[w4llstr33t]

I was going to mention HFT. How is it a level playing field when they are in the picture? Paying top dollar just to be closer and closer to the exchanges to get the fastest, "best price", when really, they have info before anyone else.

Also, what about dark pools?

Contrary to my username, which I just get a kick out of, I don't actually work on wall street or anything, but I've always felt the stock market was rigged for the elite. I think it is very likely that they have info before normal retail investors have any idea.

[carnitine]

HFT is the best thing to ever happen to the average Joe retail investor. They have increased liquidity and price discovery dramatically at a fraction of the cost of the people they replaced.

[w4llstr33t]

At what cost are they providing this service though? They make a ridiculous amount of money doing so. Shouldn't the exchanges have offered the best price, and provided liquidity, in the first place?

Flash Boys: A Wall Street Revolt by Michael Lewis painted HFT in a pretty bad way. I have read criticisms of the book, but it's hard to separate out bias from the criticism.

There's also all the heat on Robinhood about selling order flow, which I'm surprised was even news to regular investors. It's great they eliminated fees for normal trades, and I also understand most major brokerages sell order flow as well (and still charged for trades for a long time). I read that Fidelity is the only major player that doesn't sell order flow.

Do you have some sources that someone could learn more about this, ones that don't have a vested interest in painting it in a positive way?

Also, I'm still wondering, considering dark pools [1], and the inside information that would come along with that, since those trades wouldn't hit public markets, how the stock markets can be considered a fair place to trade?

[1] https://www.investopedia.com/articles/markets/050614/introdu...

[pgwhalen]

> They make a ridiculous amount of money doing so.

I suppose it depends on how you define ridiculous, but HFTs actually make a surprisingly small amount of money these days. Probably single digit billions across the entire industry (https://quant.stackexchange.com/questions/34856/how-much-pro...), though 2020 was an exceptional year for many firms.

> Shouldn't the exchanges have offered the best price, and provided liquidity, in the first place?

Either your wording is a little funny, or this question indicates great ignorance about how trading works. Exchanges do not provide liquidity, market makers do. In 2021, "HFT" ~= "market maker".

[w4llstr33t]

I don't know that much about this, so you could chalk it up to "great ignorance", I suppose.

I'm a software engineer, interested in crypto, and not that involved in traditional markets (except for holding an S&P 500 index fund).

I do think the exchanges in traditional finance shouldn't have required HFTs in the first place (i.e. it's an antiquated technology). I also think hedge funds and the ultra rich have privileged info, that retail investors don't have.

Anyway, I appreciate the clarification. I like learning about all this.

[pgwhalen]

> I'm a software engineer, interested in crypto, and not that involved in traditional markets

As you learn more about crypto and traditional finance, it'll be fun to compare the two. Your confusion about the role of an exchange in traditional finance might be because you see the crypto world, where a single entity often performs the roles that many entities perform in traditional finance (exchange, clearing firm, broker, etc.).

> I do think the exchanges in traditional finance shouldn't have required HFTs in the first place (i.e. it's an antiquated technology)

I'm not quite sure what this means, but it's important to understand that HFTs exist in the crypto space as well. Capital markets don't function particularly well without marker makers, and absent some rule explicitly preventing high speed trading, marker makers will tend towards being the fastest traders in any market.

[w4llstr33t]

> As you learn more about crypto and traditional finance, it'll be fun to compare the two. Your confusion about the role of an exchange in traditional finance might be because you see the crypto world, where a single entity often performs the roles that many entities perform in traditional finance (exchange, clearing firm, broker, etc.).

Yes, I agree!

In terms of what I called antiquated technology, I think there are a lot of layers on traditional finance, and a lot has changed since its beginnings. I think crypto will go through a similar evolution, in terms of tech, regulation, etc. I think we're in the very early stages for crypto and it has a chance to be an even better system.

I do know that HFTs exist in crypto, and it still is the wild west in some ways, but in the end I like that innovation is happening and that there are alternatives to existing systems.

That said, I appreciate all the responses and I'll take some time to learn more about traditional markets.

[IncRnd]

Today's crypto has the same issues: the fastest decision-making computer with the shortest time to the network makes the block.

Just like cutting inches off mainframe cables, manufacturers of ASICs purpose-build computer chips for crypto. GPU operators tune their cards and even download new code to get every last bit of processing capability from their devices. Crypto in these ways is just like HFT.

[Dylan16807]

Isn't that the opposite of how it works?

Transferring data and calculating the core of a new block takes a fraction of a second, and then it takes an average of several minutes to find the right random numbers to finish the block.

A latency advantage in HFT lets you take most of the profits. A latency advantage in cryptocurrency mining gives you a fraction of a percent better profits.

A calculations-per-second advantage helps in mining, but it's strictly proportional.

[w4llstr33t]

I still like the distribution of power to those who wouldn't have had a chance otherwise.

[eu90h]

I'd like to recommend the book "trading at the speed of light". It's an in depth look at the world of high frequency trading based on first hand interviews with traders, court documents, etc. It would appear based on what little information is actually available that HFT firms net only modest profits after taxes and fees on trades. Historically, it appears most firms fail to turn a profit and shut down. A paper of Laughlin (2014) suggests virtu, a hft firm that now executes Robinhood orders, earns an estimate profit of 0.24 cents per trade, with 0.05 to 0.1 cents per share traded being a respectable profit.

I highly recommend this book though if your into this topic

[w4llstr33t]

Thanks. I'm going to check this book out.

[traceroute66]

> I was going to mention HFT. How is it a level playing field when they are in the picture? Paying top dollar just to be closer and closer to the exchanges to get the fastest, "best price", when really, they have info before anyone else.

Apologies if my post implied insider knowledge on the part of HFTs. That's not the case.

The point I was making is their model is ONLY viable if they have the best mathematical brains, the best computing power, the best connectivity. If anything in that fragile chain is broken then their model is unviable.

In the end, they trade on what is best described as noise. They look for patterns in the noise. And so they need "the best" noise, as soon as instantly as they can get it, and the computing power to process it as close to instantly as possible.

I called it "another story" because its a truly nuts way of making money. ;-)

There is an old saying. "Time in a trade is better than timing a trade". HFTs are basically trying to do the latter all day, every day.

In my view, John Doe the buy & hold investor actually has the advantage that they can wait for weeks, months or years.

Tortoise & Hare and all that ....

[Galanwe]

> Paying top dollar just to be closer and closer to the exchanges to get the fastest, "best price"

Being able to send an order with a smaller latency does not magically get you a "better price".

99.9999% of the market participants couldn't care less if their orders arrived 1ms or 1m after they send it. Hell, most hedge funds trade on a _daily_ basis, with multiple days of expected returns predictions, and are more concerned with the transaction cost than the latency, thus opting for a very slow "market close price" execution algo.

Those interested with very low latency are not hedge funds but market makers, and the kind of microstructure signals they exploit is not only orthogonal to what a retail investor would do, but often brings in just bips per trade, meaning the leverage required to make it worth it is anyway out of the retail league.

> I think it is very likely that they have info before normal retail investors have any idea.

What is a normal retail investor? Obviously hedge funds are going to be faster to react to e.g. earnings events than you. That doesn't mean this information is not public. It's just that HF pay data providers, invest in automatic data processing and decision making, etc.

But normal retail investors don't trade on events, they trade for the long term. For the simple reason that they don't want to hit refresh every second on the web page publishing earnings calls of each stock they want to buy.

> what about dark pools?

Yes, what about them? The name triggers the imagination of people but there's really nothing fancy about it. The objective of dark pools is to allow the exchange of shares without too much of a movement in the orderbook. This is actually good for both users of dark pool (they get lower slippage) and users of the public market (it prevents artificial big swings in price due to large buyouts, which would be announced anyway). The liquidity at time T in the order book is not tailored to absorb any ridiculous amount that a large investor could be willing to exchange.

> Shouldn't the exchanges have offered the best price, and provided liquidity, in the first place?

What does that even mean? The exchanges don't offer price by themselves, they just reflect what participants are willing to pay or receive. They are just middlemen facilitating the exchange of goods by publishing the order book of who's willing to buy/sell and at which price.

The exchanges also cannot magically provide liquidity out of thin air. Liquidity means there is someone real on the other end of your trade that is willing to buy or sell to you. Exchanges cannot create that artificially.

What exchanges do, though, is offer rebates to providers of liquidity (including the market makers that you seem to despise) in exchange for the liquidity they provide. This is not a random decision by the exchange, it's because providing liquidity to the market is beneficial for everyone. As an investor, it means I won't have to worry that I will not be able to sell my shares whenever I want to. It also means that the spread will be tighter, thus lowering my slippage. And subsequently, it also means arbitrage is most likely in place, so I'm not being scammed just because I didn't check the price on 5 different platforms.

[w4llstr33t]

> Those interested with very low latency are not hedge funds but market makers, and the kind of microstructure signals they exploit is not only orthogonal to what a retail investor would do, but often brings in just bips per trade, meaning the leverage required to make it worth it is anyway out of the retail league.

Thanks for clarifying.

> What is a normal retail investor? Obviously hedge funds are going to be faster to react to e.g. earnings events than you. That doesn't mean this information is not public. It's just that HF pay data providers, invest in automatic data processing and decision making, etc.

Well, this is sort of what I'm saying. As a regular person, you just don't have the same information, or the ability to act on it as quickly. Sure, buy and hold investors aren't really affected, but they are providing liquidity for these folks who can take some advantage. I may be pretty wrong about this, however, it's just like anything where there are friends / contacts / associates. Some parties just have more information, especially if they have money to spend. You did mention earnings though. I just have a hard time believing that hedge funds only act on public information. They might structure their trades based on how not to get flagged, but how do they not have friends or contacts in the space that tell them a thing or two? This is what they are doing full time, so I would imagine they spend a good majority of their time thinking about how to make the most money and not raise any red flags. I actually don't have an issue with this, but I always see claims that the traditional market is totally fair, but it does not seem like a very flat system to me. Those in power seem to have some advantage. If that was how the market was presented (i.e. some people have sway, more information, and the ability to act more quickly than retail), I wouldn't have any issue with this. I see the opposite though, the narrative is that retail traders can make trades without worrying because it's totally equal. If all retail traders were doing was buy and hold, then again, no issue, but not all retail traders trade that way.

> Yes, what about them? The name triggers the imagination of people but there's really nothing fancy about it. The objective of dark pools is to allow the exchange of shares without too much of a movement in the orderbook. This is actually good for both users of dark pool (they get lower slippage) and users of the public market (it prevents artificial big swings in price due to large buyouts, which would be announced anyway). The liquidity at time T in the order book is not tailored to absorb any ridiculous amount that a large investor could be willing to exchange.

Where do I learn more about dark pools? My initial response to learning about them was that they are basically tailored to hide trades from the general public, for the benefit of institutional traders. I was concerned that dark pool operators would also have information that then they could front-run the rest of the market with. I feel like when I make a trade in the equity markets, or if I read something in traditional news, someone else has heard about this earlier that day, or maybe days before, based on insider information, just due to them being more deeply involved with the market. I just don't really see how this is fair (and this is the claim I see time and time again in traditional markets). I don't think all this information is public. If it's in some obscure place, that 95% of the investing public doesn't see, is it really public? Maybe the SEC protects against that, but it seems like the big players have an advantage. It seems like I have a lot of incorrect assumptions though, so I'd like to learn more about this.

> What exchanges do, though, is offer rebates to providers of liquidity (including the market makers that you seem to despise) in exchange for the liquidity they provide. This is not a random decision by the exchange, it's because providing liquidity to the market is beneficial for everyone. As an investor, it means I won't have to worry that I will not be able to sell my shares whenever I want to. It also means that the spread will be tighter, thus lowering my slippage. And subsequently, it also means arbitrage is most likely in place, so I'm not being scammed just because I didn't check the price on 5 different platforms.

Yeah, I get it, this is a quite mature market (and that's a good thing). I still have a feeling that the extremely powerful have sway in the market, in a way that isn't exactly "fair", but maybe it just comes down to the amount of capital they have (but again, I would think that the size of the trades should be on public markets then, not dark pools). Anyway, in the end, what I've learned from all this is how far the traditional markets have come, and how other markets (like crypto, which also have things like dark pools) can learn from this.

[Galanwe]

> Well, this is sort of what I'm saying. As a regular person, you just don't have the same information, or the ability to act on it as quickly.

Well the general idea is that everyone have the possibility of getting the information at the same time. The difference is how fast you can react, which seems fair to me.

To be frank, hedge funds, especially quantitative ones, are usually not the fastest to respond to earnings. The lifecycle of earnings announcements often roughly goes like that:

- Company X releases its earnings on the SEC website. This usually happens once the market is closed (~6pm) so that people have until the next morning to digest it, and avoid dubious ultra fast reactions. The publication date was already announced so everyone know it's coming.

- The next morning at market open, some (few) investors already place trades based on the earnings published. Most of the time, these are human decisions made by financial analysts experts on company X that read the earnings, because systematic funds seldomly trade on unstructured data such as PDF reports.

- an earnings calls takes place the next morning also, so that financial analysts can ask questions and clarifications about the figures to company X. Right after, the wav/mp3 of the call is uploaded (often on the company website). Some more investor do trade based on the earnings call, either by financial analysts listening to it, but more and more just by reading the transcripts. Some (few) hedge funds apply NLP to parse the transcripts at that point, and trade based on the results.

- The next day, major data providers (think Reuters/Refinitiv, Bloomberg, etc) have processed the transcripts to structured data. The major hedge funds all subscribe to these data providers, and are now able to start trading on the earnings event.

- The same day, Bloomberg releases an article about the earnings of company X and explains why its good, dedicated retail investors and non systematic hedge funds get interested and join the trade.

- for the next 10 days or so, more and more (slower) people will continue the trend on these earnings, until the price stabilizes to a market consensus. See PEAD - post earnings announcement drift - for more information.

This is more or less how it goes for earnings. Nothing strikes me as _unfair_ here. Everyone had the opportunity to put effort in reading the earnings. It's just a trade-off of convenience (i.e. I want structured data), price (i.e. I hire a financial analyst to interpret the earnings early), and R&D (i.e. I invested in NLP to parse transcripts) versus the speed of reaction to the event.

What could make it more fair for retail investors? Forbidding the use of financial analysts because they are more knowledgable than average Joe? Forbidding the use of NLP because average Joe does not know how to code?

> I just have a hard time believing that hedge funds only act on public information.

Oh but trust me they do. Now there will always be outliers, shaddy deals, etc. Any system with rules have cheaters. But that's definitely very very exceptional. This is especially true for non proprietary funds (funds managing money of other people - the vast majority), since the amount of scrutiny is huge.

Allow me to use myself as an example. I work in a hedge fund, though I deal mainly with operational / technical / quantitative matters. I have one of the lowest grade of surveillance level (MIC) which still entails:

- All my work phones are tapped (mobile and fix)

- All my work conversations are logged.

- I am forbidden from contacting anyone about professional or financial matters if the medium is not logged (i.e. No whatsapp, no signal,...)

- I am forbidden to invest in most asset classes. Except for equities, for which I need pre-approval of the trades 2 days in advance, and have a minimum holding period of 30 days. Compliance has access to my brokerage account, and reports on those of my close relatives.

- I am forbidden from giving any financial advice to anyone, even family or friends

- I am forbidden from receiving any financial research or counseling material from anyone, through any medium (mail, phone, conference) if the material is 1) free or 2) undeclared.

- I am forbidden from discussing or meeting with some people in the office, as well as walk in certain parts of it ("Chinese walls") , since screens could reveal information, or conversations could take place.

- At leat 15h of compliance / legal training per year.

- I am personally (not the company: myself) liable up to $10 millions (disclaimer: I don't have that kind of money) if any material incident happens that could be traced by me not setting up the proper mitigation. E. G. If a bug happens and I did not give the team the means to have catched it. Or the worst nightmare of MICs: if someone does some shaddy business, and I did not arrange for enough control or compliance training for him to know that it's illegal.

- The usual set of no paid gifts, trips, conference in fancy hotels or whatsnot.

- etc etc etc

Keep in mind that's not even the highest scrutiny level. So, yes, some people cheat, we see it in newspapers, but that's the 0.0001%

> Where do I learn more about dark pools?

I honestly don't know. This is really a detail of equity markets, each broker have a different one with different specificities. As for front running, this is IMHO something of the past (at least on equities, for major brokers). Clients are well aware of the risk and require huge amounts of compliance and processes on their brokers to prevent that, not even mentioning the regulators themselves. The reputation risk is just not worth it.

> My initial response to learning about them was that they are basically tailored to hide trades from the general public

Well that's true. But it's often because the purchase is too huge to be made public, it would disrupt the market for no reason. Think of what happens to crypto when a whale sells off, huge upswing followed by huge downswing, until the price settles back again,and in the meantime the investor got an awful slippage, people panicked, bit trade crazy stuff, etc.

I know dark pools trigger the imagination of journalists and retail, but there's really nothing fancy about them. Let's take a real world example to explain how they are used.

Every year, Apple reserves a portion of their profits to buy back some shares from the market, which they then destroy (I won't enter into the details of why they do that, it's a pretty common practice for growth companies). Apple does this every quarter, it amounts in 2021 to $20 billions of share buyback per quarter (~$80 billions last year). What would happen if Apple just goes on the market and places a fat $20 billion market order? It would be total chaos. With such a big order, the whole liquidity of the book would disappear, price would skyrocket, people shorting apple would receive insane margin calls, people long apple would be instant billionaires for a split second, volatility would cramp up and market dislocation would trigger, meaning the stock would have to be halted, trading bots would sell everything, Apple itself would be ruined to buy at such a large price, etc, etc, etc.

That's where the dark pool can be handy. Apple announces publicly the buyback amount and date (this is mandatory for public companies), and in exchange for a (often) slightly less good price, apple can perform its buyback on a dark pool where the price won't move, and nobody will panic.

[w4llstr33t]

Thanks for all the information. I was operating on some false assumptions, so this clarifies quite a bit.