at every step. Otherwise there's no need for humans on the edges, either.

Re:Humans in the loop.

[blair1q]

In other words, computers are perfectly capable of putting every stock on the market into the rail, and it's the human traders who are keeping market value anywhere within praying distance of the actual value of the thing being traded.

Re:Whoop De Doo

[ColdWetDog]

The blue lights. According to TFA,

And yes, there are blue lights to keep things cool – both the equipment and the visuals.

I'll bet your clunky ol data center doesn't have lots of blue lights.

Re:Whoop De Doo

[SuricouRaven]

There is just one difference, though. The trading machines, regardless of their location, have the same length cable to the switch. Even if it means coiling some of it up. The latency demands are so strict, the customers even care about the cable length - and it's just easier to give all the customers the same length than to maintain tiered pricing on the racks.

Average stock purchase held under a minute

[cpm99352]

Majority of trading (at least in the US) is computer. According to this, average length of time a stock is held is under 35 seconds.

The mainstream financial reporting in the US is a complete joke -- everyone fixates on the Dow, as though it held any meaning. At the end of each day, some "meaningful" reason is given for a less than 1% move, however automated trading never seems to be included.

Netflix joins the Dow??? Is that what this country is reduced to? No manufacturing, just service?

Meanwhile, SEC regulation is a total joke, insider selling is rampant, accounting is a joke...

But, if you're a retiree, where else can you hunt down returns? CDs are long dead.

Re:Average stock purchase held under a minute

[0123456]

Not true either. It is trivially easy to find articles with data to the contrary.

Are those the articles where flipping a burger into a bun and sticking a piece of lettuce on top is counted as 'manufacturing'?

Re:Average stock purchase held under a minute

[Billly Gates]

Mod up.

Bush changed the rules and McDonalds workers are considered manufacturers.

We are the #1 manufacturer corporate headquarters in the world. The products are actually made in China by these American companies.

They put the servers in The Situation Room

[Dachannien]

In other words, the IT guys who maintain these servers all have greasy hair, don't wear shirts, and are total douchebags.

Re:They put the servers in The Situation Room

[couchslug]

"In other words, the IT guys who maintain these servers all have greasy hair, don't wear shirts, and are total douchebags."

Where do I apply?

Re:Whoop De Doo

[biryokumaru]

No, no, it's wall to wall Denon AK-DL1.

Common View, Common Error

[istartedi]

If you can find a way to reduce bid-ask spreads without this kind of stuff, then I'll agree. Until then, I can't join the chorus of detractors.

With liquidity in the market, anyone who buys stock gets a narrow spread. Take liquidity out of the market, and you send us back to the dark days when stocks would trade at $1/8th spreads if you were lucky. $1/4 was common. Not only did you pay higher commissions, you paid the spread.

Unless you're pining for the days when you called your broker, paid him a percentage of the trade, and he placed your order in a market with a huge spread then you should be thanking the liquidity providers, not bashing them.

The current system doesn't hurt the little guy. The old system made it so the little guy wouldn't even think about it. I know, because I came of age when the old system was still in place for a few years. Buying in with a $1/4 spread on something trading for $10-$20, and then waiting for a significant percentage gain just to cover the spread??? No thank-you. HFTs? I LOVE them.

Re:Common View, Common Error

[e065c8515d206cb0e190]

No offense, but if you need a definition of bid-ask spread, you need to learn the basics before criticizing HFTs.

Re:Common View, Common Error

[istartedi]

Perhaps you could provide more details so I can understand what exactly you mean by "bid-ask spread", and how exactly HFT lowers it by holding onto stocks for a few hundred milliseconds.

OK, let's say there's a hypothetical security X.

X BID 45 @$0.50 ASK 10 @$0.70

If you want to buy security X, you could try bumping up the bid to $0.55 and see if anybody will temporarily lower their ask that far.

The market for security X has terrible liquidity.

Now let's say somebody looks at this, and sees the awful liquidity. They say, hey, the market-makers suck. Let's do something better. They start "scalping" security X. They place bids at $0.55, then immediately flip for $0.65.

Now the market for security X has better liquidity. Somebody interested in X might be more inclined to buy, knowing that it doesn't have to rise too far before they can reasonably cover the spread.

The market-maker just bested the previous market maker. Market-maker A is shut out.... unless he can narrow the spread even further.

Now, the market-maker doesn't actually want to speculate in X if he can avoid it. It's in their interest to hold for as short a time as possible, and to make all their money off scalping or "skimming" as you call it. Without some kind of market-maker, the spreads are wider. You can hate the market-maker if you like; but try finding a better way to narrow spreads? I haven't heard of it.

That's how it works, in a nutshell. I'm glossing over a lot of detail, such as rebates and the different ETNs, and a lot of other stuff.

Note, I'm not belonging to an HFT religion. I'm just seeing it as "the worst system except for all the others". I don't believe in just turning these guys loose without regulation or oversight.

You asked for an explanation of how this stuff works, and I've given you my best understanding of it. I don't hold myself out as an expert. I'm just somebody who has been trading a bit, and watching markets since my teens...

Re:Common View, Common Error

[istartedi]

That's a compelling argument.

Bid-ask spread is readily quantified, and readily available. Any inequity due to HFT might be harder to quantify.

In highly liquid, HFT dominated markets, it's possible for the price to be unfairly set. The big problem? How do we know what a fair price is?

There are a lot of standard numbers you use to evaluate stocks: P/E, etc. At the end of the day though, it always boils down to market price.

The idea that the old bid-ask spread is "hiding" in the new market is possible; but how do you quantify it? Where would it go? I'm purely speculating here (no pun intended) but perhaps it went to volatility. It would be interesting to go back and look at real data from HFT vs. non-HFT markets, and see if there is more volatility in them.

Note, volatility doesn't hurt small investors unless they get stopped out. Stop-loss is a double-edged sword, and options have problems of their own. To reiterate, I didn't say HFT was perfect; I just don't think it's the demon that some make it out to be. A buy-and-hold investor isn't affected by volatility in the short run at all--certainly not the kind that HFTs might cause. An HFT can only drive the price of International Buggie Whip to a PE of 1000 for so long before they get burned.

Or, more simply, are market-makers "taxing" trades more now or less? Certainly there is more trading VOLUME now; but is the percentage going to HFTs greater or less than the percentage going to brokers/specialists under the old system?

If HFTs are making $1 billion on a trillion trades, while brokers/specialists made $500 million on 200 billion trades, which is more fair?

Plainly, further study by guys whith degrees different than mine (and actual jobs doing the studies) is needed...

Re:Common View, Common Error

[Estanislao Mart�nez]

I object to your assertion that these systems add liquidity. They consume as much as (if not more than) they add. They are executing orders as much as they are adding to the book.

And what's worse is that every time I look into these schemes, they seem to be predicated on detecting matching buy and sell offers quickly enough to get in between them before the market pairs them up. That is, the HFT only kicks in when a trade was going to happen anyway. That not only doesn't add liquidity, it assumes that the liquidity is already there.

Re:Common View, Common Error

[LordNacho]

I've worked in markets for years, though nobody can really can themselves an expert in something so complex.

As for dividends, there's no requirement that you hold on to high-div stocks for a long time. Also, and this is critical, you know exactly when that dividend is coming out of the price. So, basically, it completely doesn't matter whether the stock is paying a high dividend or not, since the liquidity providers know this. Having a narrow spread is good for you no matter what you're buying.

BTW, you might like to consider that ALL prices can be considered as bid/ask spreads. It's just that in your everyday life, people tend to only show you ONE side. In a supermarket, all the prices are Walmart's ASK price. Walmart got your potatoes by BIDDING for them from the wholesaler. They pocket the difference (bid-ask spread) just like a market maker.

When you buy a house, you are BIDDING (though confusingly this is colloquially called an offer on a house). If the owner is wanting 100K, and you are willing to pay 95K, one of these things will happen: 1) You cross the spread to LIFT THE OFFER 2)He crosses the spread to HIT THE BID 3) One of you moves their price and either 1 or 2 happens. The guy who crossed the spread is the aggressor, and he basically has swapped 5K for immediacy, ie to make the deal happen now rather than wait.

Re:Common View, Common Error

[LordNacho]

Analogy for why you need a market maker:

There's a market where farmers come to sell pigs, and butchers come to buy them. Unfortunately, the farmers and the butchers are not there at the same time. They might arrange a market day, which concentrates the trading in certain periods. Fine. But that leaves risk. What if market day is in a few months, and farmer doesn't know whether it's worth making some more pigs? Maybe he'll keep safe and decide not to. Result: fewer pigs, even if butcher actually wanted to buy them.

So, let's keep the market open. But farmers and butchers won't know when to show up? What if I go to market, and no butchers are there? Same problem as before... take less risk.

Enter the market maker. He doesn't know how to farm or butcher, but he does hang out at the market all day. He has a good idea of how many pigs are needed, because each time a real farmer/butcher comes in, someone is asking around about the pig price. So he uses his own money to buy pigs from farmers and sells them to butchers, based on what he thinks the balance is. So now, farmer guy can offload his pigs, and butcher guy can buy them, without having to coordinate with each other. They just talk to the middle man.

Now, the middle man has to manage the pig inventory. What prices does he make? Well, again, he thinks about risk. If he makes a wide spread, he'll make more money on each turn. But that will discourage the farmers/butchers, because they lose more from when they do their business. But if he tightens, he'll make less. He'd have to have enough business to compensate.

Enter middle man 2. He spots the same opportunity. Interestingly, now the two middle men need to trade with each other. And also, their trading doesn't need to be governed by the external customers.

Re:Common View, Common Error

[LordNacho]

A wide bid-ask spread IS a form of rent. Just look at the FX shops in any airport.

Re:Common View, Common Error

[swb]

While what you say makes sense, I think the entire philosophy is wrong. I think it's fueled by short term profiteering vs. investing for a profit.

Wider spreads and a more limited market were a disincentive for small-value, short-hold stock trading; they really didn't have any impact on long-term investing in stocks, which was more about buying, holding and collecting dividend checks. Mutual funds had to be more straightforward "baskets of stocks" and not complex, opaque investment vehicles with more churn than a pound of butter.

Basically, the market was more like what it should be for -- a place to invest on longer time horizons and a place for business to raise capital necessary to do something, not a quantitative casino where the house takes bets, makes bets and picks the winners.

Maybe I'm just nostalgic, but I can't help couple American economic decline with all of the short-term thinking associated with HFT, derivatives and all the other smoke and mirrors investing Wall Street has to offer.

Re:Common View, Common Error

[smellotron]

I must agree with the GP that if you don't understand something as fundamental as the bid-ask spread, your personal opinion on HFTs (or any other "classes" of traders) just isn't very useful or valid. To put it as a car analogy, it's akin to arguing with your car mechanic, "I don't know what an interference engine is, but I just don't see the value in a timing belt."

You can read the book Trading and Exchanges if you really want to get into gritty details. Otherwise, if there's ever a term you don't understand I suggest searching for it on investopedia.com. Both of those are very good resources for learning more about the markets.

Re:Common View, Common Error

[istartedi]

America, particularly the western states, were much more inclined to gamble back in the 'ol days. Gold mining claims, striking out into the territories to reap a harvest or get reaped.

When guys weren't gambling their lives in mines or on horseback, they were gambling around a card table (OK, maybe not as much as the movies depicted, but the West was full of risk).

Shit. The whole country was a gamble. If anything, I'd say the introduction of high-stakes financial poker into our living rooms represents a return to Amercian values; but that's just one man's opinion.

Re:Common View, Common Error

[TheLink]

What do you mean by this? The market enforces rules as to which orders are first in the queue.

Unfair rules in this context. They get to be 30 milliseconds ahead of everyone:
http://www.nytimes.com/2009/07/24/business/24trading.html
http://www.nytimes.com/imagepages/2009/07/24/business/0724-webBIZ-trading.ready.html

They can also post orders AND cancel them before others can go through with the transaction. So if you have a simple automated system - they can figure out what your minimum/maximums/rules are.

Quote first link: "High-frequency traders often confound other investors by issuing and then canceling orders almost simultaneously. Loopholes in market rules give high-speed investors an early glance at how others are trading. And their computers can essentially bully slower investors into giving up profits -- and then disappear before anyone even knows they were there. "

Re:Whoop De Doo

[vlm]

There is just one difference, though. The trading machines, regardless of their location, have the same length cable to the switch. Even if it means coiling some of it up. The latency demands are so strict, the customers even care about the cable length - and it's just easier to give all the customers the same length than to maintain tiered pricing on the racks.

Its marketing. The propagation delay between different pairs can vary by up to 50 ns due to the different twists. That is why the fancier "VGA over CAT-5" converter box thingies have a skew compensator. If you use a layer 1 that uses all 4 pairs it doesnt matter, but if you use a layer 1 that uses only two pair, then theoretically some customers will have a ping time 50ns lower than the slowest customers. one foot roughly equaling one nanosecond means the electrical delay can't be specified more accurately than 50 feet. Noobs have all kinds of fun with TDRs because of this.

You'd be way the heck better off using fiber, as first of all, it will actually work, and secondly, its more expensive so it must be better (aka monster cable marketing)

Re:Whoop De Doo

[drsmithy]

It's absolutely real. Check out the Amazon page for some thoroughly entertaining reviews.

Re-couple Market Access With Market Making

[tyen]

The standard explanation proffered by the HFT owners and customers is they "add more liquidity". This is repeated so many times that laypeople buy it; see typical comments in this thread like "we have traded wider spreads for higher instability". This is not the entire story: the liquidity is for them, not for you . That there is sometimes a spillover liquidity and spread improvement for participants in the wider market is merely a convenient observation suitable for PR. The past and ongoing flash crashes demonstrate that when the liquidity trades against them, they pull this vaunted liquidity quicker than you can blink, literally. They're not going to leave money on the table supplying liquidity into the market if they don't have to.

Another oft-made claim is "anyone is welcome to do what we do, there are no barriers to entry". That is not quite the entire story as well. The defining feature of an HFT firm over the retail investor apart from scale (you need accredited investor-scale financial depth just to ante up the money to the exchange to cover their risk for you fracking up your code and making market on your fracked up orders they then have to make good upon) is access, as the articles this story links to amply documents. They are quite different from most market participants. While it is true that one doesn't have to have special institutional privileges and access to buy these newfangled digital-age "exchange seats", and "merely satisfying" some financial and technical criteria make these seats putatively easier to obtain than the old seats, make no mistake about it, they are more privileged than the old school NYSE exchange seat holders: they enjoy special access to the markets that "non-seat holders" do not, namely preferential positioning in the order flow inspection pipeline, or put another way, they enjoy market making access without market making responsibilities. Just because you no longer have to have a hallowed name descending from the Mayflower, a family history intertwined with the exchange, and an imposing granite edifice for offices to qualify for an exchange seat that buys access to the order flow doesn't mean that preferential access is open to everyone. The day the exchanges open up the HFT level and quality of tick access for the same price as 15-minute delayed ticker quotes, would be the day that I withdraw this observation.

If you chafe at these new special breed of privileged market participants, then an old school remedy is still available: with privileged market access, comes market making responsibilities and market making regulatory oversight. Perhaps not as much responsibility as the exchanges, but definitely more than those without the preferential access, commensurate with their impact upon the market as shown by the flash crashes. Let them have the special access, but make good on the liquidity and spread claims with regulatory enforcement; that is, they continue eating at the trough even when the liquidity and spread moves against them. It didn't stop the old school market makers from coming up with different licenses to print money, so they'll still make great bank (though they'll bitch like a platoon of coked-up noob IB's at Penthouse for having to run through regulatory hoops that didn't exist before, instead of spending that time cranking the next batch of algorithms onto FPGAs), but coupling privileged market access with market making responsibilities did truly impart long-term benefits to participants in the wider market. Arguable if the benefit was proportional, but as long as we will tolerate differential access, we might as well at least maintain the marginal benefits of status quo ante, eh?

Re:Re-couple Market Access With Market Making

[alexmin]

When retail investor enters orders into his Schwab/Ameritrade/Interactive Brokers web portal, guess where those orders go? Yep, his broker colo facilities in Mahwah (NYSE), Carteret (NASDAQ) or Weehawken (ARCA/BATS). Main difference is that those orders get exercised by broker-owned systems and not customer's. Want your's gear in place? Power, cooling are not free as you probably know so be ready to pay up beyond $10/month account maintenance fee.

Anyway, you are missing the point. Investment in stock market does NOT require frequent executions. It is about buying when the stuff is cheap and then holding long time (like many years long) and then selling when you need money (not when it's expensive, that's speculation.) Speed is not important, valueing correctly to know when stuff is cheap is paramount.

I am involved in trading for living but did not touch my personal account in many-many months.