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More Warnings About High-Frequency Trading
bfwebster writes "From The Big Picture (a great finance/econ blog) comes a link to this New York Times article on some of the risks and problems of high-frequency trading on financial markets and a couple of 'gadflies' who are pushing hard to get some changes and reforms in how Wall Street handles HFT. Key question: when is fast trading too fast?"
Key question: when is fast trading too fast?
Trading is too fast when it ceases to mean anything. The rate at which these decisions are being made indicates that it is not going through a human mind. The stock market is about people being able to buy and sell securities that allows businesses to raise additional capital. It was originally a very social thing so much so that it could reflect the mood of the populace's strength and development.
Many ordinary Americans have grown wary of the stock market ...
Right you are! It's no longer about humans making decisions. It no longer reflects social aspects of a sector or country or world market. It's more and more about what algorithms your "opponents" are using and what your algorithms are set at. And that's where it ceases to make sense. I'm okay with some guy waking up at 3am and reading every newspaper in the world and beating me at stock trading. I'm not okay when the name of the game today is who can pay tons of money to have their own servers set up across the street from a major exchange with a special dedicated fiber going straight to them as they pay off said exchange. That's starting to become so abstracted from the initial concept of a stock exchange that these big firms have walled everyone else out.
... which they see as the playground of Google-esque algorithms, powerful banks and secretive, fast-money trading firms.
If only they were Google-esque algorithms, they'd at least be innovative. SNAFUs have shown they're far from complex and often so stupid they loose hundreds of millions. But, yeah, who in their right mind would play a game like that?
What the algorithms are buying and selling no longer make any sense, the turn around is so insanely quick on these trades that there is no point at which a normal human can say "Oh, that algorithm thinks that Microsoft stock is going up and will hold it for some amount of time." No, instead what's going on is someone put out a big pre-order for Microsoft stock and so the HFT guys are buying stocks at a lower price than that only to turn over and dump them almost instantly as the order actually comes through netting fractions of a penny.
My work here is dung.
when your average investor is having an unseen tax applied to his transactions
which is what HFT is: an unfair tax by those who can afford the screamiest servers, the closest fibre optic connection, and the scariest code. it renders the idea of a fair marketplace a lie
the solution is easy: queue all trades on a heart beat
once every second, once ever three seconds, once a millisecond... whatever is agreed upon, all trades are queued up and then released on this schedule, and no one or nothing can surpass it
there are many complex unfair problems in life. but this is one with an easy solution. the problem is no finding the willpower to enact the change. as with many problems in american civil and political life, the will to do the right thing is polluted by the plutocrat's money
intellectual property law is philosophically incoherent. it is your moral duty to ignore it or sabotage it
I would say whenever the system is operating faster than humans can understand or react. The way it is now, HFT is just a layer to siphon off money from people who do not have their own system.
A 5 minute hold on a purchased stock, either before delivery or before another transaction with it, would fix the HFT problem.
Though, if you listen to the people making money off HFT, there is no problem, and HFT benefits everyone through "increased liquidity". The problem is, the HFT system is flipping stocks on the ms scale, causing stocks to be less volatile (stagnant), and not really filling large time gaps of supply or demand that would cause liquidity issues.
while(1) attack(People.Sandy);
The speed of trading is irrelevant to the serious investor. Speculators will always make trades as quickly as possible to make a quick buck regardless of the fundamentals; investors will buy and hold based on the fundamentals, buying and selling after months, not fractions of a second. Prices will always revert to a more "intrinsic" value, regardless of any skewing by speculators.
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Key question: when is fast trading too fast?
When it ceases to be trading and becomes gambling instead.
Basically, if you are looking at numbers and not meaning, you aren't trading anymore. Here's a suggestion for a totally impractical test: If you call up the trader in question and ask him what the company behind the shares does (i.e. which business it is in) and he has no clue, then he's not a trader, he's a gambler.
Assorted stuff I do sometimes: Lemuria.org
stock market should not be about what you said: speculation. it should be about long term investments, that way, speculators, adventurers and all sort of thieves will go way. once or twice per day is more than enough. the way stock markets are now, is simply a distortion of its purpose. p.s. shorting should be outright banned too.
The function of the stock market is not to make you able to buy and sell stocks based on what other people might pay for them. That is an unfortunate side effect.
Some people like you have long since abandoned stocks as a way to distribute risk and capital investment among more than one investor. Instead you view it as a game where its all about tricking some poor sod out of their money. Where the fuck do this contribute in any way to anything? Personally i would be all over a stock market that was regulated back to what it was first meant to be, somewhere i could invest in good ideas and ventures based on how much they would pay off in dividends, not inflated stock prices.
HTTP/1.1 400
Why should shorting be banned?
Why should I not be able to promise you a stock tomorrow at less than todays price?
Either I made the correct prediction or you get a great deal.
At such short timescales, trading is a provably zero-sum game. So where do all the fantastic profits that HFT operations claim come from? Everyone else. If you invest in a stock, during that process, an HFT algorithm (or ten) attempt to manipulate the market to cost you a fraction more, sweating the coins that you might receive. (The rest of the time, the HFT algorithms end up fighting each other, but apart from driving the market unstable, its only the HFT operators who win/lose amongst themselves, the HFT industry gains nothing).
Yet they don't actually provide the much vaunted "liquidity": if they did, they couldn't extract the revenue by making the liquidity dissipate when its actually needed: if the HFT bots added liquidity, Knight Capital wouldn't have taken a huge loss, as they could have sold the stock they bought back to the market rather than having to lose $400M! selling the shares to Goldman Sachs.
It really is time for a microscopic but non-zero Tobin tax on stock transactions: $.00001 per buy or sell request issued to the market. That should stop the bots from spamming the market with bogus requests, and level the playing field for everyone else.
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Here's what most magazines and newspapers discussing the topic are missing:
A definition of what we want the stock market to be like.
Everyone is focussing on what they don't want. But that's not how you build a resilient system. Basically, that's using default-allow for your firewall. You'll be spending the rest of your life adding rules of what you don't want.
Once you switch around your mind, the questions become a lot easier. Decide what you want the stock exchange to be, and you get your answers almost for free.
If you want the stock exchange to be a place where companies can meet investors and get capital raised, then everything that doesn't serve that purpose directly or indirectly is out. You define how the process should work and allow only that, done. Everyone who wants to play games will have to do it within the parameters you have defined.
The whole problem here is that too many people still believe the old nonsense about the invisible hand. Yes, to some extent you can build a sandbox and people will come and build their sand castles. You can provide a market place and have the participants sort out how everything works.
But you will get scammers, fraudsters, thieves, HFTs and all the other scum as well. If your sandbox is an MMO, you will get gold farmers and scammers and spammers. If your sandbox is a stock exchange, you will get HFTs and stock fraud and insider trading.
Letting chaotic self-organization create the rules of the game through emergence is an interesting experiment, one that I enjoy quite a bit when it comes to games or small settings (book a weekend with friends in a summer cottage and something will happen, no need to set up a schedule beforehand).
Allowing corrupt idiot politicians to base the world economy on chaos theory was one of the dumbest ideas we as a species ever had. Read some catastrophy theory first (at least check out the graphic if the article is tl;dr). There's a reason we call it chaotic systems, you know?
Assorted stuff I do sometimes: Lemuria.org
The NYT article sucked. Can't wait for print journalism to die.
1) Here's some authorities who are authorities because we say so, who are fighting like little middle school drama queens
2) Everyone loves a good "rich people suck and they're corrupt
3) Rabble rousing tired old cliche of "kids have no idea what they're doing vs old people are obsolete"
If you want the real story try Stucchio's blog series beginning at:
http://www.chrisstucchio.com/blog/2012/hft_apology.html
My pitiful TLDR summary of Stucchio's work combined with some other observations
1) Idiotic SEC rule 612 quantizes share price into small enough increments that you can raise the capital to HFT and increments that are large enough that you can make some serious dough doing HFT. HFT is not caused by Bolshevists in your bathroom or too many atheists or gobblin infestations, its caused by a stupid SEC rule that was created in a snap of the fingers and can go away just as quick.
2) Ask ANY EE or "real" telecom guy HFT is a real world application of dithering to improve resolution. Oh the "real" price of a share is 100.003 but we're only allowed to report price to a resolution such that its either of two quantum states 100.00 or 100.01. Simple system solution? Dump out 10 orders, 3 at 100.01 and 7 at 100.00 to meet some idiotic SEC rule. Now "everyone" knows the real free market price is signalled at 100.003 even if the unfree market is only allowed to trade at one cent increments.
3) Most of the whiners on both sides have a dog in the fight, if they are in the business and can't HFT for whatever reason they hate HFT and if they can they love it. Or they're just doing witchcraft style persecution where no logical mechanism is necessary... my sheep died therefore we should hang some old woman is no different than my dotcom bombed therefore we should punish a successful HFT trader "just because".
4) The ratio of HFT trading vs retail trading is absolutely exploding not entirely because HFT is growing (although it is...) but because retail trading is absolutely dying. Retail is dying for two reasons: Headed into next down leg of the second great depression (bubbles usually melt up in price and down in volume) and demographic stuff like looking at labor force participation graphs tens of millions of working age americans are no longer working, therefore there is no need to invest their 401K and IRA money from non-existent jobs. So yes HFT is growing but don't make the mistake of thinking the ratio of HFT to retail is in any way relevant, because retail is terminally ill and almost dead.
5) Some elderly/lazy people get all confused about frontrunning (which is illegal) because both frontrunners and HFTers are nuts crazy about low latency and fast execution. Therefore they obviously must be the same, at least to an idiot. This is about as intelligent as the anti-vaxers ... "Getting hit in the head by a 2x4 causes stupidity... high levels of lead in the blood cause stupidity... therefore getting hit in the head by a 2x4 results in high blood levels of lead". Morons.
6) Some lazy people enter market orders instead of limit orders. Probably not a wise idea any time in the last 150 or so years, although it is an even worse idea when retail volume is melting down and HFT volume is melting up. You could ban market orders for retail investors, but stupid people are always going to find a way to lose money, so I'm not sure there's any point to it. There's an infinite pool of ways for morons to lose money so removing one isn't going to really change the outcome. Its not the end of the world in that any average long term retail investor trade has just about zero odds of being stuck in a "flash-anything" related HFT event.
"Science flies us to the moon. Religion flies us into buildings." - Victor Stenger
Posting AC as I've been working in HFT for 5 years now. You have no idea what you're talking about, errything you just wrote is absolute rubbish. It seems as if you would have the markets swinging wildly based on people's moods. There have been many many fat finger mistakes that were nothing to do with HFT, but you rarely hear about those these days. And when trading systems do go awry most exchanges have built-in and often automated undo not to mention penalties. Some exchanges even changes modes to auction when shifts over a certain percentage occur. This stuff is almost always blown out of proportion and you'd never read about the actual workings of the regulation and clearing processes which protect all players - believe me it is pretty tough building in some of the mandatory short circuits and all the realtime accountability documentation. There hasn't been the likes of Citi's "Dr Evil" algorithm since regulation caught up. Obviously I can't really elaborate on algorithms, but suffice it to say your understanding is naive at best - you're talking 2004 type games.
Nothing so extreme is necessary. You can kill the HFT nonsense with a few straightforward tweaks:
1. Put a random delay on every order, up to 60 seconds. This makes millisecond-level speculation worthless.
2. Assign a small fee (0.1%, 0.5%, something on that level) to every transaction.
3. Require sellers to make good on their offered prices. Don't offer a price you aren't willing to actually take.
Some combination of those would eliminate HFT as a useful vector of profit-taking.
Check out my world simulator thingy.
This is why I favor a 0.1-0.5% fee. If we really want, we could also assess the fee as an inverse function of how long you've held it: the longer you've held the stock, the lower the fee, and it gets exponentially smaller with time until it is insignificant.
But if you want to trade something you bought 5 seconds ago? Enjoy your 90% fee.
Check out my world simulator thingy.
The root cause behind HFT is
SEC rule 612
My advice is if you don't know the rules don't pontificate on the philosophy of the game's rules. You accurately listed several things that suck. I agree with you on your list and your interpretation of your list. Unfortunately your list has very little to do with why HFT exists.
Of-course the actual solutions aren't even accepted on silly public forums, and they are definitely not going to be accepted by the politicians
The SEC is controlled by private firms that control politicians, not the other way around. If you really want to destroy HFT, for whatever reasons, the way to do it is to convince trading firms that if you want sub-penny price discovery, you could continue the buildout of your rather baroque and expensive HFT infrastructure, or you could just tell your elected pawns in the govt to tell the SEC to modify rule 612 to force rounding to the nearest dollar or the nearest millionth of a penny.
If you round to the nearest dollar no one will ever (famous last words) accumulate enough capital to HFT. If you round to the nearest millionth of a penny then millions of dollars of infrastructure will only bring in fractional millionths of a penny times perhaps millions of trades per day or about a thousand bucks a year. Which compared to buying federal bonds at roughly 0 percent or soon to be defaulting muni bonds at -100% is actually not that bad of a return on equity, but anyway...
Either way the only way for HFT to exist is to set the quantum interval for trading to be "about a penny" which ... tada happens to be right exactly what its set to. I think the way the game's rules are set up precisely perfectly to maximize HFT profits does kinda indicate the people in charge of the market at the big firms want it to be that way, this is not some kind of weird coincidental engineering accident.
The only real long term effect of destroying HFT would likely be to heavily reduce the transfer of wealth from the FIRE sector to the telecom and IT sector. I'm not sure anyone outside the FIRE sector would benefit by that... I like having the FIRE sector crooks, in a small way, subsidize my IT and telecom service.
"Science flies us to the moon. Religion flies us into buildings." - Victor Stenger
pause. think. then post
intellectual property law is philosophically incoherent. it is your moral duty to ignore it or sabotage it
Incorrect. Every short trade has a corresponding long trade. If the guy borrowing the stock loses money, the guy lending it makes money.
Nonsense. No one is against technology here. What is being decried is the unregulated use of technology to enable profit-taking by an elite class of investors who contribute nothing through their market manipulation, and instead have caused multiple "flash crashes" through their incompetence.
Just because we have the technology to do something, doesn't mean we should just do it, or allow it because it is possible. That our laws haven't caught up to this sort of thing doesn't mean it's perfectly fine.
Check out my world simulator thingy.
what's going on is someone put out a big pre-order for Microsoft stock and so the HFT guys are buying stocks at a lower price than that only to turn over and dump them almost instantly as the order actually comes through netting fractions of a penny.
That would be "insider trading" and it's illegal.
The solution to this is to put a fixed tax on all stock trades. Make it unprofitable to buy/sell in this way.
No sig today...
The rate at which these decisions are being made indicates that it is not going through a human mind.
Why's that a problem? Index trackers don't involve human minds either.
I'm fine with HFT. My only conditions are:
1) No rollbacks for HFT trades[1]. You screw up you eat the loss.
2) If bailouts are needed for whatever reason (your company loses billions of other people's money), the traders involved (if any) and the bosses go to jail for 20 years.
3) The exchange only allows you to see what everyone else sees. No "peeking at other people's cards".
If they still do HFT with these conditions we might eventually see an improvement in algorithms, software quality and testing.
[1] Rollbacks are only allowed if it's not your fault e.g. the casino aka exchange screws up big time (slow downs don't count, going down doesn't count, exchange treating 1=2 counts, exchange treating buy as sell counts.).
Obviously I can't really elaborate on algorithms, but suffice it to say your understanding is naive at best - you're talking 2004 type games.
Great so you can't tell me why my understanding of how HFT works is wrong and I'm talking about "2004 type games" which would explain why I read about automated trading algorithms losing Knight Trading $440 million two months ago? Tell me, all those protection measures and penalties, did they protect the company running the automated trading software or the parties who engaged with trading with the automated trading software?
This stuff is almost always blown out of proportion and you'd never read about the actual workings of the regulation and clearing processes which protect all players
"Protect all players" you say? So that would mean that everyone gets paid when someone screws up big time? Well, I bet they're learning their lessons. I think what you mean is that it "protects the big firms that are doing the HFT" while the market is just a big massive beast ripe for the skimming?
And when trading systems do go awry most exchanges have built-in and often automated undo not to mention penalties.
So, when I buy stock in Wal-Mart and my "algorithm" (my brain) was screwed up, where's my automated undo button?
This is a game where someone's loss is almost always another party's gain. There is no way to "protect all parties involved" with that sort of game. It's the nature of the goddamn game.
If you're just some guy taking the highest paying programming job, I'm not mad at you -- that's capitalism. But if you're actually running the show or defending your boss, you and I are basically at polar opposites. HFT doesn't provide anything and receives an insane amount of cash. Betting on arbitrages isn't betting, you're basically taxing everyone else little bits of money and just being a huge fucking leech.
My work here is dung.
I see it as more of a high-end gambling. You're trying to make money, with money, hoping to outguess someone else. It's really not all that different than going to vegas and playing the poker table. If you can find a few suckers, and avoid being one yourself, you can make money.
All these people are doing is trying to speed up the process and make it easier to do. Some opportunities may only exist for a few seconds. Someone decides to sell when they shouldn't and causes price to dip momentarily. If you have automated systems in place you can take advantage of it better.
The problem of course is the computers can get really twitchy and cause shockwaves of trading to occur. My favorite thing to watch is how people scream about how all this money "just disappeared". Idiots. The money was never there to begin with. There was just an opportunity for money and now there isn't. Big difference. Money doesn't disappear, liquidity disappears. But that can cause problems for companies that are running closer to the edge. When there's a "crash", the money is just taken back out of the system. 100% of it CAME from the investors (the public) and for awhile some of it was in the hands of companies, selling stock is like getting a loan from the public. A crash just means people try to take their money back. They won't get it all back, the company has some of it and the public has some of it. No money disappears, you just don't see as much anymore.
It's all an illusion created by liquidity. It's like a group of three friends passing a $1 bill around. All three of them see $1 and get the impression that it looks like $3 since all three of them see $1. Until someone pockets the bill and the other two don't see it anymore, and start freaking out wondering where the other $2 went. A loss in liquidity makes people think (their) money has vanished, and someone must be to blame, and tends to cause a panic.
Same effect with stock. If you buy a stock from a company for $1, where's the money? They have $1 cash and you have $1 in stock. Does that mean that $2 exists in this closed system? NO. There was $1 and there still is only $1. If you turn around and sell your stock back to the company, you have $1 cash and the company, well their own stock isn't worth anything to them unless they can sell it so they really have nothing. So now we went magically from $2 to $1 as a dollar disappeared? NO.
I work for the Department of Redundancy Department.
You are right about that, long term investments don't care about this stuff but the thing is HFTs still act like leeches, sucking energy (i.e. money) out of the system by producing nothing. I never understood why an investor needs a response time faster than 1 second.
ics
This is so wrong. The reason it is called an Initial Public Offering is that there may be other public offereings, later, when the company decides to sell more of its stock.
The real "Libtards" are the Libertarians!
I agree with most of your post except for this:
That was the original purpose of the stock market, but I'm not so sure that it actually plays out that way, at least for stocks. The primary reason for my skepticism is that once a company has sold its stock through an IPO, the company itself has little to gain through an increased share price. A higher share price means more money for the people who have stock options, but the company itself only benefits from the money originally raised through the IPO. After the IPO, most of the trading is done between investors and the company has little to no involvement. The stock basically becomes gambling chips with a corporate logo that you use to play a giant game of poker to attempt to win money from the other gamblers at the table.
This is spot on. The problem is that too many people in the media, politics and the general population still think that the stock price is a reliable indicator of the actual financial health of the company. These days it's more likely just the outcome of whatever algorithms the automated trading systems are using.
I've never understood why they needed a response time faster than a day. Seriously, set it up so you can only trade shares once a day. It wouldn't change a thing for normal investors but it would obliterate this algorithmic crap.
It's more and more about what algorithms your "opponents" are using and what your algorithms are set at.
Only if you are in it for day-trading profits. And if you are, well, you deserve to be beaten senseless by some HFT algorithm.
If you're a long term investor, with a time horizon of many decades, this doesn't matter. For example, I have a stock I bought 15 years ago. It has gone up by around 3X in that time. HFT makes no difference to me when I've held a stock over many years or decades. The exact microsecond it sells doesn't matter to me after a period of decades.
The fundamentals are driven by stock valuations, which are based in what people guess about the future of the company. You can be as informed about that as anybody. If you believe a company will do well over the long haul, buy some of their stock. Don't worry about HFT. You don't have to microsecond-time your sale and beat some other HFT algorithm when you've made a lot of money over years, rather than little bit over seconds.
It's more and more about what algorithms your "opponents" are using and what your algorithms are set at.
Only if you are in it for day-trading profits. And if you are, well, you deserve to be beaten senseless by some HFT algorithm.
If you're a long term investor, with a time horizon of many decades, this doesn't matter. For example, I have a stock I bought 15 years ago. It has gone up by around 3X in that time. HFT makes no difference to me when I've held a stock over many years or decades. The exact microsecond it sells doesn't matter to me after a period of decades.
This is a good point. But then the question becomes: what good does HFT provide? A lot of smart people are sucked into that sector because of the money, where they are arguably causing a net loss to society by participating in an arms race that does not produce any real goods or services. Those smart people could in principle be contributing to research and development in areas that actually improve everybody's standard of living, such as medical research and robotics - or perhaps even in economics when it comes to analyzing long-term successes (after all, genuinely improving the capital allocation in the long-term could be beneficially to society, unlike the short-term gambling that is happening these days).
With that in mind, there needs to be a discussion on how best to disincentivize this kind of extremely short-term behavior, where it is via transaction fees or via trading on heartbeats.
Goldman&Sachs would go belly up in a week. So yeah, no downsides.