Arbitrage trading has a long history has a long history of finding inefficiencies in the market and squeezing money out of them. It tends to be a dull, low risk business. The end result is profit to the broker and a more efficient market. I don't know of any of these firms have a 5 year track record like that but I would not be surprised.
HFT front running is different because they make a profit from the inefficiencies that they cause. They don't make the markets more efficient. They just game the system. I am not saying they don't bring talent and resources to the game but their game is to exploit a privilege position.
The point that Lewis makes is that HFT are not middle men. They "front run" (or step inbetween) the client and the middle men. They don't arrange trades and they don't provid liquidity.
Now, can I think of classes of high speed trading that does what you suggest - Yes. Just not this particular case.
Errr.. The whole point of market makers is to churn their account. Buy when the prices are low, sell when high, keep the inventory low to reduce risks. Market makes make their money from the spread in bid / ask prices. Today those spreads are less than a fraction of a penny. Even a small tax would force these spreads to widen.
As for being too small, I will point to France. When they introduced their "small" Tobin tax liquidity went down and volatility went up in a measurable amount.
If there is a problem fix the problem. The issue is that HFT are front running trades. Imposing a tax is not going to prevent front running.
I don't see what the problem is with the front running form of HFT.
Here is an example.
You say out loud that you want to buy an Apple but will pay no more than $1.05.
You see a vendor selling an apple for $1.00.
As you walk towards the vendor, I run ahead of you and buy that apple for $1.00.
I turn around and sell that apple to you for $1.01.
I do this 1.6 billion times a day.
What value do I add to society? Why is society paying me $160m a day to do this? I am not taking any risks, making markets, increasing the liquidity of the market, or any other value add service. All I am doing is stepping in-between you and the buyer and extracting a penny tax so it makes the trading system more inefficient.
My beef is not with high speed trading. I can think of dozen of legitimate strategies which improve the overall integrity and efficiency of the market. Front running doesn't.
Insider trading is acting on non-public material information. Seeing an order posted to a public exchange is neither. Front running your own client is illegal because there is a conflict of interest. Front running a competitor is not. The issue is that HFT trades are exploiting a flaw in the system that requires them use "best price" instead of "best execution" when placing order.
Don't throw the baby out with the bathwater. Legitimate high speed trades (i.e. traders that actually improve the performance, depth, and liquidity of the market) have cut trading costs by about 80% over the past 20 years. To use your example of "Trading on probabilities and trends" has wrung out huge inefficiencies in the market.
We don't have to agree to disagree because we agree. I too believe that high speed, algorithmic, and other computerized forms of trading has brought depth and liquidity to the market. This is all good.
Generally speaking – but here we have a particular case where this is not true. Under the current law, brokers must seek "best price", not "best execution". This flaw lets fleet footed trades to front run orders. They are gamming the system. For you, a small investor, these front running HFTs are skimming a few pennies for each trade. It is worse institutional players.
As you say the current system is more efficient than the old system. That misses the point. There is a flaw in the current system that should be fixed. Note that I think the answer is to eliminate the flaw, not eliminate high speed trading.
And hey, even if you don't pick up Flash Boys try picking up one of Lewis's other books. He has also written Liar's Poker (about his time as a trader), Blind Side, and Money Ball (one that I have not read yet.)
If the quote driven market with a blood sucking leach delivers better results than a book driven market (which has its own, but different, blood sucking leach) that tells you something. Like a physical system, you measure how inefficient it is. Look up "Implementation Shortfall" to see how it done.
Your not going to get that because the stock market is a murky place. You can see that a trade has happened but you can't tell who the buyer or sells is, but I will try to break it down the best I can.
25 years ago if you saw a $100 stock for sale and put in a large order you would buy it for $101. Today it would be closer to $100.15.
$.10 commission then, $.01 today. Here IT has it strongest impact reducing the back office costs.
, $15 in the bid / ask spread then, $.01 today. The market changed from quoting prices in 1/8s of dollars to pennies. and $.75 in that the market moved against you – today about $.12. Let's look at these 2 together. Here is the big gain.
What is happening is that we now have a more liquid and deeper market. Technology and market structure have broken up the old oligopoly and allowed new market makers in. Who are these market makers? Then range from investment banks, hedge funds, arbitrage traders, statistical arbitrage trades, HFT, etc.
“advances in IT” is not a magic wand. Take the arbitrage trader who is a high speed trader They ensure that the same stock on different exchanges trade at the same price. In the old days of telephones they needed a margin of error of 10s of pennies. Now a penny. They can track more and different prices. etc. All thanks to computers. How do you pull apart the effects of having more arbitrage players verse general technology advancement?
You need to read Lewis's book. I agree with you mostly but not in this particular case.
High speed trading is supposed to be about wringing out inefficiencies in the market. If you figure out how to squeeze an extra penny out of the bid/ask spread you make the system more efficient so society wins and you make a profit. Win-Win. Incentives are properly align.
In this particular case it is about introducing inefficiencies into the market and raking profit off of those increased inefficiencies. The trader makes a profit but everybody else is worse off – there should not be incentives to decreasing market integrity.
Most portfolio managers and not paid a bonus based on their returns but are paid on their returns (Alpha) relative to an index (Beta).
Most pension I know off have large slug of stocks that track the index and don't move – say 80%. Then there is a thinner slice (say 20%) which is actively traded to generate Alpha – sometimes turning over dozens of times a year.
Or they split the Alpha from the Beta.
But there is always a large slug of securities that match the index. Outperforming the market is good, underperforming the market is bad, but significantly underperforming the market gets one fired.
Financial transaction taxes are not better . They cut into the profits of legitimate market makers and dry up liquidity. Investors get a worse price and more volatility - leaving them worse off.
HFT are gaming the system because brokers are required to execute on "best price". Go back to "best execution" and you close the loophole that HFT use.
Investment theory has gotten a bit more sophisticated than from Gramm's day. Then factor is poor accounting and stock manipulation by management. Gramm was very conservative.
One is the recognition that it is not the dividend that is important it is the cash going to a shareholder. For example a stock buyback basically does the same thing as a dividend except that buybacks tend to trigger lower capital gains than dividend income.
Second one needs to balance the value of a payout (bird in hand) verse reinvestment in business (2 in the bush).
As for Apple – year – I can't defend their cash pile.
"Rent seeking" is a technical economic term about abusive behavior and not about renting land. The fact that it time skill and money does not matter. Lobbying congress for fat subsides takes "extraordinary amounts of capital and technology" but it is also considered rent seeking behavior.
On to your point. Are there classes of high speed trading that bring value? Yes. I have argued before in Slashdot that high speed trading has drastically cut the cost of trading.
However, the article reefer's to Lewis's book "Flash Boys". Lewis researches a class of traders that exploit a flaw in the trading system to "front run" trades and shave off a fraction of a penny per share. They do not bring money to the market or liquidity. They bring nothing – they are strictly a tax on the system. Lewis call these trades HFT.
Before I Lewis's book I held the same position as you. However, this HFT front running is strictly rent seeking, bring no value.
Personally, I need to figure out better names for the evil "front running" HFT and the good high speed traders.
Can you point out the link? I don't think it was directly reference in the underlying article.
And even if that was true I would be skeptical. Most private pension funds are well funded – public funds are another matter. If you want to crank up returns (which is not the correct choice – cranking up contributions is the correct choice) my experience is that portfolio managers move to higher risk stock – not by trying to generate trading profits with short term trades.
What you are suggesting is book market – expect for the random part. Book markets in recent years have fared worse than quote driven markets – much worse. 5 to 10 cents worse per share – much greater than the fraction of a penny that the HFT steal.
You might want to a look at IEX. They use a quote driven model with a 350m delay. Lewis have them high praise but even they have had criticisms that they can be exploited.
Funds are allowed to trade without paying taxes; taxes are assessed only when money comes out of the fund.
What funds are these? All of the funds that I can think of have to pay capital gains. A expectation might be pension funds but that is because they are tax deferred saving accounts, and retirement savings accounts are almost always tax deferred.
First, dividend payout has nothing directly to do with the return of a company. If a company makes a profit it can:
Reinvest the profit into new business
Company pays out a dividend and you reinvest that dividend back into the company.
Do a stock buyback / pay down debt While it is a bit counterintuitive, if you run though the numbers you will see that all 3 strategies return exactly the same return for the investor. I am making the assumption that the company has adequate projects to invest its profits and that leverage is not an issue.
Second, while you might not have direct control of the shareholder vote you do have indirect control. Control over the 401(k) (and its voting rights) should fall to some employee committee – which legally should be separate from the ownership of the company that you work for.
HFT is an example of rent seeking - where somebody is able to shave some of the economic profit from an activity without doing much of anything. In the HFT case, the US Congress put in a trading rule that caused a little bit of inefficacies in the market and HFT trading ruthless exploits that imposed inefficacies. Those inefficacies will never amount to a fraction a penny per share, but do it millions of times a day..
Think of it as a 160m dollar a day tax on investors. (the number comes from Lewis's book.)
Most stocks are held long term by long term investors. A example, as you suggest, are pension funds. Most trading is done by short term holders – like HFT.
This is why in a single year more stocks of a company can trade than have been issued (suggesting huge turnover) yet the majority long term holders barely budge.
Of course, the only reason why there is a primary stock exchange is that the initial investors expect there to be a secondary stock market. This is particularly true for equity, which has an unlimited lifespan. Most investor's lifespans are shorter than that.
More to the point, stock ownership (and thus the stock market) is about ownership of the company, not the funding of the company.
Is there any reason that reducing pointless barriers to trade has to occur in one giant all-or-nothing pact, instead of lots of little treaties over a period of years that don't depend on each other?
Because lots of small packs could actually make trading harder. The big issue is not tariff items (taxes charged on imports) but non-tariff items.
Consumer safety regulations are a big one. American and European auto safety regulations are about equivalent but have some minor variations. But there are enough minor differences that the car has to be redesigned and retested effectively blocking trade. Sometimes it is just bureaucracy but other times it is just a thin veil for protectionism. For example, the US barely exports any rice to Japan because it does not meet their quality standards – which are basically set up to excluded any rice not grown in Japan.
The idea is to reduce the number of differences between countries. Small treaties might lower the differences in regulations between countries but could increase the number of permutations and complexity of differences.
Well, I was referring to the Dragon Capsule, not the SS. But to your point.
Lines that hold pressure may be rated for weeks and thousands of temperature cycles may not be rated for months and 10's of thousands.
The Soyuz capsule is designed to be a life boat and for months at a time it is basically dead. so it has the ability to start from a cold start. The SS couldn't do that.
Not saying that it (either the SS or Dragon) couldn't be designed to those specifications but that were not. The things you point our were ratted for those missions.
Space is a harsh mistress (or was that the Moon?). You don't have to worry about corrosion but there are many other things one has to worry about - most which are exotic and that we have only have modest understanding of. (Unlike corrosion - a well know and understood monster)
When I read the comment my mind jumped to harsh conditions of space. Having all of the components work flawless for a few weeks is one thing, a few months is another thing.
The thing is that it is not snowing most of the time so you only need the heat for brief periods of time. The road can soak up the solar power over many days (where individually each day could not provided the power) and dump it's power over a short period of time to heat the road to melt the snow.
No, it is totally legitimate to say it is "private" even if the government is the only buyer (and their not –as others have pointed out.) – the profits flow to Musk & Company.
I think what you are trying to say is that it is not a free market – but that also is not true. For a free market to work all you need is multiple independent agents (publicly or privately owned) who can freely bid for the work. That is the bare minimum in order to have a free market is to have multiple producers or multiple consumers.
Of course the fewer agents involved the greater the chance of mischief will occur but that would be a different point – the efficiency of the market.
Slashdot Mirror
Arbitrage trading has a long history has a long history of finding inefficiencies in the market and squeezing money out of them. It tends to be a dull, low risk business. The end result is profit to the broker and a more efficient market. I don't know of any of these firms have a 5 year track record like that but I would not be surprised.
HFT front running is different because they make a profit from the inefficiencies that they cause. They don't make the markets more efficient. They just game the system. I am not saying they don't bring talent and resources to the game but their game is to exploit a privilege position.
The point that Lewis makes is that HFT are not middle men. They "front run" (or step inbetween) the client and the middle men. They don't arrange trades and they don't provid liquidity.
Now, can I think of classes of high speed trading that does what you suggest - Yes. Just not this particular case.
Errr.. The whole point of market makers is to churn their account. Buy when the prices are low, sell when high, keep the inventory low to reduce risks. Market makes make their money from the spread in bid / ask prices. Today those spreads are less than a fraction of a penny. Even a small tax would force these spreads to widen.
As for being too small, I will point to France. When they introduced their "small" Tobin tax liquidity went down and volatility went up in a measurable amount.
If there is a problem fix the problem. The issue is that HFT are front running trades. Imposing a tax is not going to prevent front running.
I don't see what the problem is with the front running form of HFT.
Here is an example.
You say out loud that you want to buy an Apple but will pay no more than $1.05.
You see a vendor selling an apple for $1.00.
As you walk towards the vendor, I run ahead of you and buy that apple for $1.00.
I turn around and sell that apple to you for $1.01.
I do this 1.6 billion times a day.
What value do I add to society? Why is society paying me $160m a day to do this? I am not taking any risks, making markets, increasing the liquidity of the market, or any other value add service. All I am doing is stepping in-between you and the buyer and extracting a penny tax so it makes the trading system more inefficient.
My beef is not with high speed trading. I can think of dozen of legitimate strategies which improve the overall integrity and efficiency of the market. Front running doesn't.
Insider trading is acting on non-public material information. Seeing an order posted to a public exchange is neither.
Front running your own client is illegal because there is a conflict of interest. Front running a competitor is not.
The issue is that HFT trades are exploiting a flaw in the system that requires them use "best price" instead of "best execution" when placing order.
Don't throw the baby out with the bathwater. Legitimate high speed trades (i.e. traders that actually improve the performance, depth, and liquidity of the market) have cut trading costs by about 80% over the past 20 years. To use your example of "Trading on probabilities and trends" has wrung out huge inefficiencies in the market.
We don't have to agree to disagree because we agree. I too believe that high speed, algorithmic, and other computerized forms of trading has brought depth and liquidity to the market. This is all good.
Generally speaking – but here we have a particular case where this is not true. Under the current law, brokers must seek "best price", not "best execution". This flaw lets fleet footed trades to front run orders. They are gamming the system. For you, a small investor, these front running HFTs are skimming a few pennies for each trade. It is worse institutional players.
As you say the current system is more efficient than the old system. That misses the point. There is a flaw in the current system that should be fixed. Note that I think the answer is to eliminate the flaw, not eliminate high speed trading.
And hey, even if you don't pick up Flash Boys try picking up one of Lewis's other books. He has also written Liar's Poker (about his time as a trader), Blind Side, and Money Ball (one that I have not read yet.)
If the quote driven market with a blood sucking leach delivers better results than a book driven market (which has its own, but different, blood sucking leach) that tells you something. Like a physical system, you measure how inefficient it is. Look up "Implementation Shortfall" to see how it done.
Your not going to get that because the stock market is a murky place. You can see that a trade has happened but you can't tell who the buyer or sells is, but I will try to break it down the best I can.
25 years ago if you saw a $100 stock for sale and put in a large order you would buy it for $101. Today it would be closer to $100.15.
$.10 commission then, $.01 today. Here IT has it strongest impact reducing the back office costs.
, $15 in the bid / ask spread then, $.01 today. The market changed from quoting prices in 1/8s of dollars to pennies. and $.75 in that the market moved against you – today about $.12. Let's look at these 2 together. Here is the big gain.
What is happening is that we now have a more liquid and deeper market. Technology and market structure have broken up the old oligopoly and allowed new market makers in. Who are these market makers? Then range from investment banks, hedge funds, arbitrage traders, statistical arbitrage trades, HFT, etc.
“advances in IT” is not a magic wand. Take the arbitrage trader who is a high speed trader They ensure that the same stock on different exchanges trade at the same price. In the old days of telephones they needed a margin of error of 10s of pennies. Now a penny. They can track more and different prices. etc. All thanks to computers. How do you pull apart the effects of having more arbitrage players verse general technology advancement?
You need to read Lewis's book. I agree with you mostly but not in this particular case.
High speed trading is supposed to be about wringing out inefficiencies in the market. If you figure out how to squeeze an extra penny out of the bid/ask spread you make the system more efficient so society wins and you make a profit. Win-Win. Incentives are properly align.
In this particular case it is about introducing inefficiencies into the market and raking profit off of those increased inefficiencies. The trader makes a profit but everybody else is worse off – there should not be incentives to decreasing market integrity.
Me too.
Most portfolio managers and not paid a bonus based on their returns but are paid on their returns (Alpha) relative to an index (Beta).
Most pension I know off have large slug of stocks that track the index and don't move – say 80%. Then there is a thinner slice (say 20%) which is actively traded to generate Alpha – sometimes turning over dozens of times a year.
Or they split the Alpha from the Beta.
But there is always a large slug of securities that match the index. Outperforming the market is good, underperforming the market is bad, but significantly underperforming the market gets one fired.
Financial transaction taxes are not better . They cut into the profits of legitimate market makers and dry up liquidity. Investors get a worse price and more volatility - leaving them worse off.
HFT are gaming the system because brokers are required to execute on "best price". Go back to "best execution" and you close the loophole that HFT use.
Investment theory has gotten a bit more sophisticated than from Gramm's day. Then factor is poor accounting and stock manipulation by management. Gramm was very conservative.
One is the recognition that it is not the dividend that is important it is the cash going to a shareholder. For example a stock buyback basically does the same thing as a dividend except that buybacks tend to trigger lower capital gains than dividend income.
Second one needs to balance the value of a payout (bird in hand) verse reinvestment in business (2 in the bush).
As for Apple – year – I can't defend their cash pile.
"Rent seeking" is a technical economic term about abusive behavior and not about renting land. The fact that it time skill and money does not matter. Lobbying congress for fat subsides takes "extraordinary amounts of capital and technology" but it is also considered rent seeking behavior.
http://en.wikipedia.org/wiki/R...
On to your point. Are there classes of high speed trading that bring value? Yes. I have argued before in Slashdot that high speed trading has drastically cut the cost of trading.
However, the article reefer's to Lewis's book "Flash Boys". Lewis researches a class of traders that exploit a flaw in the trading system to "front run" trades and shave off a fraction of a penny per share. They do not bring money to the market or liquidity. They bring nothing – they are strictly a tax on the system. Lewis call these trades HFT.
Before I Lewis's book I held the same position as you. However, this HFT front running is strictly rent seeking, bring no value.
Personally, I need to figure out better names for the evil "front running" HFT and the good high speed traders.
Can you point out the link? I don't think it was directly reference in the underlying article.
And even if that was true I would be skeptical. Most private pension funds are well funded – public funds are another matter. If you want to crank up returns (which is not the correct choice – cranking up contributions is the correct choice) my experience is that portfolio managers move to higher risk stock – not by trying to generate trading profits with short term trades.
What you are suggesting is book market – expect for the random part. Book markets in recent years have fared worse than quote driven markets – much worse. 5 to 10 cents worse per share – much greater than the fraction of a penny that the HFT steal.
You might want to a look at IEX. They use a quote driven model with a 350m delay. Lewis have them high praise but even they have had criticisms that they can be exploited.
Funds are allowed to trade without paying taxes; taxes are assessed only when money comes out of the fund.
What funds are these? All of the funds that I can think of have to pay capital gains. A expectation might be pension funds but that is because they are tax deferred saving accounts, and retirement savings accounts are almost always tax deferred.
First, dividend payout has nothing directly to do with the return of a company. If a company makes a profit it can:
Reinvest the profit into new business
Company pays out a dividend and you reinvest that dividend back into the company.
Do a stock buyback / pay down debt
While it is a bit counterintuitive, if you run though the numbers you will see that all 3 strategies return exactly the same return for the investor. I am making the assumption that the company has adequate projects to invest its profits and that leverage is not an issue.
Second, while you might not have direct control of the shareholder vote you do have indirect control. Control over the 401(k) (and its voting rights) should fall to some employee committee – which legally should be separate from the ownership of the company that you work for.
HFT is an example of rent seeking - where somebody is able to shave some of the economic profit from an activity without doing much of anything. In the HFT case, the US Congress put in a trading rule that caused a little bit of inefficacies in the market and HFT trading ruthless exploits that imposed inefficacies. Those inefficacies will never amount to a fraction a penny per share, but do it millions of times a day..
Think of it as a 160m dollar a day tax on investors. (the number comes from Lewis's book.)
See the historical Robber Barons as an example of rent seaking.
http://en.wikipedia.org/wiki/R...
Errr.
Most stocks are held long term by long term investors. A example, as you suggest, are pension funds.
Most trading is done by short term holders – like HFT.
This is why in a single year more stocks of a company can trade than have been issued (suggesting huge turnover) yet the majority long term holders barely budge.
Of course, the only reason why there is a primary stock exchange is that the initial investors expect there to be a secondary stock market. This is particularly true for equity, which has an unlimited lifespan. Most investor's lifespans are shorter than that.
More to the point, stock ownership (and thus the stock market) is about ownership of the company, not the funding of the company.
Is there any reason that reducing pointless barriers to trade has to occur in one giant all-or-nothing pact, instead of lots of little treaties over a period of years that don't depend on each other?
Because lots of small packs could actually make trading harder. The big issue is not tariff items (taxes charged on imports) but non-tariff items.
Consumer safety regulations are a big one. American and European auto safety regulations are about equivalent but have some minor variations. But there are enough minor differences that the car has to be redesigned and retested effectively blocking trade. Sometimes it is just bureaucracy but other times it is just a thin veil for protectionism. For example, the US barely exports any rice to Japan because it does not meet their quality standards – which are basically set up to excluded any rice not grown in Japan.
The idea is to reduce the number of differences between countries. Small treaties might lower the differences in regulations between countries but could increase the number of permutations and complexity of differences.
http://www.npr.org/2014/04/30/...
Well, I was referring to the Dragon Capsule, not the SS. But to your point.
Lines that hold pressure may be rated for weeks and thousands of temperature cycles may not be rated for months and 10's of thousands.
The Soyuz capsule is designed to be a life boat and for months at a time it is basically dead. so it has the ability to start from a cold start. The SS couldn't do that.
Not saying that it (either the SS or Dragon) couldn't be designed to those specifications but that were not. The things you point our were ratted for those missions.
Space is a harsh mistress (or was that the Moon?). You don't have to worry about corrosion but there are many other things one has to worry about - most which are exotic and that we have only have modest understanding of. (Unlike corrosion - a well know and understood monster)
Is it a human consumables issue?
When I read the comment my mind jumped to harsh conditions of space. Having all of the components work flawless for a few weeks is one thing, a few months is another thing.
The thing is that it is not snowing most of the time so you only need the heat for brief periods of time. The road can soak up the solar power over many days (where individually each day could not provided the power) and dump it's power over a short period of time to heat the road to melt the snow.
No, it is totally legitimate to say it is "private" even if the government is the only buyer (and their not –as others have pointed out.) – the profits flow to Musk & Company.
I think what you are trying to say is that it is not a free market – but that also is not true. For a free market to work all you need is multiple independent agents (publicly or privately owned) who can freely bid for the work. That is the bare minimum in order to have a free market is to have multiple producers or multiple consumers.
Of course the fewer agents involved the greater the chance of mischief will occur but that would be a different point – the efficiency of the market.