Former High-Frequency Trader writes about HFT

[Liberty]

http://www.chrisstucchio.com/blog/2012/hft_apology.html

 

First part of many. Should be interesting to hear the other side.

 

I’m a former high frequency trader. And following the tradition of G.H. Hardy, I feel the need to make an apology for my former profession. Not an apology in the sense of a request for forgiveness of wrongs performed, but merely an intellectual justification of a field which is often misunderstood.

 

In this blog post, I’ll attempt to explain the basics of how high frequency trading works and why traders attempt to improve their latency. In future blog posts, I’ll attempt to justify the social value of HFT (under some circumstances), and describe other circumstances under which it is not very useful. Eventually I’ll even put forward a policy prescription which I believe could cause HFT to focus primarily on socially valuable activities.

[Rabbitisrich]

Thanks for sharing. Interesting site too. I like his decomposition of employment-population and investment % of gdp by decade. As unfair as Krugman can be (most recently misrepresenting Steve Keen w/ no apology forthcoming) he has been pretty on the ball with bigwigs like Taylor and Fama.

[Myth465]

Call me closed minded, but I stopped reading after this part.

 

I’ll attempt to justify the social value of HFT (under some circumstances), and describe other circumstances under which it is not very useful.

 

Time is valuable. Have I really missed anything?

[Liberty]

 

Time is valuable. Have I really missed anything?

 

I could tell you but that would take too long...

[Myth465]

LOL Fair enough. I just dont want to read a 4 part series on legalized front running. The guy should be able to tell you in 2-3 sentences how its helpful to society. I have a reading list 8 miles long, and this wreaks of a guy trying to justify bullshit because it pays the bills.

[Liberty]

Well, either you already know everything about HFT and it's pointless to read more about it, or you don't know much about it, and with this attitude you'll never learn. Not sure what else to tell you.

[Myth465]

Well, either you already know everything about HFT and it's pointless to read more about it, or you don't know much about it, and with this attitude you'll never learn. Not sure what else to tell you.

 

With that attitude you will reading about everything for the rest of your life, until you know everything about everything. I know its BS, and dont mind hearing about why its not, but I have yet to hear a valid argument. I have a basic idea of what HFT is, but am more concerned with how it helps and why it should be allowed. I will likely scan that article, but I dont have high hopes.

[Hielko]

Thanks to HFT it's possible to offer smaller bid/ask spreads, and this makes it possible for you to buy and sell cheaper.

[Liberty]

With that attitude you will reading about everything for the rest of your life, until you know everything about everything.

 

There are worse things in life. But that's not what I do. I found that link on a reputable site, and I had read a lot about HFT but never from someone who actually worked on it. I did find that article an interesting introduction, which is why I posted it here. If it had been a waste of time, I wouldn't have posted it.

 

I'm not saying it made me change my mind on HFT, but it was a good reminder that not all computer-based-trading strategies are the same, and some are definitely more market distorting and not beneficial socially while others can probably actually help with liquidity and reduce spreads. As with most things, reality is probably in the gray zone.

[writser]

Thanks to HFT it's possible to offer smaller bid/ask spreads, and this makes it possible for you to buy and sell cheaper.

 

Shit, I wrote a large first post but my internet connection went down. I'll write a small recap.

 

Market makers (including High Frequency Traders) provide liquidity. And they take risks. They get paid for that, in the form of earning the bid/ask spread. Market takers require liquidity. They pay the bid/ask spread. For them, a tighter bid/ask spread is good because trading will be cheaper. But this is a zero sum game, right? So who's losing? Answer: the other "market makers". Because they don't earn the bid/ask spread anymore. This is why HFT is causing the demise of traditional market makers and daytraders.

 

But: if you are a patient value investor and you put in some bids below the market and offers above the market you are ALSO a market maker. You are providing liquidity but chances are you will not get filled because HFT are providing liquidity at a better price! Suppose you want to buy Microsoft. The market is 30.29$/30.31$. You might think that's a good thing because the spread is "only two cents". But without HFT the quote would be 30.20$/30.40$. Now, if you enter a bid at 30.25$, in which situation are you more likely to buy the stock at this great price? (forgive me for promoting my own holdings).

 

If you are a patient value investor, liquidity is not necessarily a good thing.

[writser]

LOL Fair enough. I just dont want to read a 4 part series on legalized front running. The guy should be able to tell you in 2-3 sentences how its helpful to society. I have a reading list 8 miles long, and this wreaks of a guy trying to justify bullshit because it pays the bills.

 

I will probably not convince you but let me try. HFT firms mostly earn money that would have been earned by other market makers, like the "good old floor trader" and the "nice broker on the telephone". HFT firms can afford to give sharper prices because their systems make faster and better decisions. It's like a race to pick up nickels in front of a steamroller. Twenty years ago, floor traders would only pick up nickels a meter in front of a steamroller. Nowadays, HFT firms can pick up a nickel 5cm in front of the steamroller. It doesn't make any difference for the guy throwing away his nickels. But people are angry about this because A) they are scared of a robot racing around collecting nickels and B) they do not realize that they were fucked even harder by their friendly broker 20 years ago. The guy sounded so human on the telephone! ;)

 

Regarding front running:

 

A) No electronic exchange allows front running because this would kill their business instantly. It's a myth.

B) Where do you think front running would occur more often? In an anonymous, completely automated electronic order book or in the "good old pit" where you can wink to your favorite trader if you have a big client on the phone?

[benhacker]

What Writser said.

 

Most of the issues with HFT could be solves by some simple sounding (might be hard to impliment) rules. 

 

1) Ensure quotes have to put in place for a minimum period of time (say 1 second)

 

2) Ensure HFT have to register as market makers and can't exploit rules that disadvantage registered market makers (For good reason)

 

The goal of a market is to have real bona fide market makers with very tight spreads.  HFTs tighten spreads but may bring some other negatives.

 

The whole front running BS has nothing to do with HFT from what I can tell, and is just a misnomer.  You can read what the CEO of IBKR has to say about some of this to get some color and I think.

 

I'm sure there are many ways to manipulate the market, and I'm sure I don't know all of them, but I think it is too easy for folks to conflate a term that is nebulous at best (HFT) with a range of activities that take place in the market that may or may not be very applicable. 

 

In the end, it is far to easy to demonize what we do not understand well and it's easy for the mind to be lazy and not try to learn more.

 

If anyone has some solid documentation about why HFT is worse than I've described above, I would be happy to read it...

 

Ben

 

PS - Long IBKR

[Myth465]

Thanks for the various replies. I will read the article, this weekend. The replies are interesting and provide the other side of the argument that isnt usually heard in value circles.

[Liberty]

Part 2:

 

http://www.chrisstucchio.com/blog/2012/hft_apology2.html