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"That seems to be a disputed issue right now; claiming that scenario 2 does happen in practice was, as I understand it, one of the main points of Michael Lewis' latest book on HFT." Let me come right out and say it. Michael Lewis is not "wrong" because he never actually says that scenario 2 happens. The reason he doesn't say that, is that there is no proof that it happens. The reason he couldn't find proof is that it doesn't happen. Any cursory examination of the HFT side of the industry will show that it doesn't happen. He never even does this cursory examination. Go through the book, catalog when he talks to the HFT side. He doesn't do it. The closest he gets is interviewing a developer who is being persecuted by his own buy side firm. Michael Lewis implies that something happens but never actually shows it happening. He does this either due to incompetence, malice, or prejudice. To prove my point, let's do a thought experiment. Let's say I have 2 HFT systems, each of which are equally fast and are equally good at determining if fills indicate true price movements or blips in the market, and are equally good at evaluating outstanding risk. HFT A's strategy is to quote "small" size in a single market and then when it sees fills it thinks indicate price changes to buy a level in order to raise the price in a particular market. HFT B's strategy is to quote at every level in every market and when it see's fill's that indicate price movements cancel it's order's that are at a bad price. If their price discovery or risk algorithm are perfect the best case scenario is that HFT A and HFT B are paying the exact same price for the right to trade. If there is any slippage in their price discovery or risk algorithms, HFT B wins as it is not paying for the privilege to trade. QED, algos that don't pay up to jump priority queues do better than algos that do. In the blood thirsty world of HFT market making this inefficiently quickly leads to HFT A going out of business. As far as your scenario about an exchange that is open to distributed systems attacks, that is akin to asking about a casino that has a secret flaw in their poker shuffling. Yes, that would give an unfair advantage to anyone that found the flaw, but it would also kill their ability to host poker games if it became public knowledge. IE exchanges have a huge incentive to make sure this doesn't happen. |
> algos that don't pay up to jump priority queues do better than algos that do
It looks to me like all of this is addressed at the version of scenario 2 that I was not talking about, the one where the HFT is working across multiple exchanges.
> exchanges have a huge incentive to make sure this doesn't happen
I'm not sure the casino analogy quite holds here, but I'll have to defer any further comment until I can find the article I mentioned somewhere in this subthread, that went into how this scenario would work in more detail.