[patio11]

Millions of trades a day each contain teensy, tiny little updates about the state of the economy. Think of them like tweets, not like State of the Union addresses. This married couple wants to send their daughter to college more than they want Google. That hedge fund likes Coke more than Apple. This pension fund doing it's weekly buy of an index to prepare for 2075.

The market is these little packets bouncing off each other and summarized. High numbers of them are not unhealthy. On the contrary, it means more information is moving with less overhead loss to middlemen. (By analogy: What's more expensive, 100k tweets, 10 phone calls, or a FedEx envelope? If you say "clearly it's the tweets because there are so darn many" that would be a weird answer for an engineer to believe.)

If you believe the world economy is going to heck in a hand basket, there exist ways for you to be richly compensated for that expert opinion by sending your tweets into the machine. (Well, if you're proven right.) HFTs will happily minimize the transactional costs you incur while making that statement, as compared to the sweaty, yelling colluding-against-you jocks they have replaced.

[codeshaman]

All that you said is true.

But that which you control, controls you back with equal force.

While it is assumed that the state of the stock market reflects outside reality, it is in fact both ways - the state of the stock market affects and changes outside reality. And now it's a feedback loop, which involves software on one side and humans and "natural resources" on the other.

So now the married couple's daughter future is dependent on the outcome of this "game of trades" that HFT algorithms play day and night. And the people who write those algorithms do so to satisfy themselves, they don't know or care about the married couple.

Just like Google Maps - when there are few drivers using it, it's a handy little helper, if everyone uses Google Maps, it now defines the traffic pattern.

[RobertoG]

If markets are about information, they are, then, an information channel.

As Shannon told us, information is the resolution of uncertainty, and information channels can be more or less noisy.

It occurs to me that it's possible that adding more data to the channel is making the channel more noisy not more informative.

[thewarrior]

But what is the social benefit of the stock markets being synced to the state of the economy at the micro-second / nano-second time scale ?

That's surely taking things a little too far. Nothing in the real economy changes that fast.

[tptacek]

There's probably not much social benefit to getting pricing resolution down below 100ms.

However, there is an enormous benefit to getting pricing resolution down from the double-digit seconds level it was at when humans were able to keep up. The market driven by human intermediaries was crooked as a barrel of fishhooks. When these discussions come up, I always urge people to Google [odd eighths scandal] for an example of what things were like prior to electronic trading.

Once you have electronic trading, it makes sense that there either needs to be some "figure of merit" to allow different electronic traders to compete, or else some sort of permanent monopoly for the most successful initial electronic trading firm. Better, I think, that firms compete pointlessly to price instruments at subsecond granularity than that Goldman Sachs simply buys the (thankfully nonexistent) market maker version of Google.

[wcummings]

>But what is the social benefit of the stock markets being synced to the state of the economy at the micro-second / nano-second time scale ?

It's cheaper than people doing it, and the lower the latency, the faster a trader can move his position to match changes in the market.

What is the social benefit of Twitter loading in 100ms instead of 150ms? Why is latency important for peoples' stupid mobile apps, but not important for financial transactions?

>Nothing in the real economy changes that fast.

Sure, but you don't want to have to wait for an earnings report to sell your shares when you want to buy a house or something. You want people to always be trading your stock so it's easy to buy and sell. Similarly, when a big pension fund buys or sells a lot of your stock at once you want "people" trading to reduce volatility.

[thewarrior]

Dude its not 100 ms we're talking 100 microseconds.

[Zach_the_Lizard]

> But what is the social benefit of the stock markets being synced to the state of the economy at the micro-second / nano-second time scale ?

This sort of HFT smooths out prices over this time frame. The thing is, as it smooths out the peaks and valleys, the value in doing so decreases as those peaks and valleys are what made it profitable in the first place.

>That's surely taking things a little too far. Nothing in the real economy changes that fast.

Why? Computers have changed the game. We went from mailing our brokers or visiting them in person to calling them to conducting trades over the Internet. The 'real' economy changes quite quickly.

[Retric]

Market makers can have actual value by reducing bid/buy spread.

However, I don't think reality supports the idea that HFT are adding real signals to the market. HFT software has little understanding of the 'world' so they add noise which reduces signal. Taking the markets further from reality.

See: flash crashes. They don't actually have anything to do with the wider economy just feedback loops devoid from reality.

PS: Some software is designed to automatically read and interpreted news, but they often get it wrong moving the market in the wrong direction.

[yummyfajitas]

Flash Crashes also have no effect on the wider market. When you look at end of day prices for various stocks and indices, there is only a single symbol where you can actually see the effect of any flash crash:

https://www.chrisstucchio.com/blog/2012/flash_crash_flash_in...

Also, HFT lowers the price for people who do have information to trade with it. In this way, while HFT adds little information of it's own, it does enable better information transmission.

[Retric]

In other words in the short term can and will distort the market. So, the question becomes do they discover a economically meaningful price in the short term or is the processes essentially random.

As to lowering the price, arbitrarily increasing or decreasing the price is not an economically useful activity. The value of markets is price discovery, at best HFT reduce transaction costs though this is somewhat debatable as they are extracting money from somewhere.

[yummyfajitas]

You should read the article to see which symbol actually displays the effects of HFT shenanigans by end of day. (Hint: it starts with K, and it deserved everything it got.)

To see how cheaper liquidity directly enables speculators, read the section "Why Speculators Need Liquidity" in this post: https://www.chrisstucchio.com/blog/2012/hft_apology2.html An example is worked out in detail illustrating the point.

Also, HFTs are extracting far less money than the humans they replace. So if extracting money is what you want to prevent, congrats.

[mrchicity]

This paper studies the effect of a high-frequency market maker entering the Dutch stock market: http://www.amf-france.org/technique/multimedia?docId=workspa...

The trader they study reduced the bid/offer spread and trades 80% passively (he is primarily providing liquidity in the order book for others to trade with). His limit orders are more informative about "hard" news such as changes in the index future price than other traders, meaning he tries to buy stocks that are cheap and sell those that are expensive relative to the overall market, steering them toward their correct prices. This is just a simplistic HFT from almost a decade ago, modern prop traders have teams of researchers building prediction models with many more inputs.

And for all that, he earns a realized spread of 0.72 basis points, before paying for computers and employees. 1 basis point is 1/100 of 1%. That's in 2008, a time when HFT was relatively new and competition was less fierce, margins are considerably lower these days, not like making 0.72 basis points is exactly robbing widows and orphans to begin with. No human would make a market for such low margins, no human could react nearly instantaneously to changes in the index/stock prices to set his quotes, and no human could trade hundreds of stocks at once.

How do you think HFTs cause flash crashes? If you look at the middleman's net position on page 3, he never accumulates more than 10000 shares in one direction, and his position mean reverts every few minutes. How could a trader who primarily trades passively (others choose whether to elect his orders sitting on the book), never accumulates a significant directional position, quotes both buy and sell prices on the order book, and who aims to flatten his trades relatively quickly (whatever selling pressure he could create is quickly turned into buying pressure after he's given a short position) have such a large impact on prices?

I don't think trading off news feeds is a typical HFT trade. Some market makers may use these feeds to get out of the way during announcements. Maybe it's an automated trade for hedge fund types, but it's a high-risk, high-reward infrequent type thing. If a trader is incorrectly predicting prices long enough, they'll lose money and go out of business.

[chipsy]

The crucial aspect is the "crunch per bit" of HFT. We know that an electronic system is mostly an improvement over having pit traders yell at each other all day.

What we do not know and cannot prove without experimenting is whether our electronic markets benefit from following smarter, more complex rules of play instead of the same ones faster.

[gist]

> Millions of trades a day each contain teensy, tiny little updates about the state of the economy. Think of them like tweets, not like State of the Union addresses. This married couple wants to send their daughter to college more than they want Google. That hedge fund likes Coke more than Apple. This pension fund doing it's weekly buy of an index to prepare for 2075.

Can you explain this further in context to the parent comment? You lost me after "married couple wants to send their daughter to college more than they want google".

[sithadmin]

I think the gist of what's being argued here is that the increased volume of trades (facilitated by HFT's drive to minimize transaction time) allows more 'real time' information about the relative value of instruments to be communicated.

That said, the first example quoted don't really make a lot of sense, in my opinion. A couple selling off some stock to pay for their child's tuition probably won't ever have their transaction directly represented in the market (it will likely be lumped in with or divvied up from other orders handled by the same brokerage), so the information conveyed is ultimately somewhat diluted.

[crdoconnor]

It's no more an update on the state of the economy than a gambler making a bet on a betting exchange is an update on who is going to win a football match.

It's simply another mechanism for gambling.

HFT also rarely involves value investing (how much research can you do in a millisecond?). It usually uses low-to-zero-profit market-making strategies as cover for higher profit less than ethical trades.

[sjg007]

HFTs front run the trades.

[tptacek]

No, they don't.

[sjg007]

You and patio11 are smart enough to understand that all the HFT strategies are equivalent to front running. Each and every HFT strategy exploits some aspect of front running. In this world the market is by definition a misnomer because it does not exist on a single exchange and is fragmented.

Sure you cannot front run a single exchange when every buy and sell is on that single exchange but that's not how the actual market and front running works.

HFT requires that the market is distributed. You can say this is market maker arbitrage but it is actually equivalent to front running the market the same way a retail to broker initiated trade can be front run.