[anonymouse008]

I'm merely an observer, but it feels, intuitively, that HFT was great when things were fairly predictable -- or more like the major indices and individual names moved a most 2% on any given day -- and now, in the post-covid era, starting with the DPZ spike, and you could argue the TSLA original call buying spree, everything is in shambles. A lot of HFTs I know of suffered serious losses...

Could you explain, indirectly or without identifiers, why now is different than back then?

[valkmit]

It's kind of an open secret, but retail traders hopping onto meme stocks like DPZ and TSLA is, counterintuitively to an outsider, actually very profitable for HFTs and market makers.

A good example might be - imagine you are a car dealership, so serving as a rough approximation of a market maker. What kind of entities do you want to trade against? Other car dealerships (informed counterparties), or your average suburban minivan owner (uninformed counterparties)?

It's immediately obvious - the rationale is that when you trade against uninformed order flow, your measure of adverse selection is far lower than if you trade against informed order flow. Your average suburban minivan owner is going to be more time-sensitive and price-insensitive than another car dealership who is willing to look high and low for better deals.

Adverse selection, in this context, is that of the orders you're offering to the market, only the subset which have the greatest likelihood of immediately losing you money are selected. From the perspective of your counterparty, they will only lift your offer if they think it will make them an immediate unrealized profit. Keeping track of your adverse selection is an extremely important part of HFT - in fact, HFTers will try to identify informed vs uninformed order flow and only try to trade against the latter, to reduce immediate unrealized losses due to adverse selection.

This is why PFOF (payment for order flow) exists. It's because companies like Virtu think that traders on RobinHood have no clue what they're doing, and they [Virtu] can come in and eat all the alpha. Virtu doesn't frontrun RH orderflow - instead, they get what's called "first look" at the flow. They get to decide to either immediately fill the offer, or let it hit the real market. From the perspective of a RH user, this is really no harm, because whether Virtu trades against you, or your offer gets lifted against the broader market, doesn't really matter to you.

[anonymouse008]

> PFOF (payment for order flow) exists

So my inner self says that these are red herrings, or false flags set by 'real players' to lead the stampede into your living room.

It feels like there's never been a better 'cover' than r/wallstreetbets for firms with real capital to put material volume behind names that would in other scenarios be extremely suspect, or near manipulation. Now you can say, 'see, retail said they like AMD, AMC, etc... (THE STOCK)" because, yes, some random user with karma can now be the input to your 'algo' to move $name_of_stock, or generally, SPY calls / 'poots' in size wildly impossible otherwise.

Humbly, I think it's brilliant

[Edit] to put this comment in context of my response to another poster, I believe the macro can be independent of the micro (aka many little names can get blown up while your main indices maintain some sense of normalcy).

[valkmit]

The more retail traders, the more money that institutional traders can make! Institutional traders love the uninformed flow. It's no fun trading purely against other algorithms (and also not nearly as profitable)

[Kranar]

I'll just chime in and say I believe you are misinformed and wrong on this issue. I can say definitively that my firm which engages in HFT and all the other quant/HFT firms I know of have decided to stay clear of the meme stocks, ie. GME, BB, AMC, and a few others and I am not aware of any open secret that HFT firms are sneakily taking advantage of this situation.

Your statement that HFT firms think that retail traders have no clue what they're doing is a complete misrepresentation of the intention behind PFOF. It's not at all that we think retail traders are idiots, it's that retail orders are usually not coordinated and sustained activities the same way that institutional orders are. If an institution is buying and I sell into it, it is quite likely that the institution will continue buying more and more over a long period of time which increases the duration of my exposure to that institution's order flow. Furthermore it's unlikely that institutional order flow on the continuous market will balance out with other institutional order flow, since in situations where such an opportunity exists, brokers for said institutions will arrange for a block trade or use auctions instead of the continuous market. So trading against an institution means assuming exposure for an extended period of time.

With retail orders, usually a trader buys with a few orders in a way that's typically uncoordinated with other orders and that's it. I don't need to be worried that if I sell to a retail trader that a whole bunch of further traders will follow behind them in the same direction, increasing my exposure.

This is not to say that institutions know what they're doing and retail traders don't, or vice-versa. An institution may have no idea what they're doing and pissing their money away and I still won't want to trade against it simply because as an HFT firm my goal is to lock in a spread as quickly as possible as opposed to speculate on the long term prospects of a company. If anything, to the extent that there is an open secret in this industry, it's that institutions don't perform much better or have much of an advantage over anyone else. That said even if they did it wouldn't matter one way or another, what I care about is that the order flow that I am trading against can balance out over a short period of time so that I can lock in the spread.

It is precisely because retail traders are behaving in a coordinated manner on meme stocks that my firm and all the other ones I know about are not participating in them. Retail flow on meme stocks is often coordinated, at least implicitly so as an HFT firm you may risk holding a significant position for a long time, which is not ideal.

That said the market is very big and the meme stocks constitute but a tiny fraction of a fraction of the activity. It's not a particularly big deal one way or another.

[usefulcat]

Having worked in HFT for many years now, this absolutely rings true. I would add, backtesting a meme stock strategy sounds like an exercise in over fitting. There are so few previous examples to look at. And all for something that rarely happens, relative to how many stocks are out there and how many trading days there are in a year.

[ReggieCommaRose]

I’m not sure about delta one firms but almost all the options MM firms have been having record years in the COVID / meme stock era.

In broad strokes, the things that hurt market makers the most are long winded price trends and accumulation of inventory. So generally MMs can and often will eat large initial losses (depending on how many wings they happened to have owned at the time) when huge volatility spikes happen but when the raised volatility stays at that level for some amount of time (you’ll sometimes hear this referred as market “regimes”) and the MM was able to not blow out from the initial spike they’ll more than make up their losses from the good trading environment after the fact.

Market makers as a whole were suffering during the mid 2010s when volatility was low year to year, correlation with SPY was high, and all the indices basically just went straight up every month.