[gizmo]

A few points:

1) This doesn't address the front-running issue. (Where different exchanges receive the buy/sell order at a different times and HFT can abuse those microsecond differences)

2) It's a universal truth that people who are better informed are harder to rip off. So that's not very persuasive. You can't reasonably expect regular people to know in which situations they'll be paying a premium for a liquidity service they may not even want.

3) It's completely fair to ask ourselves as a society if HFT groups are making a contribution to society that warrants the money they make. And if transparency with regard to HFT trading strategies leads regular people and sophisticated investors to make different decisions, then that means that the lack of transparency worked in favor of HFT. Therefore, it's reasonable to assume much of the HFT profits are just an externality. The decline of HFT is in part because investors are getting wise to the shenanigans.

[kasey_junk]

"1) This doesn't address the front-running issue. (Where different exchanges receive the buy/sell order at a different times and HFT can abuse those microsecond differences)"

This is only an issue if your order is large enough to take out the entire liquidity of one of the exchanges. If that is the case, by definition you are not a retail investor, you are an institutional investor and part of the value add you are supposedly adding is your ability to operate in a complex market.

"2) It's a universal truth that people who are better informed are harder to rip off. So that's not very persuasive. You can't reasonably expect regular people to know in which situations they'll be paying a premium for a liquidity service they may not even want."

So informed market participants should subsidize ignorant ones?

"3) It's completely fair to ask ourselves as a society if HFT groups are making a contribution to society that warrants the money they make. And if transparency with regard to HFT trading strategies leads regular people and sophisticated investors to make different decisions, then that means that the lack of transparency worked in favor of HFT. Therefore, it's reasonable to assume much of the HFT profits are just an externality. The decline of HFT is in part because investors are getting wise to the shenanigans."

Agreed. We should also have that discussion around dark pool operators, hedge funds, and investment banks. While we are at it, lets talk about photo sharing websites and internet chat services as well.

[KingMob]

We already regard some profitable activities (e.g., slavery, child labor) as unacceptable, so there's no reason a priori to rule out considering whether HFT falls in the category of "too detrimental to society to allow".

Likewise, the more esoteric forms of finance (CDS) and the people who made them and continue to game the system greatly contributed to the recent recession without suffering any of its ill effects.

And furthest down the chain of societal damage are photo sharing sites and chat services, which mostly just waste time and supplant the revenue of film/phone companies.

If you're implying that considering HFT's societal worth is as silly as examining photo sharing services, you're mistaken.

[kasey_junk]

"We already regard some profitable activities (e.g., slavery, child labor) as unacceptable, so there's no reason a priori to rule out considering whether HFT falls in the category of "too detrimental to society to allow""

I agree, I think a robust conversation about the pluses and minuses of electronic trading are of value, and there is nothing sacred about electronic trading activities that means they are a natural right. That conversation needs to be an informed one though, and discussions about HFT never are.

"Likewise, the more esoteric forms of finance (CDS) and the people who made them and continue to game the system greatly contributed to the recent recession without suffering any of its ill effects."

This is a point that is most aggrevating about the narrative that Michael Lewis is pushing about HFT. The people being "hurt" in his hypothesis, are in fact the people who create esoteric forms of finance. The big institutions are upset by HFT because it has cut into their profits, not because it is unfair.

"And furthest down the chain of societal damage are photo sharing sites and chat services, which mostly just waste time and supplant the revenue of film/phone companies. If you're implying that considering HFT's societal worth is as silly as examining photo sharing services, you're mistaken."

WhatsApp was sold for 19 billion dollars. That is about exactly what the entire HFT market was worth in it's very best year if you believe very inflated stats.

[KingMob]

"This is a point that is most aggrevating about the narrative that Michael Lewis is pushing about HFT. The people being "hurt" in his hypothesis, are in fact the people who create esoteric forms of finance. The big institutions are upset by HFT because it has cut into their profits, not because it is unfair."

Yes, this was definitely glossed over in the article. But some of those large investors are things like pension funds, which hold ordinary people's savings. I'm not sure to what extent that trickles down though. Also, what about the flash crashes?

[kasey_junk]

Pension funds are operating more cheaply now than at any time in history. It is a myth propogated by large bank trading desks that HFT profits come from pension funds. Instead they come from trader bonuses that are no longer necessary.

As for flash crashes there are 2 answers to that question 1) they correct so fast that they impact very few people. 2) if exchanges would stop busting trades during crashes the practices that lead to them would stop.

[gizmo]

1) Chris claims "The fact of the matter is that HFT’s can’t rip you off.". Front-running[1] is an example where HFT's do rip people off, simply because they didn't know it was going on. When the performance of institutional investors is harmed in this way that harms everybody with savings or a retirement fund. Not just the guys at wall street.

2) Straw man.

3) Yes, while we're at it let's change the subject to photo sharing websites instead. That sounds reasonable.

Edit:

[1] Again referring to the technically legal version of "front running" as used by Michael Lewis where HFT abuse buy/sell orders arriving at different times at the exchanges.

[throwaway13qf85]

Front-running[0] is where a stockbroker abuses the relationship they have with a client to place their own order in front of a client's order, because they know that the client's order will move the market, and that subsequently they'll be able to close their own position at a profit.

Having a speed advantage over other market participants and using that advantage to pull your quotes on another exchange is not front-running! It's just sensible market-making, of the kind that has been doing on for hundreds of years. It's no better or worse than sending a pigeon over the English Channel in 1815[1], or using the Transatlantic Telegraph to outpace ships in 1866.

Also, shouting "straw man" is not actually an argument.

[0] http://en.wiktionary.org/wiki/front_running#English

[1] http://en.wikipedia.org/wiki/Nathan_Mayer_Rothschild#Legend

[001sky]

Front running is a conceptual variation of the hold-up problem. Like any concept, it can be implemented in plain-vanilla as well as syngthetic variants. Non-vanilla is not dispositive.

[yummyfajitas]

When you tell a broker "trade on my behalf" and he trades first, that's front running because he is obligated to do what's best for you. Other market participants do not have the same duty.

To make an analogy: my boxing coach is obligated to give me good advice and he's a jerk if he doesn't. The other boxer is not being a jerk if he feints and then punches me in the face.

[fauigerzigerk]

And what if your broker routes your order through an HFT for a fee so the HFT can front-run you? That's what some say is happening. I'm still unclear if I can really believe that because it sounds so obviously illegal.

[yummyfajitas]

Retail brokers often have ELP programs where an HFT has the option to fill your order (and the obligation to do so a certain fraction of the time, typically 20-50%) and avoid paying routing fees.

There is little opportunity to front-run in this case since a) no one on ETrade moves large blocks b) ETrade wants to make sure the ELP program is full of benevolent market makers and c) fill rate requirements. You can always opt out of these programs (turn off "smart routing" or something similarly named), but most people don't since they typically reduce your costs.

[kasey_junk]

That's what I was hoping Flashboys was going to be about. I haven't finished the book yet but so far Lewis mentions it in passing but doesn't dig into it.

[rayiner]

> 3) Yes, while we're at it let's change the subject to photo sharing websites instead. That sounds reasonable.

The question: "does Facebook spying on teenagers to help Abercrombie & Fitch sell them crap they don't need add social value commensurate with how much money they make doing it?" isn't an attempt to change the subject, but rather a glib attempt to criticize the structure of the question. Since when do we judge compensation based on value added to society, and if that's what we do, why don't we apply that approach beyond finance?

[gizmo]

I disagree. It is an attempt to change the subject from the object level: "is HFT harming society and do we need more transparency or regulation" to the meta level: "if we have to do something about HFT, then why not address X, Y, Z also?".

It's not a legitimate argument because it can be used to derail any conversion that criticizes one particular aspect of society.

It goes without saying that there are moral questions to be raised about facebook acquisitions and compensation in fields outside of finance. But it's not part of this conversation.

[rayiner]

That's not the argument. The argument is: "if this mode of reasoning is valid, and pursuant to it we must do something about HFT, then we would also feel compelled to do something about X, Y, and Z as well. But because we don't feel compelled to do something about X, Y, and Z, that implies that the mode of reasoning is not valid."

In other words, he disagrees with the premise that compensation need bear some relation to economic value created. Empirically, that's a premise that we as a society reject.

[kasey_junk]

See I think the question "is HFT harming society and do we need more transparency or regulation" is much clearer and easier to debate about than "does HFT make more money than it's value to society".

When we have that debate I'd like it to be informed about what does and does not actually happen with HFT and not bogeyman scare stories. I'd also like that debate to consider the pro's and con's of the system it replaced and the unintended consequences of any regulation we introduce.

[hsitz]

"Since when do we judge compensation based on value added to society, and if that's what we do, why don't we apply that approach beyond finance?"

We apply it in finance for a couple reasons. Securities exchanges are high regulated entities, at least since the Great Depression brought our country to its knees. Ever heard of the SEC, which exists to protect investors? There is no reason for HFT to be allowed at all unless it is creating a net benefit for society. Or said another way, if HFT provides a benefit only for the people doing HFT, and has a negative effect on others, then there's no reason to allow it. (An aside: My understanding is that studies have shown markets to have plenty of liquidity without HFT.)

[notahacker]

In response to (1), I always assumed that people talking about the "little guys" being ripped off were generally talking about the little guys holding money in institutional funds whose trades were being front-run rather than the professional money managers themselves. Of course, in most cases these "little guys" are probably being ripped off far more by the fund management fee, but still...

[throwaway13qf85]

1) It's debatable whether you can call this behaviour "abuse". It's also debatable whether you can call it "front-running". The HFT has an advantage over the rest of the market, which is that they're faster. They're faster because they've paid for faster connections and they've hired expensive developers to build fast software. They then use that advantage to propagate information between exchanges more rapidly, so that they don't get picked off by informed traders on other exchanges. The basic mechanism is exactly the same as any other market making, it's just that it happens faster.

Let's say I'm a big investor in 1960 who wants to buy 100,000 shares of MSFT (yeah, they didn't exist back then, whatever). I call up a floor broker who's standing on the trading floor at NYSE and he quotes me $49-$51 (because it's 1960 and you can drive a bus through the spread) but he can only offer me 50,000 shares. No problem, I buy from him at $51 and dial another broker at BATS in Kansas (also didn't exist in 1960) to get a quote from him too. But in the time it takes me to dial the number, the news of my trade is wired from NY to Kansas and my broker there has put his prices up in response - he now quotes me $49.50-$51.50.

What the hell? I thought it was $51 to buy? Well, it was at the time I made my first trade. But when you want to make a big trade, you don't get it all at the bbo. You expect your trade to move the market.

Exactly the same thing happens today, except that it all happens in milliseconds rather than minutes, and the spread is $0.01 instead of $2. Voice traders at banks and other big institutions (at least, the ones that didn't already adapt years ago) are getting hissy about it because they want to be able to buy everything at the prices they can see on the screen, regardless of liquidity considerations, and also they'd like a pony thank you very much.

2) 'Regular people' are not putting in orders that are large enough that they need to be routed to multiple exchanges. If I send an order for 100 shares of MSFT, it won't go anywhere near an exchange. It will get filled immediately, by my broker, at essentially the national bbo.

3) Yup, it's totally valid to ask these questions. In fact I think it would be great if the HFT industry was more transparent, and I fully expect that to happen. But that's not the same as saying that the market is rigged or labeling totally standard market-making behaviour as "abuse".

[yummyfajitas]

You can't reasonably expect regular people to know in which situations they'll be paying a premium for a liquidity

If you cross the spread you paid for liquidity. If you don't know this, don't trade.

Trading without understanding this is like coding without knowing what memory is.

It's completely fair to ask ourselves as a society if HFT groups are making a contribution to society...

The people choosing to purchase liquidity certainly seem to think they are. Their only complaint is that is that the price is not as favorable as they'd like.

[klochner]

Chris, can you at least read the NYT excerpt? I have to agree that your post does little to settle what may or may not be controversial, and it would be interesting to hear an informed response.

[rayiner]

Chris, I'd love to see you do a similar article on how human traders come into play in similar situations. Isn't the point of (at least some of) them also that they add liquidity? What makes HFT worse in that regard?

[jarrett]

> It's completely fair to ask ourselves as a society if HFT groups are making a contribution to society that warrants the money they make.

An HFT once told me his company required a huge investment to operate. Besides the infrastructure costs, the company needed cash on hand for its buy orders. Given the small profit on each trade, it needed to do many, many trades. Which necessitated a lot of buy orders, and thus a lot of cash. When all was said and done, they didn't have a particularly high return on investment. The HFT didn't give me exact numbers, but he suggested that the ballpark ROI was commensurate with that of traditional brick-and-mortar businesses. (The ROI as he quoted it counted salaries and bonuses as part of the return, so those were not disguised as costs eating away the profits.)

If the HFT was telling me the truth, then it appears that at least his firm was providing a useful service and earning modest profits for doing so. Which would make his firm not so unusual in the business world. I have no inside knowledge of other HFT firms or other niches in the finance industry.

[Mikeb85]

No, the decline of the HFT industry is because there's so many competitors they're racing to $0...

[wglb]

Keep in mind that many HFTs are market makers and have specific agreements with exchanges that pays them 0.005 cents per share traded, regardless. The other side of this is that they MUST stay in the market, no matter what.

Thus, when trading volume went down over last few years, many HFT firms had less income.

(And to answer another commenter in this thread, No, other investors are not "wise" to the ways of HFT, all traders save for the brokerage firms who used to collect $0.10 on each share traded (the spread before HFT) benefit.)

[harryh]

1) I see why the person trading a bunch of shares on different exchanges all at once is unhappy about this, but this is BETTER for literally everyone else who now benefits from more accurate pricing.

3) You're aware that HFTs simply replaced slower and more expensive humans right? These computers are a lot cheaper than the humans were and, as you said, are getting cheaper by the day. Automation FTW!

[liricooli]

1. It׳s not front-running as nobody can actually see the order book before a transaction happened. what you describe is a sort of arbitrage based on different latencies. It may be morally wrong, but it׳s totally different from front-running.