I feel sad that so much brain power goes into market arbitrage. They produce nothing usable by anyone else. Imagine if these people built companies that made new advances and new products.
I completely agree with you, but think your comment should be moderated down from 'They produce nothing usable', to 'They are paid exorbitant amounts compared to the value the produce for society as a whole'.
"but they manage your retirement fund", really? do they? last I checked there are algorithms running the entire show and making sure I and every other little investor get screwed for every 10th of a cent so that a few investors at the top who already have loads of money can have more. They've made a game out of moving money and skimming a bit off the top all the time. Let's not forget that they are actually taking money from your 401k every time they make these trades. Let's not pretend the financiers care about you, the little guy.
Another comment mentioned that YC is in finance, but let's be clear, YC is financing start-up businesses and helping them to grow. They're small finance. When I buy a share in Facebook, I'm not helping it grow, I'm betting on it's growth and the big finance industry is just the casino.
Spreads on liquid stocks are a penny now. Most limit orders are price improved by a few tenths of a cent -- a better price than you asked for. These are both courtesy of algorithmic trading. If a HFT trader does arb between two diff exchanges he's not hurting you. You're conflating it with front running your orders. That is not really a problem for a retail trader who isn't moving large block trades.
some market players are allowed to trade at sub-pennies, others are not. when one party can trade inside while leaning on the guy taking the risk to make the market, something is very very wrong with the "system". over time, the guys taking the risk are gone, and the whole market is weakened.
getting a price better than your limit isn't better than your asking price. you state i will accept nothing less, which is typically priced lower than or close to the market price. so your asking price is really the market price but with a safety net. it's not really a courtesy at all that limit sales go for higher than the limit.
and oh goodie, i made an extra $50 on my trade because of some algorithm. thank god for that.
Actually, the liquidity providers who are filling orders passed from your broker will give you a better price than the market NBBO (or your limit) by a couple tenths of a cent. You can google it to read more. It's generally called "price improvement". The main reason they do this is to capture order flow so they can use that knowledge in their own trading.
What would a FB IPO have looked like without the expectation of a deep and liquid secondary market for the lifetime of the company?
If the secondary market wasn't so big and efficient, it would be more expensive for everyone to raise capital, from large corporations to one man seed rounds.
I don't know about these guys, but according to Cathy O'Neil, D. E. Shaw profited by anticipating (c.f. index front-running) pension funds in a way that sickened her to the point of quitting.
Think about happens if indexes don't pre-announce their changes. Is their market impact larger or smaller than if people know about it and "front-run"?
Suddenly someone wants to trade 10x daily turnover in a small-cap stock right on the closing bell. It could be a dumb whale index fund, or it could be an insider trader who knows about a merger, or a sharp hedge fund who thinks the stock is undervalued.
If you're a liquidity provider or speculator, do you want to stand in front of this freight train at all? If you offset the huge liquidity imbalance, how much will you charge to cover your losses if it was an informed trader? Is it more or less than if you know it's an index fund?
Remember, even if there is some edge in this type of anticipatory trading, competition will reduce its margins significantly. Imagine I announce tomorrow in the Wall Street Journal that I'll buy 100000 off-lease Honda Accords next week from whomever will sell them to me cheapest. Everyone rushes out to buy them on Craigslist or eBay, but only those who make the least on the deal end up selling to me.
If you invest in ETFs, you are certainly being helped by automated arbitrage traders. These products rarely trade more than a cent from their true value because computers can calculate the hedging basket almost instantly. Yes, they have a profit motive, but competition keeps their profits small: https://meanderful.blogspot.com/2013/01/hfts-dirty-little-se...
It always costs money to transact. The alternative to trading against an ETF arbitrageur's quote isn't a costless transaction at the fair price, it's manually paying the spread and transaction costs on hundreds of stocks and risking slippage.
FWIW: YC probably earns more than even the biggest automated trading businesses.
> making sure I and every other little investor get screwed for every 10th of a cent so that a few investors at the top who already have loads of money can have more.
Do you have a reference for this? It runs counter to my intuition.
This is actually how algorithmic trading works. Computers are committing multiple trades in a fraction of a second in order to skim the tiniest of profits thousands of times.
The fact that computers are committing multiple trades in a fraction of second to make tiny profits does not mean that they are screwing you out of every 10th of a cent. In fact, my intuition is that you would be worse off without them because whoever you're trading with would be making big profits rather than tiny profits. It's the competition between computers that makes that profit so small.
> It is a statistical certainty that a percentage of trades will be losers. You are establishing a position with an unknown outcome. Sometimes they go your way, other times they go against you.
> How is it possible that one of the largest high-frequency trading firms executes millions and millions of orders for four years without ever having a down day? The short answer is what they do is not trading -- it is skimming. I call it legalized theft. High-frequency trading is a tax on investors, encouraged by the exchanges, allowed by the SEC. It is prima facie proof that something is amiss.
It seems to me that this author has difficulty with taking the limit of 1/sqrt(n) as n grows without bound.
I think we're discussing trading here. I'm not prepared to give anyone financial advice, but I'm probably not personally a huge fan of retail bankers, investment bankers, wealth management, expensive mutual funds, and so on.
"I feel sad that so much brain power goes into market arbitrage. They produce nothing usable by anyone else."
The simplest description of the financial sector is that they ensure that money is invested and reinvested. In general, this is good for the economy, and helps everyone. This pays for peoples wages etc.
Let's imagine a situation without financial services. All money just sits on a bank account. That's it. No return of investment. Zippo. Nada. Now, imagine that money is reinvested - now the money flows into a company, that can use the money to hire someone... etc.
The world with finance is a much more rich and varied world than a one without finance. The fact that it plays such an important role, and that it's not immune to human fallacy, leads to the pathologies we've sadly all become familiar with.
Basically, if we look this from a historical perspective, a world without finance is a world without industrialization. That's not to say finance (or industry for that matter) is always fair.
Money sitting in a bank account is invested via loans and gets returns via interest. If the bank is savvy and makes good investments they keep the spread between the interest paid and the interest earned.
From the perspective of the business owner it matters little of the cash comes from a bank or as an equity investment. The cash spends the same and they will prefer whichever they can get that is most favorable to them.
Even though public equities get all the news they are a relative latecomer to the party and are frankly a pimple when compared to the bond and cash market. Even if the entire public market disappeared tomorrow the vast majority of companies would have no issue raising cash either through private equity, bonds or bank loans.
Almost all (99.999999+%) trades on the public market have nothing to do with raising corporate equity (i.e. newly issued stock) and instead are transmitting price information about the markets current beliefs about potential future earnings. That is valuable in aggregate because it allows good companies with strong prospects to raise funds at a lower cost (if needed).
But is transmitting pricing information around the globe via dedicated links to shave off tenths of seconds really necessary? Does any company need to raise funds at a micro-seconds notice?
After all the markets close at the end of the day but somehow the world continues to function for the next 16 hours without sub-second pricing information at everyone's fingertips.
You don't. You use the profits from the transaction as capital that then eventually funds the operations of some third party, who then uses that capital to hire employees and to purchase services and materials.
Now, does it improve liquidity? Investopedia claims so, thus, making capital cheaper and making it (in theory) easier e.g. to hire new people.
In itself it's not evil and actually beneficial. Lower transaction costs and more liquidity means there are more resources to go around. What people actually choose to do with the amassed capital is another thing then entirely.
Does it cure cancer? No. But blaming smart people from not trying to be a superman is stupid. Very, very few alone are that smart that they alone would make a huge difference.
It's hard to see why a career in finance would be less ethical all around than a career in some company that just harvests clicks.
Science currently, as a career choice, needs burning enthusiasm or it will burn people out - I see no reason to chide people for not choosing it.
As a fairly low-income engineer I find it hard to see any other reason than jealousy to bash people in finance in the general context.
From your source:
"The opponents of high-frequency trading feel that whatever liquidity HFT creates is superficial because the securities are held for a very brief period (seconds or fractions of a second) before being sold back again into the market. Most of the time, securities are bought and sold very frequently between high-frequency traders until they are bought by an investor. Opponents say there is thus no ultimate creation of liquidity but a mere facilitation for order execution.
HFT results in what is called hot potato volume. Positions are being ping-ponged between high-frequency traders and the other marketmakers. Thus there is the creation of great volume and no concurrent depth. For orders to be absorbed, buyers must hold their positions for a longer time than just a few seconds.”
And then merely counters that with a argumentum ad populum:
"With more than a decade in existence, high-frequency trading is now more or less an accepted part of the stock markets. There is a consensus that, on average, HFT has added liquidity to the markets and reduced trading costs."
The evidence appears rather weak for that position.
That "mere facilitation" is extremely valuable. Do you think stock exchanges themselves are valuable and worth paying for? They bring buyers and sellers together in a centralized place, merely facilitating a pre-existing desire to trade, taking a small cut in the process.
Imagine a world without them. When you want to buy a share of Microsoft, you could call all your friends seeing if they want to sell any or know someone who does. That could take forever or you might never trade. Search costs are real.
Much like the stock exchange helps buyers and sellers find one another in the same security, HFT helps buyers and sellers find one another across exchanges, securities or risk factors. They basically create a meta-market for you, at very little cost. Typical HFT profit margins are fractions of a cent per share traded, similar in magnitude to what the exchange earns.
To give a real example, imagine you want to sell Valeant Pharmaceuticals after their latest scandal. You only have access to the US markets. There's an abundance of sellers in New York pushing the price down, but over in Canada, the price is a little higher. Someone in Toronto just read the latest report, thinks the price will rise, and put a bid in, but he only has access to the Canadian markets. The two of you wish you could find one another, but you can't.
An HFT algo with real-time data from Canada and the foreign exchange rate places a bid on the NYSE, tightening the spread. You sell to them. They turn around and hedge their stock exposure by selling to the guy in Toronto, and trade an FX futures contract in Chicago. This is "mere facilitation", but it helped two traders transact at a better price than they would have otherwise, and forces convergence between two related markets to make them more efficient. Automation lets him run this same trade over thousands of securities for very low margins, making a few dollars in each every day. How is that not a great thing?
"The evidence appears rather weak for that position."
Sure, and it's exactly not a scientifically backed site.
"Not obviously pathological" was the intended message from my part. I have no strong opinion on the matter. My weak belief is that it's non-pathological, and thus not worth chiding.
Any real world system that has enough degrees of freedom to function and not be too brittle and cumbersome is bound to have loopholes and such. Which are ok, as long as they are not grossly parasitical.
I think it's hard to say what exactly is the specific sin of high-frequency trading, and that it appears as an indistinguishable part of the current market.
Thus critizing high frequency trading appears of critique in general of parties who merely leverage the existing information disparity in the market to the fullest.
The main benefit of the market is that it removes transaction costs. Money has lower transaction costs than barter, bank transfers have lower transaction costs than coffins of money, etc.
Inducing some mechanism that would guarantee full information parity between all agents in the market sound to me like it would eat up lot of the benefits of the lowered transaction costs. Although, I'm not an economist and can be persuaded with better information.
My original query was how do you use capitol that you have for less than a second to hire someone (or do anything for that matter). I'm not aware of a mechanism that would allow HFT to create a job. (Except at a HFT firm perhaps)
You could make a similar argument about a lot of the social media sites, there are engineers at Facebook making huge money, just to work out how to make you spend an extra 1-2 minute a day on their site.
Sure they were originally doing something of value with that, but now days they're just trying to make people more addicted.
I feel sad that you think this about finance. I believe I've done a lot of good for the world and have gotten the opportunity to work with some very smart people along the way.
I first started working in finance because it was one of the few industries that paid engineers a fair salary without trying to trick us with monopoly money.
Of course, the world has changed and now tech companies are doing the same.
I genuinely want to know what you think the good you did for the world is in investment/trading. I really don't believe that the amount of money the financial industry is making is commensurate with its value provided to society.
> I genuinely want to know what you think the good you did for the world is in investment/trading.
My job has literally been to ensure that, out of every invested dollar, more money goes to the investment and less money goes to traders and other intermediaries.
It may not sound like a big deal, but this is literally billions of dollars a year that are invested in productive industries instead of going to someone's bonus or, worse yet, just vanishing due to lack of care.
> I really don't believe that the amount of money the financial industry is making is commensurate with its value provided to society.
I don't know if it's because I'm uninformed, but I would agree with you. It's not really clear to me why investment bankers earn such huge fees. I suspect that it's because they're basically able to pay their friends with shareholders' money. I don't remember where I first heard this idea, but I can't help but think that it rings true.
My hope is that some day we'll be able to do to banking what we've done for trading.
> It's not really clear to me why investment bankers earn such huge fees
You can think of investment bankers as salespeople. They sell very high value products in very competitive markets.
Whether you think that salespeople do an important job and/or a job that should be paid commensurate with the value of the product is a matter of opinion.Having spent a lot of time with salespeople when I was last in a startup, I have a lot of respect for folk who could do a job that I would most definitely, spectacularly fail at. YMMV.
> You can think of investment bankers as salespeople.
I agree. That's exactly how I think of bankers.
You actually have the same problem come up with other sales people too. If I'm buying a $100 million product from you, I'm probably buying it with other people's money.
I don't care that $5 million of that is going towards the sales person's bonus, taking me out to dinner, etc. I'd rather pay $100 million and have you buy me a $1000 steak dinner than pay $95 million and not even get a birthday card. Of course I want my HBS classmate to handle my account.
Do you not having savings you put into a retirement account? 401(k)? Who do you think the clients of the investment/trading firms are? Do you keep your money under the mattress?
> I really don't believe that the amount of money the financial industry is making is commensurate with its value provided to society.
I am not going to argue with your beliefs here, but just want to point out the amount of money someone gets paid or how much money an industry makes is not determined by "its value provided to society" as what would that even mean?
I live in LA, the entertainment industry here also seems to make a relatively large amount of money.
While the financial services industry is quite large and made up of many different types of companies, it is not a government public service or anything like that, where does "value to society" come from? Who gets to decide it?
Edit: I just want to add that we are using Hacker News which is part of YCombinator - YC is an investment company and part of the finance industry too.
You are satisfying a market demand. There are millions of companies who need to risk manage their interest rate, FX and commodity expodures. Banks offer a service to their customers and charge for that, just like any other. How is that not providing value?
I find it only natural. The free-ish market is one of the greatest things about humankind. I find the complexity, information movements etc. highly fascinating. Trying to beat the market essentially means that you're very interested in how mankind works at a core level. Academically that's very interesting and it's nice that the tokens you use to keep track of how successful you are happen to be money.
Additionally at least in theory they do help allocating capital to better uses which has giant leverage effects on the economy as a whole. I'd argue more efficient capital allocation and innovation (in the Schumpeterian sense) are both very valuable. I couldn't make a value judgment of what's more valuable tbh
I have been thinking about the "we provide liquidity and accurate pricing services and that's good" argument in the context of housing costs and gentrification.
The housing market is very illiquid—it's much harder to buy or sell a home than to rent a place to stay for the night. In the context of gentrification, though, this seems to benefit the preexisting landowners: the difficulty of moving provides downward pressure on supply, increasing prices, and also makes it less likely that longtime residents will sell before prices peak.
But, as a thought experiment, imagine if there was perfect liquidity: you could buy and sell a house at any time at the click of a button with ready financing and (somehow) free moving services, etc.
If that were true, many more residents would sell much earlier in the gentrification wave, to slightly richer people, who would sell to people slightly richer than that. This would result in the original landowners only getting a tiny fraction of the peak land value, and most of the returns going to the richest people.
This makes me wonder if this isn't generally true: that high liquidity primarily benefits the capital class at the expense of small asset holders.
There's probably also a corollary about late stage VCs here somewhere.
They generate returns for their investors, which are generally institutionals such as pension funds and asset managers. How is that not providing value?
As far as I'm concerned, markets should be put on a stepped clock with randomized queue processing. Said queue blind until processing. Then put the resources spent chasing the clock to better use.
A one minute interval seems appropriate. Plenty real-time enough to deal with most real world events and needs, while eliminating arbitrage based upon momentary, naval-gazing analysis.
Markets already belie the trope of an (entirely) "free market." At least level the playing field between moneyed quants and the rest of the world.
I for one don't feel sad, I feel good about that. I loved the movie "Good Will Hunting" and that's the message I got from it: the pursuit of the personal happiness trumps petting your mind to work for the greater good. Let's imagine, just as you said, that these brilliant mind did work towards the new advances and new products. We would get the new generation of smartphones one year sooner, and we'd be so moch richer for that, I guess. But if that comes at the expense of these people being one epsilon less happy than they currently are, that's not a trade off we as a society should be willing to make.
technically they are providing value. they have better knowledge to more accurately price assets, therefore through buying and selling they are correcting the pricing of real companies.
Liquidity that brings with it random, often unexplained volatility... But yes, I would probably buy the brick, and can understand why people lucky enough to have colo servers do this.
I was going to make the same point. At lower timescales, things look very different. Also the number of orders, cancels and corrects has exploded in the last couple of decades, purely because of algorithmic speculation. This makes the market significantly less transparent, and the weird and wonderful matching algorithms employed by exchanges often get gamed by colo'd traders with the relevant knowledge.
I don't understand what you mean about "lucky". Anybody can. I have had a rack of colo servers which I use for personal stuff for the last 15 years. In an AWS world it's in some ways absurd, but some things are easier this way.
Precisely, and money isn't the only factor here. Your contacts, your firm's contacts and your trade volumes (amongst other things) can get result in you getting preferential treatment.
As someone who works in the industry I've found that analogies are distinctly unhelpful. That's not really unique to finance [0]. Can you explain what you mean by "literally wiggles them out"? I cannot say that I have observed a phenomenon that I would describe with those words, but I'm always interested in learning more.
That increase in volatity pushes prices up and down without real logic behind, in the short term, causing the small retail pundits to hit their conservative stop losses and take them out of the market. That's what I meant by "wiggle them out". Does that make sense?
Thank you for clarifying. You're talking about retail speculators getting "stopped out".
Do you have a reference showing that is happening with increasing frequency due to HFTs? It runs counter to my intuition because HFTs lead to less "gappy" markets and markets that respond to news events more quickly. For the purposes of this comment I will assume that this is true.
Is the amount that retail speculators lose to increased frequency of getting stopped out greater than the amount they gain from tighter markets? I don't have a clear opinion on this.
Is the net loss to retail speculators greater than the net gain to all other market participants? I suspect not because retail speculators are such a tiny portion of the market.
If this kind of volatility has increased with HFTs, it's caused by an overly small tick size. Markets will go back to how they were if you increase the tick size back to 1/16 of a dollar. This wouldn't help price takers other than retail speculators, but that's how you fix it if it really is a problem.
"but they manage your retirement fund", really? do they? last I checked there are algorithms running the entire show and making sure I and every other little investor get screwed for every 10th of a cent so that a few investors at the top who already have loads of money can have more. They've made a game out of moving money and skimming a bit off the top all the time. Let's not forget that they are actually taking money from your 401k every time they make these trades. Let's not pretend the financiers care about you, the little guy.
Another comment mentioned that YC is in finance, but let's be clear, YC is financing start-up businesses and helping them to grow. They're small finance. When I buy a share in Facebook, I'm not helping it grow, I'm betting on it's growth and the big finance industry is just the casino.