Your example does exactly what the author recommends you not to do; cross the order book. In your example, you're supposed to place a limit order at 14.99.
That doesn't do anything. Then you never get any shares, and the market moves higher because there is a 100,000 shares on the order book and the market will move higher for legit reasons.
The way not to get scalped, is to place the order in a way where it arrives at all the exchanges at the same time, that way the HFT guys and their microwave data links can't peek at your order on BATS, and then beat you to the other exchanges.
The accusation is they see the 100,000 share order hit BATS, 10,000 get filed, then the HFT guys buy 90,000 shares on the other exchanges before your order gets forwarded, and you are stuck paying the HFT guys $15.02.
The HFT guys aren't buying 90,000 shares on the other exchanges. They're just updating their ASK price on those exchanges to slightly raise the price to reflect the new information that just hit the market. If someone wants to buy 100,000 shares RIGHT NOW it's a good sign that the price should be going up. Katsuyama/RBC were used to their proprietary information staying a secret that only they knew for longer before the HFTs jumped in and made the market respond faster.
That might be a bummer for Katsuyama/RBC but it's great for everyone else on the market who now benefit from a price that updates faster.
How do you "update" your ASK price? They are either front running by buying the shares at $15.00-$15.01, or, if they are their own orders, then they cancel them. It is the same thing.
If someone wants to buy 100,000 shares, and the market says there are 100,000 shares available at $15, the order should complete at $15.
You update your ASK price by canceling your order and submitting a new one with a different price.
> If someone wants to buy 100,000 shares, and the market says there are 100,000 shares available at $15, the order should complete at $15.
As long as they submit their matching order while my bid is still on the books that's fine. But why should I be required to keep my order on the books for any longer than I want to?
You should be able to cancel you order at anytime. What you shouldn't be able to do is to stiff other people's trades, and then use a microwave antenna to change your order before the other person trade arrives.
What you think is happening in the world is not what's actually happening.
What's happening:
1) A large block of shares is traded on exchange #1.
2) HFTer notices #1 and very quickly updates the price at which they are willing to buy/sell on exchange #2. No one has any sure knowledge of trades on their way to exchange #2. They can guess. They can infer. But they aren't seeing any actual trades before they hit the exchange.
The person I want to buy the stock from is only offering the shares at 15.00 and I think that is a fair price. Why should someone jump in between the two of us and buy the stock for 15.00 then offer them to me for 15.01.
This would be like going to an open house where you here someone say "I'm going to offer $1,000 over asking" then going to the seller and offering $500 over asking. Then going to the first person and saying you'll take that offer of $1,000 over asking.
You could claim that you provided liquidity and that you helped speed up the transactions but at the end of the day you made $500 for undercutting someone who already intended to make a purchase.
I didn't provide liquidity in that case, I provided risk mitigation. You see the person who said they are going to offer "1000 over asking" hasn't done it yet. Any number of things can happen before they do, and that may not ever happen. My real bid of $500 over asking is a bird in hand.
So who asked you to provide any service of risk-mitigation, liquidity injection,etc..?
This is about 2 parties that are ready to agree to a transaction and a 3rd party injecting themselves into the transaction and taking a penny of the deal.
Imagine that you go to the grocery store to buy some milk and as you are about to checkout someone buys your $5.00 milk and tells you the price is now $5.01. And that the $0.01 increase includes spoilage insurance. Maybe you like that, maybe you don't, the issue is that you had no choice in the matter.
In your original flawed analogy the seller of the house has every right to reject my +500 bid in order to wait for a better deal if they think one is coming along.
In your current flawed analogy you are assuming that there is a fixed price for the things you are buying when there aren't.
Let me offer my own flawed analogy to explain what is actually happening in the latency/venue arbitrage case.
You are a real estate developer who wants to redevelop a block. On that block are 10 relatively equal properties owned by 10 different people. On day 1 you go to the first owner on the block and offer 100K for his shop, he says yes. On day 2 you go to the second owner and offer the same 100k. Again a deal. On day 3 you go to the third but they won't sell for less than 200k because they've been talking with their neighbors and know that someone really wants these properties. On and on until you get to the last owner who won't take anything less than 900K which you pay. Now you can say that you are being taken advantage of but I'd argue that it is just as morally questionable for you to low ball those original property owners when you know their property is worth more than what you bought it for. Conversely, let's say you balk at that 900K and walk away from the deal. Is that last owner "out" 900k? Are they out 100k?
Now lets introduce these nefarious third parties. Let's say I notice that you are buying those properties and while you are negotiating with the third property owner, I offer 200k to all of the remaining owners at once. If they agree and I offer them to you for 300k, I make profit on the deal, you still get what you want (at a cheaper overall price) and the original owners are all paid a consistent amount for equivalent properties. Also, if half way through you decide that this deal is no longer for you and stop buying up properties, I am "stuck" with those properties that are now not worth as much as I paid for them.
" seller of the house has every right to reject my +500 bid in order to wait for a better deal if they think one is coming along"
You know that someone else just said they were going to offer 1000 over asking. The seller doesn't know that. You have an advantage.
" you are assuming that there is a fixed price for the things you are buying when there aren't."
When Bob offers stock X for 5.00 that is fixed until he cancels that order. Just like the milk, it is 5.00 until the store changes the price.
Your analogy implies that I need all the properties on a block. That would be similar to a hostile takeover where someone needs to buy 50+% of a company to take control.
Are you aware that HFT are not making their money by detecting hostile takeovers?
Can I hazard a guess that he is aware of how HFTs make their money, and further point out that one of the reasons he has an unusually specific amount of detail to offer about how electronic trading works is that he is in fact an electronic trading software engineer?
Further, your attempt to poke a hole in his analogy is itself flawed, because you have a poor working notion of the scarcity involved. "There aren't just 10 shares of MSFT in the market" is what you're thinking, while ignoring that there is a finite amount of MSFT offered a price compatible with your investment goal. You can't think of the total amount of MSFT that exists. To reason about the market, you have to have a notion of what you're willing to pay for it. Many people who hold MSFT are unwilling to unload it at anything near the current spot price. This stands to reason, because if they were willing to unload at that price, they wouldn't be long MSFT.
Thus assuming that someone else will always pay the spread. Tragedy of the commons ensues.
But this whole article seems to be written for retail investors. And as much as HFTs may sound scary for retail traders they make their money off institutional trading. So the larger impact to retail flow is from the response Institutional desks are forced to take to ensure they are not disadvantaged by HFTs, which then affects how institutional and retail flows are able to interact.
Ultimately a 1000 APPL.US order will get filled and who pays the $0.01 spread is largely academic as it is an inconsequentially small part of the total settlement $ paid.
The way not to get scalped, is to place the order in a way where it arrives at all the exchanges at the same time, that way the HFT guys and their microwave data links can't peek at your order on BATS, and then beat you to the other exchanges.
The accusation is they see the 100,000 share order hit BATS, 10,000 get filed, then the HFT guys buy 90,000 shares on the other exchanges before your order gets forwarded, and you are stuck paying the HFT guys $15.02.