[Frondo]

It's an excellent example of the middleman that only extracts money from a system, that adds no value to the system.

They insert themselves into the transactions where they can siphon off very small amounts of money over a very large number of transactions. Nobody benefits but them from what they're doing, no one walks away with something in their hands or brains by their actions.

It's legal, but it isn't right or a good thing.

[__d]

The counter argument is that they do provide a benefit, by providing liquidity and/or making price discovery more efficient.

Whether it's "good" liquidity or not, and whether the discovered prices actually reflect true value or not, is a discussion that seems to fairly rapidly head down an acrimonious rathole.

[Frondo]

I don't think it's acrimonious to say that no, that liquidity is not beneficial to society as a whole.

I struggle to see how any sector other than the financial sector would suffer if all trades happened once a second, or even once a minute. No process in the human world is going to change the value of a company quicker than that.

[tptacek]

It's not "acrimonious", it's just wrong.

Liquidity keeps spreads narrow. Wide spreads are a tax paid by retail investors to a cabal of sell-side firms.

[Frondo]

We don't need the amount of liquidity the HFT people say they're providing. No one benefits but them. They're not adding value to society.

[tptacek]

So what's the RIGHT amount of tax we should be paying to commercial market-makers for the privilege of trading?

The residential real estate market is gigantic, a demonstrably functional piece of the US economy. Maybe the stock markets should work more like the real estate market. Forget about liquidity. Who needs it? Instead, we'll just pay seven percent of every transaction to an "agent".

[Frondo]

Good question! I don't have an answer to that. I do know that the markets survived just fine before the HFT companies came along, and now that they're here, I don't see society as a whole any better off for their presence.

Maybe, without just saying "they provide liquidity" and leaving it at that, you can explain how the post-HFT world is better for anyone but the HFT companies?

[usefulcat]

I tend to agree that the value of a company doesn't actually change substantially from one second to the next. But to focus on that is to ignore the value of having liquidity available. For an example of what can happen when there isn't enough liquidity, take a look at the graph of RSP on the morning of August 24th.

For a more detailed description of the mechanics and motivation behind market making, I recommend "A High Frequency Trader's Apology": https://www.chrisstucchio.com/blog/2012/hft_apology.html

If traders, be they high-frequency or otherwise, can't make money by making liquidity available, they won't do it. Less liquidity means wider spreads, which means higher costs especially for smaller transactions (i.e. individual investors).

You could reasonably argue that HFT has caused expenses to increase for large investors who need to buy or sell large volumes of shares. But to the extent that is true, it is like saying that large investors used to get on average an unreasonably good deal at the expense of their counter parties. As in any free market, an especially good price for one party is by definition an especially bad price for the other party.

[Marazan]

They cannot add liquidity. They HFT can only make money when there are slower traders willing to buy and sell.

Thus, by definition the liquidity already has to exist (market participants wanting to buy and sell) for HFT's to profit.

[tptacek]

Look at a market without market-makers. Housing is a good one. Houses sell only when there are "slow" traders willing to buy and sell. Have you ever bought or sold a house? Would you like the financial markets to be more like real estate?

[Frondo]

The alternative to HFT is not the real estate market.

The alternative to HFT is how the markets operated for decades prior to HFT companies vacuuming money out of the system--that is, quite well, and with adequate liquidity, and with lots of money still being made.

[tptacek]

The markets in the decades before HFT were crooked like a bucket of fish hooks! They were NOTORIOUSLY corrupt. Everyone was scamming everyone else. The entire market was a giant grift. Are you really sticking up for 1980s trading? Or have you just not done much research about how it worked?

[Frondo]

Really? And now, with HFT, they're no longer crooked? If I remember right, in the 2000s we've seen a ton of crooked market scandals (fraudulently rated securities, LIBOR, etc etc). I don't see this relationship you're positing between HFTs and a non-corrupt trading market at all.

[Marazan]

You seem to be accepting the premise that HFT algorithms a e acting as market makers.

I reject that premise. HFT algos are majoritarily run in markets with deep liquidity.

[auntienomen]

Markets with lots of market-makers have more liquidity! Film at 11!

[tptacek]

So do most market-making firms.

[toomuchtodo]

I believe the question is: could the same market-making/liquidity be provided without the amount of profit being taken by HFT firms?

[vasilipupkin]

this is incorrect. HFT can make money adding liquidity to a market that erroneously is lacking in liquidity ( mispricing )

[kasey_junk]

> They insert themselves into the transactions

Be very clear what you mean when you say this. Because the vast majority of the time when people talk about HFT, the only way the "insert themselves" into transactions is by acting as the counter party to one side of the transaction.

In this context they add a lot of value to the system, they smooth the demand curves in time and take on some of the risks of warehousing supply.

[ConfuciusSay]

The big claim with HFT is they "add liquidity", but there's evidence that shows the opposite. Indeed it seems like HFT's only add liquidity when it's already plentiful, but reduces liquidity when it's really needed.

The Fed has said as much recently.

[kasey_junk]

> The big claim with HFT is they "add liquidity"

I'm not sure who is making that claim, but I think what they are implying is that HFT "provides liquidity cheaper than the previous system of pit traders" or even "fragmentation of exchanges has dramatically brought down exchange fees at the cost of added complexity for liquidity providers (and possibly liquidity consumers). Only HFT systems could have cheaply dealt with this new complexity".

In any case, I'd sum it up as "it is cheaper to trade now after the rise of HFT than at any other time, at least some of that is because they can market make more efficiently than a dude in a vest". Vanguard for one agrees with me (http://www.cnbc.com/2014/04/25/vanguard-chief-defends-high-f...).

What many critics have claimed is that this has come at the cost of an increase in volatility, especially in the form of flash crashes and it is unclear as of yet if that is better/worse than the traditional liquidity crunches we saw under the previous regime and still see in markets not dominated by HFT.

The Fed was specifically talking about this in the context of treasury bond (and futures) volatility and a skeptic might wonder which is more likely to have caused volatility in the treasury markets, HFT or unprecedented fed monetary policy.

None of which is germane to the question of what the OP meant when he said that HFT insert themselves into transactions.

[ConfuciusSay]

When people point out that HFT's seem basically like a giant high speed frontrunning operation, as the OP did, the usual counter is that it's all fine and dandy, because they provide liquidity. Indeed right above your reply, is someone replying saying exactly that. Therefore the question of HFT's providing liquidity, or not, is very germane to the question, and if you're willing to be skeptical about what the Fed is saying regarding HFT's, then surely you would be similarly skeptical about what CNBC or Vanguard is saying, or would that go against your confirmation bias?

[kasey_junk]

Most critics of HFT rely on three major arguments:

1) It is a front running operation.

2) It has no "social benefit".

3) It increases volatility or structural instability.

Items 2 & 3 are not germane to the question of "it is a front running operation".

My response to item 1 is simply, no it's not. If you state it is, then either you have an unclear understanding of how market mechanics work, or a specific natural opposition to HFT systems. When the OP said that HFT "insert themselves into transactions", I really wanted him to clarify if he meant "insert" in the sense that he thinks they can change a standing order based on new orders before they execute, or the more general sense of "inserting themselves" that any middleman does in any commercial transaction. That is, as an expert in sourcing/warehousing/etc items that have varied demand curves.

Your response (and the fed's part in it) seemed to muddle the responses to items 2 and 3. My answer (and the common one) to item 2 is that it provides liquidity cheaper than the prior regime. That is largely not debated, though it is an open question of whether you could provide the same liquidity even cheaper within some other environment (batch auctions etc).

The question of whether HFT contributes to high volatility vs acts as a response to it is much more nuanced and I suspect unanswered/unanswerable, but the problem with the Fed specifically speaking to it, is that the Feds own actions are at the heart of the question as well. A given bank or investment fund service is unlikely to have the systematic impact of the Fed.

Finally, notice that the Fed did not speak to whether HFT lowers the cost of trading (ie item 2) they only spoke to the volatility question. So using the Feds statements as a counter to the argument that HFT lowers the cost of trading does not work.

[ConfuciusSay]

My interpretation of his "insert" comment, was that of 1). My response to that was to preempt the common refrain of HFT defenders who universally trot out the "liquidity" defense.

As for the criticisms focusing on volatility vs liquidity, to me they are linked, because in those instances of flash crashes that are the target of the recent criticisms, the issue has been that volatity increases due to HFT algorithms withdrawing from the market (i.e. reducing liquidity).

Also, there are other criticisms of HFT's beyond those three, including the "coincidence" that HFT firms seem to be responsible for most of the major order spoofing. Regulators have been VERY slow and uneven about enforcing HFT spoofing, but are finally catching on, albeit with slaps on the wrist (excluding Citadel being banned in China).