[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.

[rondon]

That is crazy logic. Because international telephone calls used to cost over 12 cents a minute I should let my ISP charge me 1 cent a minute whenever I use Skype internationally?

[harryh]

You should realize that market makers are actually providing a service that they get paid for and be happy that due to automation & competition the price for that service has dropped by an enormous amount.

[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'?

[tptacek]

I don't understand what you're trying to say here. Tradable instruments aren't gasoline. They don't have fixed prices. There is no universe where trading exchanges have ever worked that way.

[kasey_junk]

Someone pulls into a gas station and buys all the gas they have at 3.99 a gallon. Should they be able to cross the street to the other gas station and expect to do the same thing, or can the across the street gas station raise their prices to 4.00?

[rondon]

Yes, in your example the third party has witnessed a change in demand and is now changing his prices.

In my example the Gas Station is doing a bait-and-switch where the price was 3.99 until you pull out your credit card. HF Traders are not doing a bait-and-switch since they are separate entities than the original seller but they are making money off the same principal as a bait and switch.