[kasey_junk]

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.

[rondon]

" 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?

[tptacek]

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.

[rondon]

I guess you don't quite understand how HFT works?

The simplest example is like this:

1. Bob sees that 10,000 share of MSFT are for sell on exchange X at $50.00 and also 30,000 share are for sell on exchange Y at $50.00 and 60,000 shares are for sell on exchange Z at $50.00 2. Bob attempts to buy 100,000 shares of MSFT at $50.00. 3. The HF trader sees the 60,000 order get filled at 50.00 and reasonably assumes that someone is trying to buy more than 60,000 shares right now. 4. He buys the remaining 40,000 shares at $50.00 before Bob's trade is executed. 5. The HF trader immediately lists the 40,000 shares at 50.01

Do you understand how the HF trader is injecting himself into the transaction?

[tptacek]

It looks like you just gave an example of a trader buying all the liquidity of MSFT on every market with a single market order.

[rondon]

Good point. You should ignore the previous comment based on a technicality. Since I didn't specify that the 100,000 share purchase was not actually 3 different orders

[tptacek]

Aside from the strange example you provided, what's funny is that you focused on a 1 cent price movement. The average bid-ask spread before high-volume electronic trading drove it down was 12 cents --- that was money in the pockets of middlemen. Before electronic trading, the spread could have been measured in dollars.

[harryh]

I guess you don't quite understand how HFT works? The HFTer is the one offering to sell the shares for $50.00 on exchanges X, Y & Z. He's also offering to buy for $49.99. His goal is to sit there all day long trading with dumb money making 1 cent per share he transacts.

The HFTer has a problem though. If a big & smart trader comes along with proprietary knowledge that MSFT should really be trading for $50.10 he could take a big loss. If that HFTer buys everything up for $50.00 and then the price moves to far too fast that's bad.

So the HFTer works as hard as he can to detect when this might be happening so that he can update the prices he's offering. A really big signal this might be happening is when someone eats up his whole order book on one exchange all at once. So when that happens he trys to react as fast as possible to updates pricing on the other exchanges.

He's not injecting himself into transactions, he's trying to get out of the way as fast as possible.

[kasey_junk]

TGit least is closer to what is actually happening and is much less flawed.

I still take issue with your idea that the HFT is injecting itself into some preordained transaction. Information that there is a lot of demand for something should raise the price for that thing.

Large institutional buyers already have huge information/infrastructure advantages. Why should they also be given assn exemption from market dynamics that no one else received?

[tptacek]

Let me see if I follow:

What you're saying here is that an institutional investor wants to buy MSFT at a price that does not reflect their new demand for 100,000 shares. That order, absent some external force that will put downward pressure on the shares (which, if so, why buy now?) will naturally raise the price of MSFT for everyone in the market.

The investor, in other words, wants something for nothing: they want to trade at a price that doesn't reflect their demand, and for some other market participant to take the hit for selling below the true demand.

[rondon]

Someone pulls into a gas station that says gas is 3.99 a gallon and expects to pay 3.99 a gallon to fill up his car.

Should the price increase to 4.00 as soon as he stops in front of the pump to 'reflect the new demand'?