HFT is not day trading. Day trading (by those I know who make/made a living at it) was based on movement trends. One person I know, buys on all bad news. The people who hear bad news usually over-react, and you get the immediate dip, and then a quick 5-10% bounce up, then a slow trend back to baseline. She made good money on the "bounce". Another would trend things, often tracking a few stocks (5-10 in a single industry) and when there looked to be news affecting one over the other, or there was an unexplained drop in one of spike in another, he'd buy/sell accordingly.
That's what HFT is doing as well, just on a faster & smaller scale. One of the results is that markets settle to the new clearing price much more quickly.
HFT is a pile of leaches looking for someone placing an order, then buying shares, waiting for the already placed order to catch up with them, and selling for a profit to someone who placed their order first. It's gaming the system to abuse the more casual traders. If HFT stopped tomorrow, there would be an improvement in the market. HFT is a bad thing for everyone who doesn't profit from it. The market should be adjusted to remove the arbitrage leaches.
No, that's not HFT, that's front running, which is illegal (at least if you're a broker). Front runners may _use_ HFT, but it's not HFT. Chances are when you buy/sell your 15.3 shares of IBM through Schwab, the broker is either handling the trade using its own internal pool of commonly held stocks, or it's bundling your trade together with a bunch of others and using the HFT network to execute.
HFT is, at bottom, merely a logical extension of the numerous methods of increasing the speed and accuracy of trades, starting before the invention of the ticker tape in the late 1800s. Various entities use it in different ways. Back in the day, traders who paid for a ticker machine in their office were able to trade on news perhaps an hour earlier than those who didn't. Nothing has changed, only the scale.
I'll just add that I know of people who started out with their own little neural network program on their home PC, watching 15 minute delayed quotes from Yahoo (or in some cases just watching daily closings), and let their little PC grind away and first, recommend, then later execute trades, and made money - in some cases lots of money.
The point is it's a scale free network. You don't need to know what the HFT traders need to know - you only need to know what's relevant at your time and volume scale. The HFTs are trading on ripples that, if it were an ocean, would be far beyond the visible, and in so doing are making the market an order of magnitude more liquid and more 'efficient' (in the economics sense, as well as the general sense). You can profitably trade on ripples that are (by way of analogy) the size of your fingernail up to the length of your arm (days to months); and other people/entities can make money trading on the huge macroeconomic trends over years, like Berkshire Hathaway. (When the dotcom bubble was building, BH stocks were down to about $14,000 per share but I was too broke to buy any. Now it's something like $175,000 per share.)
Sure it is. The HFT market is now essentially how the great majority of retail trades are also accomplished - your broker either sesttles your trade internally, or bundles it in with thousands of others to make a single large trade. And your broker does have access to that information, which optimizes his price to you. You are free to get that information as well, of course - but it will cost much more than any trading you're likely to do. It's pretty much wholesale vs. retail.
No single entity (with the possible future exception of NSA...) has access to _all_ information. But if the players at a given level of activity have equal opportunities to acquire that information, then that works fine. I don't want to make this statement mean too much, so let's use Warren Buffett and Charley Munger as an example. These two folks pay zero attention to the day-to-day flips and flops of the market, because that's not their game. They play a 10-15 year game. Day traders with any sense are these days not playing a 10-second game, because that's the game of the big players who are paying $1000s per day for market information that is relevant on a sub-second level. Day traders should really be thinking in terms of at least days, preferably weeks or months, because the HFT folks have almost zero interest in anything beyond tomorrow.
IOW it's a scale-free system. There are ripples of all sizes from 'quantum fluctuations' - random fluctuations around the minimum price difference - +/-1 cent or 0.1 cent are the most probable, trailing out in an inverse power law relationship to some large number, which amounts to an equivalent to a tidal wave - but in perhaps 10 to the 10th dimensions (every possible connection between every possible market input). And the key is equal access to the _relevant_ information for all players _at that level_. Given that, the market will always tend to settle to an equilibrium state (though it never will reach it).
Hmm. I'd argue that computers are inherently rational, _within the limits of their programming_. Adaptive systems like neural networks are arguably more so in one sense, and less in another - depends on whether one considers rationality == deterministic. But studies have shown that people, especially men, are very emotional in their market decision making - our egos get in the way, and we fall into various bias traps.
Heck, I'm looking at a startup now that may well be a loser, but I 'like' the idea behind it. Once I'm convinced it takes a lot of negative information to change my mind - just like everyone else.
From my somewhat closer perspective (I'm involved in some financial stuff, and one of my cohorts is a risk manager at a major investment bank), I'd say that by and large the people/entities very much DO pay the price when things go wrong, nearly all the time. This applies to individual traders and to the institutions where they work. Even the ones you hear about are more often about the price being paid by the error-maker than about getting off scot free.
I am not a fan of this 'too big to fail' B.S. and bailouts in general - that is an example of how the big institutions have managed to successfully manipulate the political system and built various 'rent-seeking' mechanisms into the rules. But (OTOH) I do see where bailouts to some extent could be used to help protect the minor players - individual investors and pension funds, for example - from the errors. That is an area of very strong debate in all arenas from academia to the companies, to the legislatures. (Chances are that any legislation will be worse than the disease, but that's another topic.) But it's well documented that bailouts and insurance have a perverse effect of encouraging investors (and whoever) to do less due diligence, and invest in things that are a bad idea. I'm trying to think of the term for this but drawing a blank.
this is no different than arbitrage has been for centuries, only faster. Baron von Rothschild used this to make money on the defeat of Napoleon at Waterloo, since his messengers were hours faster than the official royal messengers
Just because it has been done for centuries doesn't necessarily mean it is right, or just.
It's exactly the same thing as when one of my neighbors has a TV they want to sell for $10, and I buy it and sell it to a friend across the river for $11. In both cases everyone is satisfied with the value given for value received. Without my knowledge the neighbor might not have sold it at all. I may or may not know what my friend would actually pay, so I may be betting that he will pay $11 (if I do know for sure, it's more arbitrage, if not, it's more speculation). And I also paid for the phone call out of my $1 margin. There are complications we can discuss such as borrowing the money to buy the TV long enough to get paid by my friend, but that's what it is. Arbitrage is nothing more than balancing the difference between two markets.
It's also exactly the same thing as a river between two lakes - the river allows the two lakes to reach a common level, at a rate determined by the capacity of the river and various fluid dynamics considerations. Regulation has an important purpose here, such as setting the maximum flow rate to avoid erosion, flooding, 'tidal' waves splashing up on the opposite shore, etc.
There are ways within this system to cheat, but arbitrage per se is not cheating, it's implementing the system of equilibrating the markets.
Aha - this is the key insight!:) - at least as far as my intellectual model of markets (and economies) perceives. It is quite reasonable to use the physics of wave models on markets, increasingly so as computers take over the plumbing. For simple economic models, you can use the calculus of electronics and not go far wrong. A sudden event, like a sell of 100MM shares of X, looks to the market like a step function, and it will respond with a very rapid (near vertical) drop, which will 'ring' as it overshoots the new equilibrium, then reacts - a classic square wave without enough low pass filtering (if I get my low/high stuff right). HFT greatly improves that response with a much better & faster settling time to the new equilibrium.
IMHO, any market is an approximation of a 'complex adaptive system' (essentially any living system - ecosystems, brains, economies, political systems, and high school social hierarchies are some examples). These in turn are approximations that lie somewhere between 'billiard ball physics' and fluid dynamics. (For an illuminating experience, read "The Edge of Chaos" - a controversial but nevertheless very instructive book.) The finer the granulation of possible trades, the more closely the markets approximate a wave equation in a large number of dimensions, and the less the effect of 'quantization error' - fluctuations around the minimum price & trade execution time.
Ane can easily see the pool of common stocks that every broker maintains on their own books as analogous (or equivalent to) capacitors, or lakes, if one prefers to work with water. HFT has reduced the resistance (and impedance? I think so but IANA EE) in the wires, or increased the flow rate through the rivers and ocean currents if you prefer - it's reduced the viscosity of the fluid (money). The biggest difference to electronics and similar domains is the number of dimensions = it's like a circuit with 100,000,000,000 active elements and a similar number of interconnects - or more likely, another 5 orders of magnitude number of interconnects. That's why neural networks are very good at this stuff.
Sorry, I know I'm jumping around a lot - this was going to be my thesis topic in an economics PhD but I went another direction and never started the PhD program.
(The number of dimensions is an interesting area of exploration - it can be viewed in a variety of ways.)
WRT high school social hierarchies - research has shown that popularity and who-knows-who form an inverse power law distribution, which is indicative of a scale-free system or C.A.S. - a student's popularity is 1/N where N is the number of people who 'know' them.
There were citations to that earlier in the topic - I'm at work now so can't go back and look them up.
And agreed, the wave (it's still there) would be much slower and smaller. One of the relatively unknown bits about much legislation is what they call 'transition rules' that establish the rate at which changes are to take place. This often includes a gradual increase in a tax to the final amount. As a rather messy case in point, the Obamacare legislation takes a good part of a decade to go completely into effect.
As I noted, perhaps in another comment, I don't have a strong opinion on the actual tax proposed - I've been responding mainly to various commenters' lack of knowledge (excepting yourself, of course!:D ) Trading fees are so much smaller for everyone now that a small tax would not seem to make much of a difference - but it should be imposed gradually if large, and should not change back and forth, effectively 'whipping' the market response. I don't think that the government could successfully use the method of 'seeing how the market responds', unless the congress sets a maximum value and lets the SEC handle the implementation as a regulatory activity, and in fact I dislike it as a market control entirely (such a control can not respond quickly enough), though I'm perfectly OK with it as a money raising method to pay for regulation - as such they should just pick a rate and stick with it. Generally, when the government intervenes in a market - such as the Fed action, and the 'stimulus' - by the time the government's response goes into effect the market has already gone past the point where the effect would be as desired, and instead the government 'pumps the swing' up the other side, exacerbating the market swings.
HFT can not manipulate supply and demand, only respond to very small differences that a human can't respond to quickly enough.
How is that positive? These applications monitor (and take as gospel) Twitter: That's fucking stupid. They created a brief crash in the market when somebody got control of AP's Twitter account and sent out a fake "Bomb at White House, Obama injured" tweet.
Nothing to do with HFT, any more than bank robbing is a function of automobiles. Automobiles just made getting away faster. And, while it didn't get covered in the news, HFT also compensated for this glitch within minutes, rapidly moving markets back toward equilibrium.
Computers are wonderful, but they are aids to humans, not replacements for them.
Yep.:)
Another thing about HFT: It's existence dramatically limits the average investor (John Q. Public) from profiting on these differences between share price and perceived value: Even if he logs into E-trade the moment he has the idea, the HFTs have had the data for 10 minutes or more and have already profited 10,000 times and killed the average investor's profits.
If JQP is attempting to do HFT, he's a sucker. It's a scale-free system, there are opportunities to profit (or lose...) at all frequencies. JQP needs to work at the time/price range that he is competent. 10 minutes is not the proper time/price range.
And although HFT can't manipulate supply, it absolutely can manipulate demand: One of the "features" of HFT is millions of trades entered, some percentage of which are cancelled before being executed. But during that time frame between entry and execution other HFT's know about those orders and respond accordingly. A malicious person wanting to manipulate demand for a certain share to give himself a price-bump so he can unload his shares for a better price would merely need access to the person with the password to control "which trades to cancel" functions...
Manipulations such as trade cancellation are a separate problem. It's always been there, just faster now. (Heck, IIRC that's one of the ways Joseph Kennedy made his wad - and why Roosevelet made him head of the SEC, since he knew how to cheat he knew where to look for cheaters.) And regulators continue to work on those problems. The regulators themselves are now running HFT-like systems to monitor HFT-domain issues. Which is as it should be.
Your analogy neglects the difference between the roads used by a Model T and the modern roads. And blindfolded is inapplicable. A better analogy would be between a 747 and a Model T, but that has problems as well. The best analogy would be the most direct - between the Baron von Rothschild's messengers returning to London from Waterloo a few hours before the royal messengers, allowing him to arbitrage the stock market, and the ticker tape, allowing everyone to get the same information at the same time, much more quickly. The ticker tape revolutionized stock trading in the late 1800s, dramatically decreasing the gap between stock prices in different locales. HFT is just an extrapolation of that. Now the bubble is passing, it's just the way most trades are done, even when a retail trader sells 10 shares of IBM - that 10 shares is either handled internally by his broker, or bundled into a larger trade that goes through the HFT network.
(not to say I'm against the tax per se - I have no opinion on that.)
Having said that, I haven't said anything about whether the tax is a good idea or not. I really don't have much of an opinion, as long as it is small enough, and left in place unchanging for a long time. The price of trades is so much smaller for everyone than it used to be, so increasing that cost a small amount may not have much of an effect. It might be easier to just make the tax a percentage of the trading fee. Some form of tax may be a good way to raise revenue to pay for regulation and enforcement. But I'm not really up on what the taxes are now in different jurisdictions.
In my opinion HFT traders are filling a gap in the market that should not exist.
All of the research shows the opposite to be the case.
And there is nothing against introducing a tax if it is sufficiently low, and slowly increasing that tax while closely watching the effects.
This is another topic - the question of using taxation as an implement of social policy. Experts over 100 years, from SCOTUS (Chief Justice Robert Taft was the first) to academic research have shown this to be a very bad idea for a number of reasons, including inefficiency, unintended consequences and affecting all the wrong people/entities.
Using your method (slowly increasing,...) is making the government a participant in the market rather than a regulator, which is even worse. You're basically trying to establish the 'clearing price' of the tax, or if you prefer, trying to establish the most profitable supply/demand price - it's just like Levi's adjusting the price of their jeans to maximize profits. Proper regulation (even using a fixed tax, if it stays in place long enough) works by constructing the boundaries of the flows in the market(s) - think of them as the continents, islands, channels, jetties, etc. that establish the flows of the liquidity. But when governments participate in markets, they are no longer establishing boundaries, they are acting more like fish and boats, or whatever. Now every movement of the government, or even every signal that the government might do something, causes waves in the market - the opposite of what is desired. And the market response will now be casting that boat or fish about, affecting everything from the value of the dollar (or whatever currency) to unemployment in ways that are hard/impossible to predict.
If market equilibration is so essential, then why don't we let our government run this? (*)
Because that's the opposite of equilibration.
Without beating the horse more than I already have in a dozen other posts (I _really_ need to get to work!), HFT is basically implementing the interface between what one might call the 'quantum level' and the macro level. Now that the tech bubble aspect of HFT is popped and dissipating, and for every HFT algorithm there is another HFT algorithm second guessing that algorithm, HFT's primary effect is to damp out the small ripples in the global markets. Yes there will be random fluctuations on the order of T/N where T is the number of time quanta and N is the number of minimum price differences in a market (the probability of a price difference of N cents occuring increases over T microseconds). So the markets are now more purely scale-free and operate at a much finer level of granularity than used to be - it used to be minutes and eighths of a dollar, now it's microseconds and fractions of a cent. That's all. For everyone except HFT algorithms, the market is now just more efficient and the information more perfect.
Interestingly, the chaos is also self-damping as other HFT algorithms pick up on the distortion and work the other side of it. After a couple of 'rings' the signal is gone.
Key - the markets are now 'scale-free' to a pretty good approximation. Instead of competing with the robots, find the time and price scale that you can operate in - look at information and price drivers that are at a larger/slower time scale than the HFT algorithms are interested in. Also, humans, men especially, tend to use too much emotion in trading decisions.
HFT is a problem because it interferes with free markets: you can't have people make rational buying decisions within a few microseconds.
But computers can, in fact that's the whole point. In fact people aren't very good at purely rational buying/selling decisions (especially men according to the research). HFT implements the microscale component of the inherently scale-free nature of global markets - the interface between the 'quantum' level (fluctuations around the minimum price and time difference) and the macro level.
A useful lesson - HFT, together with better and faster global information, has made all markets essentially macroeconomic, and the system as a whole is becoming scale-free - there are transactions at all frequencies. So, by analogy look at the ocean. There are 'critters' of all sizes making a living, from viruses to whales. And there are ripples on the ocean of all sizes and frequencies from the quantum fluctuation to huge swells. (And there are storms, and earthquakes, etc.) So it is possible to earn a living at all frequencies and sizes - but you have to take advantage of your own 'information rate' and window your activities accordingly - don't try to compete with HFT, work at the daily or weekly or monthly information rate. HFT by its nature can not respond to slower movements - they live and die on the millisecond level, responding to overall macro events only as manifested in their short time window.
NOT DUE TO ANY ACTUAL CHANGE IN STOCK VALUE BUT DUE TO PING TIME.
Wrong. this is no different than arbitrage has been for centuries, only faster. Baron von Rothschild used this to make money on the defeat of Napoleon at Waterloo, since his messengers were hours faster than the official royal messengers.
The 'vicious cycles' were due to the early primitive nature of HFT algorithms, and the fact that there weren't enough of them (so often the HFT was on one side of a spread, and not on the other => big money transfer). TFA shows that the bubble has burst, and HFT is now going to evolve and perhaps already has evolved to a useful, stable part of the overall market. Now when one HFT senses an opportunity and makes a trade that influences the market, another HFT is likely to spot the ripple and make a countering trade. So HFT now just damps the ripples.
I could say that there is an effect analogous to the 'vacuum energy' of quantum mechanics. Let's define 1c in US trading as the 'quantum of money' - the minimum price difference. Then there is always going to be a random fluctuation of +/- 1c at very close to the maximum trading rate for HFT. and there will be random fluctuations at +/- 2c at some fraction of that maximum rate - probably 1/2 the rate. It will follow an inverse power law distribution, so there will always be a 1/N probability of a fluctuation of +/- N cents in the minimum trading period - call it 1 usec. So the distribution will be on the order of T/N for T= a given period of microseconds. This means that there is a tiny, but real, probability _from pure chance_ that a price difference will be large. But it will also be countered, and damped, within a small amount of time - you saw that several times, as sudden market errors were compensated for within a few minutes, and the market basically continued on as normal.
Your bit about buy cancellation has nothing really to do with HFT.
All that means is that HFT implements the 'efficient market with perfect information' more rapidly and correctly - which is a good thing. It means that prices for all goods in all markets are more likely to be close to their 'real' clearing price, regardless of vendor or currency.
Note that when you as a small retail investor buy or sell any reasonably well-traded stock through your broker, such as Schwab, you are no longer actually putting an order on the floor of the market - you are dealing with the broker itself. The broker keeps a small supply of that stock on its books (think of this as capacitance, if you are an EE), and resolves your trade within its books. If enough small trades add together to make it useful, necessary and/or algorithmically advantageous, Schwab will actually (instantly, automatically using its own HFT system) push a trade into the global system. (IANA broker, but this is certainly how I'd do it if I were Schwab, and I do know that small trades are handled internally by brokers.)
Front-running is a separate issue, which can happen and has happened at every trading rate. It's esentially analogous to insider information about trades, and it's illegal. It has nothing per se to do with HFT. HFT is only responding to apparent differences between value and price at a higher rate than regular trading, and using volumes to make up for the relatively small differences involved. The result of HFT (now that the bubble has burst) is just to smooth out the ripples - the 'quantum noise', if you will. I'm not sure we're down to that level of detail yet - but the minimum price difference in a given currency, e.g. 1 cent in US trading, amounts to the 'quantum of money', so there is likely to be a continuous random fluctuation of +/- 1 cent, and a bit less fluctuation of +/- 2 cents, and so on. 'Quantum of Money' would make a great book title.:)
You understand incorrectly. HFT is doing exactly the same thing as day trading (well, not exactly, but close enough for this purpose), only faster and without sentiment - day traders, being mostly men, are notoriously emotionally driven rather than methodical. HFT can not manipulate supply and demand, only respond to very small differences that a human can't respond to quickly enough. It's working on a higher frequency, i.e. a higher order harmonic, of the global market. HFT has gone a long way toward making the stock market fit much more closely to the ideal 'perfect information' model that economists talk about. One result is that almost any stock now follows the perceived macroeconomic status of the global markets very closely, in the absence of a particular event WRT that stock.
Wanna bet?:D Without speculative currency trading, the apparent value of a currency becomes disconnected from the actual value. Thus you see in countries with currency controls (e.g. Venezuela) the 'black market' value of a US dollar is several times that of the 'official' price. Speculative currency trading is what allows the liquids in different buckets to flow to their equilibrium levels. And HFT trading just makes that happen faster. I responded in more length about HFT to an earlier comment, which IMHO makes the case for HFT (now that the tech bubble aspect is over) as a useful, even essential part of everyday market equilibration.
IOW without speculative currency trading, when you go to the country next door you will have no idea what the price of goods is. (And as the Euro debacle demonstrates, sovereign countries need to have their own currency in order to have a way to balance their economies. Devaluing a currency is akin to a 'store-wide sale' for a country. To a good first approximation, a currency _is_ sovereignty.)
Wrong, absolutely wrong. The key fact of the story is that the 'tech bubble' component of HFT is over, many firms have left the business, and HFT can now evolve into a useful, stable part of the overall market. HFT is best seen as implementing the higher-order harmonics on the overall rhythm (for lack of a better word - it's early!) of the global market system, which is essentially a scale-free system. IOW, the markets ebb and flow - big waves, tides, little waves, and ripples. HFT smooths out the ripples as it reacts almost instantly to new information, and then reacts to its own influence, and then reacts to its own reaction until the differences are invisible even to HFT algorithms.
It's true, at first the algorithms were too primitive, the range of algorithms was too narrow so quite often there wasn't a compensating trade for each trade. HFT happened to catch some big waves, and reacted too dramatically in some cases, and lots of money was made by a few folks. And there was a tech bubble aspect to it. But now for every HFT trading algorithm catching some tiny fluctuation, there is more likely to be another trading algorithm trying to catch the fluctuation created by that algorithm, etc. And you now see the result. The entire global market system is now remarkably 'macro' - trading in almost any company's stock (or bonds, or whatever for that matter) follows very closely the macroeconomic status of the global economy. That is very much the beneficial result of improved market transparency and HFT. The only times when a company's stock varies from the macroeconomic base is when there is new information.
Yes, in the early days HFT undoubtedly exacerbated or in some cases created momentary (an interesting operative word in this context) glitches in the market - and also in all cases I can think of offhand, almost immediately corrected itself within a few _minutes_ - not days or weeks as in the bad old days. IOW HFT was self-correcting in those instances - a fact that was not noticed by the media, which knows nothing abaout anything AFAICT. And there was a tech bubble, as the earliest folks made a heap o' cash. (Just like Google, and many early dotcoms, only some of which survived.) But this article points out those days are gone, a lot of players have left the market either because they went bust or because it's no longer worth their effort. Note that 10 years after a tech bubble bursts, that market is essentially always four or more times as large as at the peak of the bubble. So keep an eye out - 10 years from now every major trading firm will have their little HFT system running, managing their extreme short term risk as a regular part of their business.
Slashdot Mirror
HFT is not day trading. Day trading (by those I know who make/made a living at it) was based on movement trends. One person I know, buys on all bad news. The people who hear bad news usually over-react, and you get the immediate dip, and then a quick 5-10% bounce up, then a slow trend back to baseline. She made good money on the "bounce". Another would trend things, often tracking a few stocks (5-10 in a single industry) and when there looked to be news affecting one over the other, or there was an unexplained drop in one of spike in another, he'd buy/sell accordingly.
That's what HFT is doing as well, just on a faster & smaller scale. One of the results is that markets settle to the new clearing price much more quickly.
HFT is a pile of leaches looking for someone placing an order, then buying shares, waiting for the already placed order to catch up with them, and selling for a profit to someone who placed their order first. It's gaming the system to abuse the more casual traders. If HFT stopped tomorrow, there would be an improvement in the market. HFT is a bad thing for everyone who doesn't profit from it. The market should be adjusted to remove the arbitrage leaches.
No, that's not HFT, that's front running, which is illegal (at least if you're a broker). Front runners may _use_ HFT, but it's not HFT. Chances are when you buy/sell your 15.3 shares of IBM through Schwab, the broker is either handling the trade using its own internal pool of commonly held stocks, or it's bundling your trade together with a bunch of others and using the HFT network to execute.
HFT is, at bottom, merely a logical extension of the numerous methods of increasing the speed and accuracy of trades, starting before the invention of the ticker tape in the late 1800s. Various entities use it in different ways. Back in the day, traders who paid for a ticker machine in their office were able to trade on news perhaps an hour earlier than those who didn't. Nothing has changed, only the scale.
I'll just add that I know of people who started out with their own little neural network program on their home PC, watching 15 minute delayed quotes from Yahoo (or in some cases just watching daily closings), and let their little PC grind away and first, recommend, then later execute trades, and made money - in some cases lots of money.
The point is it's a scale free network. You don't need to know what the HFT traders need to know - you only need to know what's relevant at your time and volume scale. The HFTs are trading on ripples that, if it were an ocean, would be far beyond the visible, and in so doing are making the market an order of magnitude more liquid and more 'efficient' (in the economics sense, as well as the general sense). You can profitably trade on ripples that are (by way of analogy) the size of your fingernail up to the length of your arm (days to months); and other people/entities can make money trading on the huge macroeconomic trends over years, like Berkshire Hathaway. (When the dotcom bubble was building, BH stocks were down to about $14,000 per share but I was too broke to buy any. Now it's something like $175,000 per share.)
Sure it is. The HFT market is now essentially how the great majority of retail trades are also accomplished - your broker either sesttles your trade internally, or bundles it in with thousands of others to make a single large trade. And your broker does have access to that information, which optimizes his price to you. You are free to get that information as well, of course - but it will cost much more than any trading you're likely to do. It's pretty much wholesale vs. retail.
No single entity (with the possible future exception of NSA...) has access to _all_ information. But if the players at a given level of activity have equal opportunities to acquire that information, then that works fine. I don't want to make this statement mean too much, so let's use Warren Buffett and Charley Munger as an example. These two folks pay zero attention to the day-to-day flips and flops of the market, because that's not their game. They play a 10-15 year game. Day traders with any sense are these days not playing a 10-second game, because that's the game of the big players who are paying $1000s per day for market information that is relevant on a sub-second level. Day traders should really be thinking in terms of at least days, preferably weeks or months, because the HFT folks have almost zero interest in anything beyond tomorrow.
IOW it's a scale-free system. There are ripples of all sizes from 'quantum fluctuations' - random fluctuations around the minimum price difference - +/-1 cent or 0.1 cent are the most probable, trailing out in an inverse power law relationship to some large number, which amounts to an equivalent to a tidal wave - but in perhaps 10 to the 10th dimensions (every possible connection between every possible market input). And the key is equal access to the _relevant_ information for all players _at that level_. Given that, the market will always tend to settle to an equilibrium state (though it never will reach it).
Interesting idea.
Hmm. I'd argue that computers are inherently rational, _within the limits of their programming_. Adaptive systems like neural networks are arguably more so in one sense, and less in another - depends on whether one considers rationality == deterministic. But studies have shown that people, especially men, are very emotional in their market decision making - our egos get in the way, and we fall into various bias traps.
Heck, I'm looking at a startup now that may well be a loser, but I 'like' the idea behind it. Once I'm convinced it takes a lot of negative information to change my mind - just like everyone else.
From my somewhat closer perspective (I'm involved in some financial stuff, and one of my cohorts is a risk manager at a major investment bank), I'd say that by and large the people/entities very much DO pay the price when things go wrong, nearly all the time. This applies to individual traders and to the institutions where they work. Even the ones you hear about are more often about the price being paid by the error-maker than about getting off scot free.
I am not a fan of this 'too big to fail' B.S. and bailouts in general - that is an example of how the big institutions have managed to successfully manipulate the political system and built various 'rent-seeking' mechanisms into the rules. But (OTOH) I do see where bailouts to some extent could be used to help protect the minor players - individual investors and pension funds, for example - from the errors. That is an area of very strong debate in all arenas from academia to the companies, to the legislatures. (Chances are that any legislation will be worse than the disease, but that's another topic.) But it's well documented that bailouts and insurance have a perverse effect of encouraging investors (and whoever) to do less due diligence, and invest in things that are a bad idea. I'm trying to think of the term for this but drawing a blank.
this is no different than arbitrage has been for centuries, only faster. Baron von Rothschild used this to make money on the defeat of Napoleon at Waterloo, since his messengers were hours faster than the official royal messengers
Just because it has been done for centuries doesn't necessarily mean it is right, or just.
It's exactly the same thing as when one of my neighbors has a TV they want to sell for $10, and I buy it and sell it to a friend across the river for $11. In both cases everyone is satisfied with the value given for value received. Without my knowledge the neighbor might not have sold it at all. I may or may not know what my friend would actually pay, so I may be betting that he will pay $11 (if I do know for sure, it's more arbitrage, if not, it's more speculation). And I also paid for the phone call out of my $1 margin. There are complications we can discuss such as borrowing the money to buy the TV long enough to get paid by my friend, but that's what it is. Arbitrage is nothing more than balancing the difference between two markets.
It's also exactly the same thing as a river between two lakes - the river allows the two lakes to reach a common level, at a rate determined by the capacity of the river and various fluid dynamics considerations. Regulation has an important purpose here, such as setting the maximum flow rate to avoid erosion, flooding, 'tidal' waves splashing up on the opposite shore, etc.
There are ways within this system to cheat, but arbitrage per se is not cheating, it's implementing the system of equilibrating the markets.
(Like a low-pass filter)
Aha - this is the key insight! :) - at least as far as my intellectual model of markets (and economies) perceives. It is quite reasonable to use the physics of wave models on markets, increasingly so as computers take over the plumbing. For simple economic models, you can use the calculus of electronics and not go far wrong. A sudden event, like a sell of 100MM shares of X, looks to the market like a step function, and it will respond with a very rapid (near vertical) drop, which will 'ring' as it overshoots the new equilibrium, then reacts - a classic square wave without enough low pass filtering (if I get my low/high stuff right). HFT greatly improves that response with a much better & faster settling time to the new equilibrium.
IMHO, any market is an approximation of a 'complex adaptive system' (essentially any living system - ecosystems, brains, economies, political systems, and high school social hierarchies are some examples). These in turn are approximations that lie somewhere between 'billiard ball physics' and fluid dynamics. (For an illuminating experience, read "The Edge of Chaos" - a controversial but nevertheless very instructive book.) The finer the granulation of possible trades, the more closely the markets approximate a wave equation in a large number of dimensions, and the less the effect of 'quantization error' - fluctuations around the minimum price & trade execution time.
Ane can easily see the pool of common stocks that every broker maintains on their own books as analogous (or equivalent to) capacitors, or lakes, if one prefers to work with water. HFT has reduced the resistance (and impedance? I think so but IANA EE) in the wires, or increased the flow rate through the rivers and ocean currents if you prefer - it's reduced the viscosity of the fluid (money). The biggest difference to electronics and similar domains is the number of dimensions = it's like a circuit with 100,000,000,000 active elements and a similar number of interconnects - or more likely, another 5 orders of magnitude number of interconnects. That's why neural networks are very good at this stuff.
Sorry, I know I'm jumping around a lot - this was going to be my thesis topic in an economics PhD but I went another direction and never started the PhD program.
(The number of dimensions is an interesting area of exploration - it can be viewed in a variety of ways.)
WRT high school social hierarchies - research has shown that popularity and who-knows-who form an inverse power law distribution, which is indicative of a scale-free system or C.A.S. - a student's popularity is 1/N where N is the number of people who 'know' them.
There were citations to that earlier in the topic - I'm at work now so can't go back and look them up.
And agreed, the wave (it's still there) would be much slower and smaller. One of the relatively unknown bits about much legislation is what they call 'transition rules' that establish the rate at which changes are to take place. This often includes a gradual increase in a tax to the final amount. As a rather messy case in point, the Obamacare legislation takes a good part of a decade to go completely into effect.
As I noted, perhaps in another comment, I don't have a strong opinion on the actual tax proposed - I've been responding mainly to various commenters' lack of knowledge (excepting yourself, of course! :D ) Trading fees are so much smaller for everyone now that a small tax would not seem to make much of a difference - but it should be imposed gradually if large, and should not change back and forth, effectively 'whipping' the market response. I don't think that the government could successfully use the method of 'seeing how the market responds', unless the congress sets a maximum value and lets the SEC handle the implementation as a regulatory activity, and in fact I dislike it as a market control entirely (such a control can not respond quickly enough), though I'm perfectly OK with it as a money raising method to pay for regulation - as such they should just pick a rate and stick with it. Generally, when the government intervenes in a market - such as the Fed action, and the 'stimulus' - by the time the government's response goes into effect the market has already gone past the point where the effect would be as desired, and instead the government 'pumps the swing' up the other side, exacerbating the market swings.
HFT can not manipulate supply and demand, only respond to very small differences that a human can't respond to quickly enough.
How is that positive? These applications monitor (and take as gospel) Twitter: That's fucking stupid. They created a brief crash in the market when somebody got control of AP's Twitter account and sent out a fake "Bomb at White House, Obama injured" tweet.
Nothing to do with HFT, any more than bank robbing is a function of automobiles. Automobiles just made getting away faster. And, while it didn't get covered in the news, HFT also compensated for this glitch within minutes, rapidly moving markets back toward equilibrium.
Computers are wonderful, but they are aids to humans, not replacements for them.
Yep. :)
Another thing about HFT: It's existence dramatically limits the average investor (John Q. Public) from profiting on these differences between share price and perceived value: Even if he logs into E-trade the moment he has the idea, the HFTs have had the data for 10 minutes or more and have already profited 10,000 times and killed the average investor's profits.
If JQP is attempting to do HFT, he's a sucker. It's a scale-free system, there are opportunities to profit (or lose...) at all frequencies. JQP needs to work at the time/price range that he is competent. 10 minutes is not the proper time/price range.
And although HFT can't manipulate supply, it absolutely can manipulate demand: One of the "features" of HFT is millions of trades entered, some percentage of which are cancelled before being executed. But during that time frame between entry and execution other HFT's know about those orders and respond accordingly. A malicious person wanting to manipulate demand for a certain share to give himself a price-bump so he can unload his shares for a better price would merely need access to the person with the password to control "which trades to cancel" functions...
Manipulations such as trade cancellation are a separate problem. It's always been there, just faster now. (Heck, IIRC that's one of the ways Joseph Kennedy made his wad - and why Roosevelet made him head of the SEC, since he knew how to cheat he knew where to look for cheaters.) And regulators continue to work on those problems. The regulators themselves are now running HFT-like systems to monitor HFT-domain issues. Which is as it should be.
Your analogy neglects the difference between the roads used by a Model T and the modern roads. And blindfolded is inapplicable. A better analogy would be between a 747 and a Model T, but that has problems as well. The best analogy would be the most direct - between the Baron von Rothschild's messengers returning to London from Waterloo a few hours before the royal messengers, allowing him to arbitrage the stock market, and the ticker tape, allowing everyone to get the same information at the same time, much more quickly. The ticker tape revolutionized stock trading in the late 1800s, dramatically decreasing the gap between stock prices in different locales. HFT is just an extrapolation of that. Now the bubble is passing, it's just the way most trades are done, even when a retail trader sells 10 shares of IBM - that 10 shares is either handled internally by his broker, or bundled into a larger trade that goes through the HFT network.
(not to say I'm against the tax per se - I have no opinion on that.)
Having said that, I haven't said anything about whether the tax is a good idea or not. I really don't have much of an opinion, as long as it is small enough, and left in place unchanging for a long time. The price of trades is so much smaller for everyone than it used to be, so increasing that cost a small amount may not have much of an effect. It might be easier to just make the tax a percentage of the trading fee. Some form of tax may be a good way to raise revenue to pay for regulation and enforcement. But I'm not really up on what the taxes are now in different jurisdictions.
In my opinion HFT traders are filling a gap in the market that should not exist.
All of the research shows the opposite to be the case.
And there is nothing against introducing a tax if it is sufficiently low, and slowly increasing that tax while closely watching the effects.
This is another topic - the question of using taxation as an implement of social policy. Experts over 100 years, from SCOTUS (Chief Justice Robert Taft was the first) to academic research have shown this to be a very bad idea for a number of reasons, including inefficiency, unintended consequences and affecting all the wrong people/entities.
Using your method (slowly increasing, ...) is making the government a participant in the market rather than a regulator, which is even worse. You're basically trying to establish the 'clearing price' of the tax, or if you prefer, trying to establish the most profitable supply/demand price - it's just like Levi's adjusting the price of their jeans to maximize profits. Proper regulation (even using a fixed tax, if it stays in place long enough) works by constructing the boundaries of the flows in the market(s) - think of them as the continents, islands, channels, jetties, etc. that establish the flows of the liquidity. But when governments participate in markets, they are no longer establishing boundaries, they are acting more like fish and boats, or whatever. Now every movement of the government, or even every signal that the government might do something, causes waves in the market - the opposite of what is desired. And the market response will now be casting that boat or fish about, affecting everything from the value of the dollar (or whatever currency) to unemployment in ways that are hard/impossible to predict.
If market equilibration is so essential, then why don't we let our government run this? (*)
Because that's the opposite of equilibration.
Without beating the horse more than I already have in a dozen other posts (I _really_ need to get to work!), HFT is basically implementing the interface between what one might call the 'quantum level' and the macro level. Now that the tech bubble aspect of HFT is popped and dissipating, and for every HFT algorithm there is another HFT algorithm second guessing that algorithm, HFT's primary effect is to damp out the small ripples in the global markets. Yes there will be random fluctuations on the order of T/N where T is the number of time quanta and N is the number of minimum price differences in a market (the probability of a price difference of N cents occuring increases over T microseconds). So the markets are now more purely scale-free and operate at a much finer level of granularity than used to be - it used to be minutes and eighths of a dollar, now it's microseconds and fractions of a cent. That's all. For everyone except HFT algorithms, the market is now just more efficient and the information more perfect.
Interestingly, the chaos is also self-damping as other HFT algorithms pick up on the distortion and work the other side of it. After a couple of 'rings' the signal is gone.
Key - the markets are now 'scale-free' to a pretty good approximation. Instead of competing with the robots, find the time and price scale that you can operate in - look at information and price drivers that are at a larger/slower time scale than the HFT algorithms are interested in. Also, humans, men especially, tend to use too much emotion in trading decisions.
HFT is a problem because it interferes with free markets: you can't have people make rational buying decisions within a few microseconds.
But computers can, in fact that's the whole point. In fact people aren't very good at purely rational buying/selling decisions (especially men according to the research). HFT implements the microscale component of the inherently scale-free nature of global markets - the interface between the 'quantum' level (fluctuations around the minimum price and time difference) and the macro level.
In fact, from the way flash crashes happen you can see exactly how HFT does not add liquidity ...
Actually that's pretty good evidence that HFT is decreasing the viscosity of the liquid.
A useful lesson - HFT, together with better and faster global information, has made all markets essentially macroeconomic, and the system as a whole is becoming scale-free - there are transactions at all frequencies. So, by analogy look at the ocean. There are 'critters' of all sizes making a living, from viruses to whales. And there are ripples on the ocean of all sizes and frequencies from the quantum fluctuation to huge swells. (And there are storms, and earthquakes, etc.) So it is possible to earn a living at all frequencies and sizes - but you have to take advantage of your own 'information rate' and window your activities accordingly - don't try to compete with HFT, work at the daily or weekly or monthly information rate. HFT by its nature can not respond to slower movements - they live and die on the millisecond level, responding to overall macro events only as manifested in their short time window.
NOT DUE TO ANY ACTUAL CHANGE IN STOCK VALUE BUT DUE TO PING TIME.
Wrong. this is no different than arbitrage has been for centuries, only faster. Baron von Rothschild used this to make money on the defeat of Napoleon at Waterloo, since his messengers were hours faster than the official royal messengers.
The 'vicious cycles' were due to the early primitive nature of HFT algorithms, and the fact that there weren't enough of them (so often the HFT was on one side of a spread, and not on the other => big money transfer). TFA shows that the bubble has burst, and HFT is now going to evolve and perhaps already has evolved to a useful, stable part of the overall market. Now when one HFT senses an opportunity and makes a trade that influences the market, another HFT is likely to spot the ripple and make a countering trade. So HFT now just damps the ripples.
I could say that there is an effect analogous to the 'vacuum energy' of quantum mechanics. Let's define 1c in US trading as the 'quantum of money' - the minimum price difference. Then there is always going to be a random fluctuation of +/- 1c at very close to the maximum trading rate for HFT. and there will be random fluctuations at +/- 2c at some fraction of that maximum rate - probably 1/2 the rate. It will follow an inverse power law distribution, so there will always be a 1/N probability of a fluctuation of +/- N cents in the minimum trading period - call it 1 usec. So the distribution will be on the order of T/N for T= a given period of microseconds. This means that there is a tiny, but real, probability _from pure chance_ that a price difference will be large. But it will also be countered, and damped, within a small amount of time - you saw that several times, as sudden market errors were compensated for within a few minutes, and the market basically continued on as normal.
Your bit about buy cancellation has nothing really to do with HFT.
Yes. And not only retail & pension funds - the entire market is moved closer to the ideal efficient market with perfect information.
All that means is that HFT implements the 'efficient market with perfect information' more rapidly and correctly - which is a good thing. It means that prices for all goods in all markets are more likely to be close to their 'real' clearing price, regardless of vendor or currency.
Note that when you as a small retail investor buy or sell any reasonably well-traded stock through your broker, such as Schwab, you are no longer actually putting an order on the floor of the market - you are dealing with the broker itself. The broker keeps a small supply of that stock on its books (think of this as capacitance, if you are an EE), and resolves your trade within its books. If enough small trades add together to make it useful, necessary and/or algorithmically advantageous, Schwab will actually (instantly, automatically using its own HFT system) push a trade into the global system. (IANA broker, but this is certainly how I'd do it if I were Schwab, and I do know that small trades are handled internally by brokers.)
Front-running is a separate issue, which can happen and has happened at every trading rate. It's esentially analogous to insider information about trades, and it's illegal. It has nothing per se to do with HFT. HFT is only responding to apparent differences between value and price at a higher rate than regular trading, and using volumes to make up for the relatively small differences involved. The result of HFT (now that the bubble has burst) is just to smooth out the ripples - the 'quantum noise', if you will. I'm not sure we're down to that level of detail yet - but the minimum price difference in a given currency, e.g. 1 cent in US trading, amounts to the 'quantum of money', so there is likely to be a continuous random fluctuation of +/- 1 cent, and a bit less fluctuation of +/- 2 cents, and so on. 'Quantum of Money' would make a great book title. :)
You understand incorrectly. HFT is doing exactly the same thing as day trading (well, not exactly, but close enough for this purpose), only faster and without sentiment - day traders, being mostly men, are notoriously emotionally driven rather than methodical. HFT can not manipulate supply and demand, only respond to very small differences that a human can't respond to quickly enough. It's working on a higher frequency, i.e. a higher order harmonic, of the global market. HFT has gone a long way toward making the stock market fit much more closely to the ideal 'perfect information' model that economists talk about. One result is that almost any stock now follows the perceived macroeconomic status of the global markets very closely, in the absence of a particular event WRT that stock.
Wanna bet? :D Without speculative currency trading, the apparent value of a currency becomes disconnected from the actual value. Thus you see in countries with currency controls (e.g. Venezuela) the 'black market' value of a US dollar is several times that of the 'official' price. Speculative currency trading is what allows the liquids in different buckets to flow to their equilibrium levels. And HFT trading just makes that happen faster. I responded in more length about HFT to an earlier comment, which IMHO makes the case for HFT (now that the tech bubble aspect is over) as a useful, even essential part of everyday market equilibration.
IOW without speculative currency trading, when you go to the country next door you will have no idea what the price of goods is. (And as the Euro debacle demonstrates, sovereign countries need to have their own currency in order to have a way to balance their economies. Devaluing a currency is akin to a 'store-wide sale' for a country. To a good first approximation, a currency _is_ sovereignty.)
Wrong, absolutely wrong. The key fact of the story is that the 'tech bubble' component of HFT is over, many firms have left the business, and HFT can now evolve into a useful, stable part of the overall market. HFT is best seen as implementing the higher-order harmonics on the overall rhythm (for lack of a better word - it's early!) of the global market system, which is essentially a scale-free system. IOW, the markets ebb and flow - big waves, tides, little waves, and ripples. HFT smooths out the ripples as it reacts almost instantly to new information, and then reacts to its own influence, and then reacts to its own reaction until the differences are invisible even to HFT algorithms.
It's true, at first the algorithms were too primitive, the range of algorithms was too narrow so quite often there wasn't a compensating trade for each trade. HFT happened to catch some big waves, and reacted too dramatically in some cases, and lots of money was made by a few folks. And there was a tech bubble aspect to it. But now for every HFT trading algorithm catching some tiny fluctuation, there is more likely to be another trading algorithm trying to catch the fluctuation created by that algorithm, etc. And you now see the result. The entire global market system is now remarkably 'macro' - trading in almost any company's stock (or bonds, or whatever for that matter) follows very closely the macroeconomic status of the global economy. That is very much the beneficial result of improved market transparency and HFT. The only times when a company's stock varies from the macroeconomic base is when there is new information.
Yes, in the early days HFT undoubtedly exacerbated or in some cases created momentary (an interesting operative word in this context) glitches in the market - and also in all cases I can think of offhand, almost immediately corrected itself within a few _minutes_ - not days or weeks as in the bad old days. IOW HFT was self-correcting in those instances - a fact that was not noticed by the media, which knows nothing abaout anything AFAICT. And there was a tech bubble, as the earliest folks made a heap o' cash. (Just like Google, and many early dotcoms, only some of which survived.) But this article points out those days are gone, a lot of players have left the market either because they went bust or because it's no longer worth their effort. Note that 10 years after a tech bubble bursts, that market is essentially always four or more times as large as at the peak of the bubble. So keep an eye out - 10 years from now every major trading firm will have their little HFT system running, managing their extreme short term risk as a regular part of their business.