Is there any good reason for high-frequency trading to exist? People often complain about bitcoin wasting energy, but oddly this gets a free pass despite this being a definite net negative to society as far as I can tell.
Bid/ask spreads are far narrower than they were previously. If you look at the profits of the HFT industry as a whole they aren't that large (low billions) and their dollar volume is in the trillions. Hard to argue that the industry is wildly prosocial but making spreads narrower does mean less money goes to middlemen.
> but making spreads narrower does mean less money goes to middlemen.
On individual trades. I would think you'd have to also argue that their high overall trading volume is somehow also a benefit to the broader market or at the very least that it does not outcompete the benefits of narrowing.
Someone is taking the other side of the trade. Presumably they have a reason for making that trade, so I don't see how higher volume makes people worse off. Probably some of those trades are wealth destroying (due to transaction costs) but it is destroying traders' and speculators' wealth, not some random person who can't afford it, since if you trade rarely your transaction costs are lower than before HFT became prominent.
When you buy stock, you generally by it from a "market maker", which is a middleman. When you sell, you sell to a market maker. Their business is to let you buy and sell when you want instead of waiting for a buyer/seller to show up. The spread is their profit source.
This is not true and in fact when I hire quants or developers, I have to spend a surprising amount of time even teaching people with PhD's in statistics that the random nature of the stock market does not mean that it's a coin toss. It's surprising the number of people who should know better think trading is just about being right 51% of the time, or that typically stocks have a 50/50 chance of going up or down at any given moment...
What's closer to the truth is that stocks are actually quite predictable the overwhelming majority of the time, but a single mistake can end up costing you dearly. You can be right 95% of the time, and then lose everything you ever made in the remaining 5% of the time. A stock might go up 10 times in a row, and then on the 11th trial, it wipes out everything it made and then some.
Sorry about that, I didn't mean exactly half or anything like that.
Still, I don't feel that it's wrong: Even on rereading, my phrasing seems to address GP's misunderstanding in an immediately accessible way. Which is better, a complicated answer that leads to proper understanding (if you understand it) or a simple answer that solves the acute misunderstanding (and leads to a smaller misunderstanding)? Both kinds of answer have merit IMO.
I would argue that HFT is a rather small space, albeit pretty concentrated. It's several orders of magnitude smaller in terms of energy wasting than Bitcoin.
The only positive from HFT is liquidity and tighter spreads, but it also depends what people put into HFT definition. For example, Robinhood and free trading, probably wouldn't exist without it.
They are taking a part of the cake that previously went to brokers and banks. HFT is not in a business of screwing 'the little guy'.
From my perspective there is little to none negative to the society. If somebody is investing long term in the stock market, he couldn't care less about HFT.
Buying and quickly selling a stock requires a buyer and a seller, so it doesn't seem like an intrinsic property that real liquidity would be increased. Moreover, fast automated trading seems likely to increase volatility.
I tend to agree that for long term investment it probably doesn't make a huge difference except for possible cumulative effects of decreased liquidity, increased volatility, flash crashes, etc. Also possibly a loss of small investor confidence since the game seems even more rigged in a way that they cannot compete with.
Warren Buffett proposed that the stock market should be open less frequently, like once a quarter or similar. This would encourage long-term investing rather than reacting to speculation.
Regardless, there are no natural events that necessitate high-frequency trading. The underlying value of things rarely changes very quickly, and if it does it's not volatile, rather it's a firm transiton.
> Warren Buffett proposed that the stock market should be open less frequently
This will result in another market where deals will be made and then finalized on that 'official' when it opens. It's like with employee stock. You can sell it before you can...
> It's like with employee stock. You can sell it before you can...
I thought that this was explicitly forbidden in most SV employment contracts? "Thou shalt not offer your shares as collateral or (I forget the exact language) write or purchase any kind of derivative to hedge downside.' No buying PUTS! No selling CALLs! No stock-backed loans!
Or do people make secondary deals despite this, because, well, the company doesn't know, does it?
AIUI the point of HFT isn't to trade frequently, but rather to change offer/bid prices in the smallest possible steps (small along both axes) while waiting for someone to accept the offer/bid.
Why shouldn’t people be allowed to do both? I don’t see much of an advantage to making the markets less agile.
It would be nice to be able to buy and sell stocks more than once a quarter, especially given plenty of events that do affect the perceived value of a company happen more frequently than that
The value of a stock usually doesn't change every millisecond. There doesn't seem to be a huge public need to pick winners and losers based on ping time.
Seems like a testable hypothesis. Choose the four times a year that the stock is at a fair price, and buy when it goes below it and sell when it goes above it?
Non-bitcoin transactions are just a couple of entries in various databases. Mining bitcoin is intense number crunching.
HFT makes the financial markets a tiny bit more accurate by resolving inconsistencies (for example three pairs of currencies can get out of whack with one another) and obvious mispricings (for various definitions of "obvious")
That's a nice fairy tale that they probably tell their kids when asked, but what the profitable firms are doing at the cutting edge is inducing responses in the other guys' robots, in a phase that the antagonist controls, then trading against what they know is about to happen. It is literally market manipulation. A way to kill off this entire field of endeavor is to charge a tax on cancelled orders.
Exchanges put limits on cancellation rates as measured by a multiple of filled orders.
You have to allow strategies that can induce other strategies as by definition those also increase liquidity. It’s a difficult problem to explain to anyone except the very few people who can understand the extremely complicated feedback loops that result from bots fighting bots, however the regulators actually have access to counterparty tagged exchange event data and what is found when this is analyzed is that the net cost for liquidity that is extracted by market makers and short term traders from longer term participants is continuously decreasing not increasing. The system is becoming more and more efficient and not less. This is good for markets and the economy. There are also less people working in financial markets per capita than ever before, granted those who are might include a higher percentage of highly skilled and specialized and educated individuals than previously, which some might argue might be better used in some other industry, but that is rightfully not what the market wants.
There is absolutely no logical reason to “kill off this entire field” those sentiments are purely envy based reactions from those who don’t understand what is happening.
Adding liquidity means to place an order that sits on the book while removing liquidity means to execute against an order that's already resting on the book.
The order type is a red herring (you can take liquidity with a limit order).
The only difference between an order that removes liquidity and an order that adds liquidity is whether it executes upon arrival (removing liquidity) or rests on the order book on arrival (adding liquidity).
If one outlawed / disincentivized hostile the bot behavior you described, there would still be the opportunity to do the good and profitable things I described.
These commenters have no clue what they are talking about. You don’t need to worry about hostile behaviors in the way they claim. These HN individuals are not domain educated and are spouting highly uninformed nonsense. Silly ideas like market orders take liquidity and limit orders provide it show an extremely rudimentary familiarity with only basic terminology of the field and with no understanding of the extremely dynamic and complex nature of modern capital markets. For instance they don’t realize that most longer term managers execute as much as 80% of their orders as passive limit orders, yet they are the ones that are actually liquidity demanders not suppliers.
> These HN individuals are not domain educated and are spouting highly uninformed nonsense.
Yeah, this is highly frustrating particularly for people like me who don't know anything about the domain i.e. HFT/Trading and would like to know more.
Can you recommend some good introductory books/resources ?
I might be biased for some almost personal reasons, however I think there is one book that anyone serious about the field should just read, period.
“Trades, Quotes and Prices”
Authors:
Jean-Philippe Bouchaud, Capital Fund Management, Paris, Julius Bonart, University College London, Jonathan Donier, Capital Fund Management, Martin Gould, CFM - Imperial Institute of Quantitative Finance.
Just FYI for others; the full name of the book is "Trades, Quotes and Prices : Financial Markets Under the Microscope".
Looks like a very comprehensive book though somewhat advanced for me at my current level. Do you have a more beginner level book/resource recommendation to go with this where from i can get an overview and familiarize myself with the jargon?
How far have you tried to tell, and do you buy/sell stocks?
There's someone on the other side of your trade when you want to trade something. You're more likely than not choosing to interact with an HFT player at your price. If you're getting a better price, that's money that you get to keep.
*I'm going to disagree on "free pass" also. HFT is pretty often criticized here.
- Increased liquidity. Ensures there's actually something to be traded available globally, and swiftly moves it to places where it's lacking.
- Tighter spreads, the difference between you buying and then selling again is lower. Which often is good for the "actual users" of the market.
- Global prices / less geographical differences in prices. Generally you can trust you get the right price no matter what venue you trade at, as any arbitrage opportunity has likely already been executed on.
> Tighter spreads, the difference between you buying and then selling again is lower. Which often is good for the "actual users" of the market.
I just wanted to highlight this one in particular - the spread is tighter because HFTs eat the spread and reduce the error that market players can benefit from. The spread is disappearing because of rent-seeking from the HFTs.
What needs to be pointed out is that the rent and spread is the same thing in this equation. Before the rise of HFT actual people performed these functions, and then the spread/rent-seeking was a lot higher.
Yes: it put a much larger, more expensive, and less efficient part of wall street out of business. Before it was done with computers, it was done with lots of people doing the same job. What was that job? Well, if you want to go to a market and sell something, you generally would like for there to be someone there who's buying it. But it's not always the case that there's a buyer there right at the time who actually wants the item for their own use. The inverse is also true for a prospective buyer. Enter middle-men or market makers who just hang around the marketplace, learning roughly how much people will buy or sell a given good for, and buy it for slightly less than they can sell it later for. This is actually generally useful if you just want to buy or sell something.
Now, does this need to get towards milli-seconds or nano-seconds? No, this is just the equivalent of many of these middle-men racing to give you an offer. But it's (part of) how they compete with each other, and as they do so they squeeze the margins of the industry as a whole: In fact the profits of HFT firms have decreased as a percentage of the overall market and in absolute terms after the initial peak as they displaced the day traders doing the same thing.
> it's not always the case that there's a buyer there right at the time
This hits the nail on the head. For a trade to happen, counterparties need to meet in price and in time. A market place is useless if there is nobody around to buy or sell at the same time you do.
The core service market makers provide is not liquidity. It's immediacy: they offer (put up) liquidity in order to capture trades, but the value proposition for other traders - and the exchanges! - is that there is someone to take the other side of a trade when a non-MM entity wants to buy or sell instruments.
It took me a long time to understand what the difference is. And in order to make sure that there is sufficient liquidity in place, exchanges set up both contractual requirements and incentive structures for their market makers.
Central counterparty concept implemented by most exchanges is a valid service, as otherwise counterparty risk management would be a nightmare - an example of a useful “middleman”.
Yes, but you and I can't even talk to the exchange. We have to talk to one of many brokers that are allowed to talk to the exchange, and brokers do much more than just passing your orders to exchanges. For example, IIRC they can legally front-run your orders.
Brokers are required to give you NBBO or better. You could set up a direct connection to an exchange if you were willing to pay and were sufficiently motivated to deal with all of that
What I was actually thinking about was the infamous Payment for Order Flow, where your broker doesn't actually send your orders to an exchange, but gets paid to send them to a giant HFT firm which can do whatever it wants with no oversight, including using the information that you are about to place an order to inform their algorithms which may result in them putting out a similar order before yours.
FYI, this is false. These HFT firms are subject to the same regulation as other brokers, which is extensive. In particular, it's explicitly forbidden to front-run pending customer orders, or to share any information about them with the proprietary side of the firm. In my experience, these firms take these rules very seriously.
Under the carpet deals would make it less transparent. It would be hard to detect that top manager sold all his stock to competitors and now is making decisions in their favor.
You mean like settling trades every 0.25 seconds or something like that? Wouldn't there be a queue of trades piling up every 0.25 seconds, incentivizing maximum speed anyway?
Usually the proposal is to randomize the processing of the queue. So, as long as your trades get in during the window, there's no advantage to getting in any earlier. In theory the window is so small as to not have any impact on liquidity but wide enough to basically shut down all HFT.
How would that work? Would you randomly select a single order posted, go by market participant (like randomly select some entities that posted a trade in this window), and would you allow prices to move during this window?
If you don't like it, try to convince regulators that it shouldn't be legal and provide a framework for criminalizing/fining it without unintended consequences, and then find a way to pay regulators more in bribes than the HFT shops do, even though their pockets are deeper than yours, and then things may change.
If that sounds impossible, that's another answer to your question
> a definite net negative to society as far as I can tell.
What did you examine to reach that conclusion? If high-frequency trading were positive for society, what would you expect to be different?
The reason for high-frequency trading to exist is that the sub-penny rule makes it illegal to compete on price so you have to compete on speed instead. Abolishing the sub-penny rule would mean high-frequency trading profits got competed-away to nothing, although frankly they're already pretty close. The whole industry is basically an irrelevant piece of plumbing anyway.
> A net negative to society, but a positive for the wealthiest.
No.
When your passive index fund manager rebalances every month because “NVDA is now overweighted in VTI, QQQ” the manager does not care about the bid/ask spread.
When VTI is $1.6 trillion, even a $0.01 difference in price translates to a loss $60 million for the passive 401k, IRA, investors.
HFT reduces the bid/ask spread, and “gives this $60 million back” to the passive investors for every $0.01 price difference, every month. Note that VTI mid price at time of writing is $272.49.
