Barbarians At the Gateways

CowboyRobot writes "Former high-frequency trader Jacob Loveless gives an in-depth description of the math and technology involved in HFT. From the article: 'The first step in HFT is to place the systems where the exchanges are. Light passing through fiber takes 49 microseconds to travel 10,000 meters, and that's all the time available in many cases. In New York, there are at least six data centers you need to collocate in to be competitive in equities. In other assets (foreign exchange, for example), you need only one or two in New York, but you also need one in London and probably one in Chicago. The problem of collocation seems straightforward: 1. Contact data center. 2. Negotiate contract. 3. Profit. The details, however, are where the first systems problem arises. The real estate is extremely expensive, and the cost of power is an ever-crushing force on the bottom line. A 17.3-kilowatt cabinet will run $14,000 per month. Assuming a modest HFT draw of 750 watts per server, 17 kilowatts can be taken by 23 servers. It's also important to ensure you get the right collocation. In many markets, the length of the cable within the same building is a competitive advantage. Some facilities such as the Mahwah, New Jersey, NYSE (New York Stock Exchange) data center have rolls of fiber so that every cage has exactly the same length of fiber running to the exchange cages.'"

Comments

Liquidity

[Anonymous Coward]

Please, I just pray nobody justifies this obvious non-productive activity by explaining it lends necessary liquidity to the markets. The markets were liquid enough for me back when telegraphs were used to send messages to human traders.

Re:Liquidity

[kajsocc]

a HFT system will notice the spread, but from one at 11 and sell it to the other at 10 and capture the difference for themselves.

I would not recommend buying high and selling low as a long-term strategy.

Re:Liquidity

[Copid]

This is the point I always make. There have always been useless lumps who happen to be close to the action who make money off of the spreads. There are just more of them now, and they're fighting really fast over micropennies. If we're going to complain, I'd like to see evidence that the total profit these guys are making is going up relative to the size of the market. Sure, if they're giving the average trader a huge haircut, that's not a good thing, but market efficiencies being what they are, I suspect that the total amount of skim hasn't changed all that much since the early days.

The only real problem I can think of is that we've replaced that useless lump who has no real skills with mathetmaticians and engineers who could be doing something more useful elsewhere. It's probably not a great use of those resources, but it's pretty small scale.

Re:Liquidity

[DCFusor]

Trader myself. Mod parents up - they are correct. Check the Knight trading debacle: http://www.coultersmithing.com/forums/viewtopic.php?f=51&t=328&p=3924&hilit=knight#p3924
The deployed their test harness instead of their HFT bots for 44 min and lost half a billion in that time - now out of business. I made good money during that time using human judgement. You can often catch an accidental high bid or low ask from an HFT, when they screw up, which is fairly often, as well.

What purpose does HFT serve?

[Opportunist]

Please enlighten me, dear wizards of the wall street. Please teach me what purpose HFT serves to our economy.

Somehow, to me this just looks like it is the most blatant proof that the whole stock trade has become a self serving gambling place without any connection to reality and economy anymore. It used to serve the purpose of accumulating money for projects larger than what any single person or even government could finance. Today, it is just a self serving leech on our economy.

Re:What purpose does HFT serve?

[Impy the Impiuos Imp]

This isn't even gambling. It's pseudo-precognition, taking advantage of price differentials between computers in different cities or buildings, before the other guy's system promulgates the updated price.

Re:What purpose does HFT serve?

[mythosaz]

I'm obviously a rube with regards to how the magic happens beyond "Strike first, strike fast, strike often!" but it's pretty fucking clear to everyone that Average Joe doesn't benefit one bit from this unless he's bought stock in SuperHFT TradeCo.

Nobody benefits from this except 1/100th of 1%'ers trying to move into the 1/1000th of 1%'ers at the sake of making sure that you or I can't possibly play, because the playing field is so un-level it's a miracle we don't slide right off it... ...after leaving our wallets.

Re:What purpose does HFT serve?

[mcrbids]

We slid off the playing field years ago. This video takes just six minutes. It's a factual demonstration of just how skewed the system really is.

Re:What purpose does HFT serve?

[Ubi_NL]

The Zeconomist has a debate about it

http://www.economist.com/debate/days/view/816

Re:What purpose does HFT serve?

[ShanghaiBill]

Please teach me what purpose HFT serves to our economy.

This question has been beaten to death every time a HFT related article is posted. But people still ask, so I will try to answer. High Frequency Traders (HFTs) are not investors, they are market makers. They find a willing buyer and a willing seller, arrange the transaction, and execute the trade. They make a profit on the spread between the buy price and the sell price. The problem is that once they locate the buyer and seller, they need to buy the stock from the seller first, then turn around and sell it to the buyer, but the buyer may have cancelled they transaction, or they may have already bought the stock from someone else, in which case the HFT is stuck with the stock and may have to sell it to someone else at a loss. If transactions are granulated to one second intervals, instead of say, millisecond intervals, then the risk of this happening is a thousand times higher , and the HFTs will insist on higher spreads, resulting in lower liquidity and higher transaction costs for both buyer and seller.

Since the introduction of high frequency trading, transaction costs have fallen considerably, saving plenty of people a lot of money. The only losers are the old market makers that used to have lucrative sweetheart deals with the exchanges. Many of those old market makers are now bankrupt. Good riddance.

Re:What purpose does HFT serve?

[Anonymous Coward]

It's a technical form of arbitrage, which is not illegal and may improve market liquidity. I think the downside is that trades are made on the basis of inferred choices and this distorts the real market influence of "People who invest" versus "Machines that exploit market mechanics." The former requires contextual analysis and the ability to evaluate products, management teams, etc. The latter is a numbers game of pre-destined metric comparison, equivalent to banal tasks such as gold farming in an MMORPG.

Re:What purpose does HFT serve?

[kajsocc]

Please teach me what purpose HFT serves to our economy.

The best analogy I've heard is to transportation / shipping. Back when such transport was new, people scoffed at the idea of making money for moving things around. "You aren't producing anything, making anything, it's a complete waste." But today, we can see how moving goods around is actually of extreme importance.

Trading moves another kind of economic good--capital. That is, trading is to capital as transportation is to physical goods.

High-frequency trading is just trading... but faster. You'll notice how the summary mentioned New York and London. This is because the HFTs are arbitraging between those two major exchanges. If they were slower, you'd have more people getting "incorrect" prices, in the sense that there was a better price in NY but the information hadn't been priced into the London exchange yet. Hence, London traders would be getting screwed out of better deals that they technically could have known about.

However, HFT has also become associated with a bunch of "dirty tricks", like flash trading, etc. These kinds of things actually CAN hurt investors and other traders. This gives HFT as a whole a bad name, as it is viewed negatively by those who feel they are taken advantage of by these tricks.

In general, though, HFT has lowered market spreads, meaning it costs less to trade. Those lower costs show up in investors' bottom lines, which obviously include retirement accounts, so a lot of people are helped by HFT. However, I think a lot of people believe that without HFT, money would simply not be "leeched out", because they view traders as middlemen who are price gouging. The problem with this view is that all trading requires either paying middlemen, paying the spread, or taking on risk like traders do. So, take out the middlemen and you'll just pay higher spreads or incur larger risks, both of which are real costs, economically-speaking.

Another thing is that if you check the trading volumes, you'll see that HFT makes up a substantial (50+%) of trading volume. People I've talked to often think this equates to 50% of the "profit" leeched by HFT. This is not so at all... the reason they have such high volumes is they'll buy and sell multiple things simultaneously, then trade back to a fully-hedged position moments later or at least by the end of the trading day. As an HFTer you might buy 100,000 contracts and sell them a bit later and net just $5-10 for the whole thing. Of course, there might be thousands of such opportunities in a given trading day, if you're a large firm with a competitive HFT program. As such, this type of trading incurs a very high volume-to-profit ratio. On top of that, a substantial portion of their would-be profits are eaten up by trading fees. And then, as the summary mentions, you've got substantial electricity costs, top-end hardware costs, collocation costs (which can be obscenely expensive for the prime real estate locations), etc., so it's not at all like HFT is making money hand over fist.

HFT was a big thing a few years ago because it was a new thing, there wasn't much competition, and the profits were fierce. Now it's just the competition that is fierce.

Re:What purpose does HFT serve?

[Anonymous Coward]

Please teach me what purpose HFT serves to our economy.

... they are market makers. They find a willing buyer and a willing seller, arrange the transaction, and execute the trade.

Umm, bullshit. The exchange is supposed to match up buyers and sellers. That's what exchanges are FOR. If there is a buyer but no seller, then the market maker steps in and sells at a higher price. If there is no buyer, the market maker buys at a lower price. This is how price movements happen. HFT is a middleman. If there is no buyer or seller, then HFT wouldn't go in on the trade at all. If there is a buyer and a seller, HFT does not need to exist, since the exchange is supposed to match up the two parties already.

Easy solution for all their technical problems.

[Anonymous Coward]

Make all offers valid for at minimum one second and poof 99% of high frequency "trading" vanishes.

Gross receipts tax

[Overzeetop]

Forget "income" - change toa gross receipts tax. It only requires a couple percent (well, maybe up to 4) to have a sustainable tax base. You pay your real estate agent 6% to sell your house, you pay most brokers 2-4%, you should probably kick in a couple percent for the government defending that investment with nuclear weapons.

No deductions, no exclusions. Whatever you receive, you pay 3% to the feds. My town happens to have a GRT for business and it's quite difficult to dodge. It makes HFT and short term, high volume trades a losing proposition. It effectively punishes any entity - person or corporation - which does not add value to a transaction. And that, imho, would be a good thing.

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