

New stock market for long-term investors/reducing high-frequency trading - ad
http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=akTimUBYXtW4

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noname123
Excellent. Another dark pool for people who think that they are safe. There
are already have a bunch of these, Crossfinder, Liquidnet etc.

Here's how you game them without being detected. Have your long term hedge
fund/mutual fund department set up an connection to that market. Make sure
that you only do long term investing on these venues (e.g., buy blue chip
stocks that have low PE) so that they don't ban you.

Now you feed the information about displayed liquidity on high volatility
stocks that you are interested in trading (e.g., small biotechs) from those
exchanges. Especially this new one that isn't even a dark pool but has
displayed liquidity.

Now next you use that information to front-run the mutual funds who are trying
to execute their VWAP in other exchanges such as BATS. Most investors don't
have access to dark pools and dark pools aren't obligated to conform to NBBO,
so you could get cheaper shares elsewhere and sell when the VWAP is reported
in the next hour/end of trading day by dark pools.

Other way you can play this is play the liquidity rebate game. So much rebate,
$.14/100 shares. Just trade C all day long, high liquidity, low slippage.
Offer and buy back at same price as long as C doesn't slip too much. Guess
who's paying for the rebates, the mutual funds who's taking the liquidity.
Wall Street, what a scam.

~~~
qq66
You sound like you have a lot of experience here but I can't understand what
you've written. Can you explain in a little more detail?

~~~
noname123
Typical stock exchange is a lot of like eBay bidding auction. A full-depth of
quote book is maintained for the best and near-best bid and offers. When a
buyer's highest bid price matches with a seller's lowest offer price matches,
an transaction is made. For those bids and offers that are below/above the
current market price, they are kept on the books.

Now HFT algorithms, daytraders and market-makers all monitor this full-depth
book for patterns whenever a large order is coming in. Suppose I'm a Fidelity
Investment trying to acquire 5 million shares of MSFT for my $20 billion
mutual fund, if I just put that huge order out there on the order book.
Everyone else will jump in and buy MSFT; front-running me because stock market
is like everything else, supply-and-demand; when there's a huge demand and you
buy the supply ahead of time, you can charge more and make profit.

So to disguise my huge order, mutual funds prefer dark pools where the full-
depth of books are not maintained. Instead, it's like shooting fish in the
dark. A big mutual fund wants to buy 5 million shares of MSFT at 25, another
big fund wants to sell 5 million shares at MSFT at 25. You submit your order
to that market totally blind because there's no quote book and just have to
see if your order gets filled. But the positive side is that no one could see
where the market demand and supply is, so the mutual funds gets their orders
filled and not front-runned. Dark pools also typically limit their
participants to large institutional investors to limit the information because
what HFT firms used to do is to "ping" the dark pools, send out random orders
to buy 1 share of MSFT at a certain price to see if there's a "whale" order
out there and then proceed to front-run. So lots of them got banned.

Now, the problem with dark pools is that there are sometimes not many people
who trade on it because it's "dark," kind of like egg-and-chicken problem, no
one could see the full-depth of book and so don't put their orders out there.
That's what's called lack of "liquidity". Exchanges want to have people trade,
because the higher volume, the more people will come and trade on that venue
and the more money they make. So this "light pool" tries to fix this problem
by having "displayed" quote book but the market participants are still limited
and regulated still to make mutual fund participants comfortable about not
being front-runned.

Well, as the saying goes, "it's never illegal unless you get caught"; so
suppose if you are a huge fund or a bank with a HFT prop desk. You could
register your mutual fund section with this "light pool" for its displayed
liquidity. Now, you might even do some real trades on the exchange to make
everything legit; but feed the market data section for your HFT prop desk
which is registered with a totally different LLC designation, and have that
fund execute orders on other exchanges based on information from this "light
pool" (e.g., whale buy order on IBM on "light pool," front-run IBM on BATS).

Now for liquidity rebates on these exchanges, exchanges are now locked in a
bitter battle to see who can attract the most volume and trades (because it's
a snowball effect, more volume, more interested traders who come on to trade,
more money). So they offer "liquidity rebates" for traders who put orders out
there on the full quote-book because the more entries on a exchange's order
book means that there are greater potential for greater volume on a exchange.
A more concrete example is, let's say I'm a liquidity rebate trader on
Citigroup (NYSE: C); C is last traded at $4.30, with national's best bid at
4.29 and national's best offer at 4.30 (NBBO). So I could submit out a sell
order for C at $4.30 on the exchange's quotebook (I don't have to physically
own C, I could short sell the stock). Now although NBB was at 4.29, someone
might come alone and they are really impatient and submit a market order to
buy C at $4.30 and they hit my order; now they are "taking" liquidity that I
put out there on the market. So they are paying the exchange for the liquidity
for doing so, typically, $0.02-$0.05/100 shares and to encourage more
liquidity providers like me, the exchange passes some of that profit to me,
$0.01-$0.03/100 shares.

Now a stock like C is heavily traded, there are literally thousands of orders
on C's quotebook just between $4.30 and $4.29; suppose that a bad/good news
come out on Citigroup, many of the traders who have their offers to buy or
sell C at these cents increments might not all cancel their orders to adjust
the valuation of C to the new news. This is called "low slippage," that in a
high volatile event, you could trade out of your positions very easily with no
"slippage" as trading in a small cap stock where in a volatile event, no one's
willing to trade with you.

This is perfect for a liquidity rebate trader who literally goes around all
day, offer to sell C at 4.30 and then buying back their short C shares at
4.30. They break even on the trade and get to collect $0.02-$0.05/100 shares
liquidity rebates. So you do this over and over again on the market,
generating higher volume on the exchanges and get to collect more rebates and
everyone's happy at the expense of the liquidity takers. Now, with this
exchange, the liquidity rebate is at $0.14/100 shares because they want to be
attractive to the liquidity rebate crowd and generate lots of volume; and
because the rebate is high, you could afford even higher slippage on C.

~~~
qq66
thank you so much... I still have a lot to learn about this! :)

------
klochner
I like that this innovation is market-driven and introduced as a competing
alternative, rather than imposed on existing markets in the form of
regulation.

It will be interesting to see if this market provides better pricing for non-
HFT participants.

The HFT outfits claim they net out to better pricing for all ("liquidity
benefits"), but that's somewhat hard to swallow given that they're acting as
giant money sinks on the market system.

~~~
tptacek
I don't understand that last sentence at all.

HFTs demonstrably are liquidity providers. That's a technical term with a real
meaning: liquidity is the ability to trade when you want to trade in the
quantity you want to trade it, and it most certainly is _not_ a natural
property of the market; in order to buy an instrument, someone has to be
willing to sell it.

Meanwhile, what is a "giant money sink", and how is that what HFTs are? I see
how HFTs cut out the middlemen who used to profit from volatility, but the
low-tech traders they replaced were not themselves value investors.

~~~
hackerblues
My take on the money sink comment:

If there are n people in the market moving money around in a closed system
then the combined wealth of those n people is constant.

If another person joins in and is making a net profit then it must be the case
that the combined wealth of the original n is decreasing.

Admittedly this relies on money not being created or destroyed, which may
cause the model to be a poor approximation of reality.

~~~
tptacek
The stock market is not a closed system. The total value contained in the
markets rises over time.

~~~
klochner
Not as a result of trading.

You can argue that getting equity pricing right helps companies with their
access to capital, but once you have the pricing right at 100ms I don't
understand what value HFT firms are adding by pouring money and talent into
getting the pricing right at 10ns.

It seems like such an obvious win for society to mitigate the winner-take-all
incentive of being first to market on a pricing disparity.

~~~
tptacek
That's slippery slope logic. If the pricing is right at 1s, why pour money and
talent into getting it right at 100ms?

What's the win to society to "mitigate" an "incentive"? Is the problem
volatility? Other forces create huge volatility. Should we penalize anything
that creates volatility? Maybe we should end all program trading?

Meanwhile, you're effectively vouching for a comment that models the markets
as a closed system of people dividing up a single pot of money. Isn't it plain
that such a model is wrongheaded?

~~~
yummyfajitas
_What's the win to society to "mitigate" an "incentive"?_

The main incentive is reducing time and energy devoted to a zero sum game.

A hypothetical: imagine a sunken pirate ship is discovered. Now suppose 10
crews of divers get into a race to retrieve the pirate gold. It's useful to
society to bring up the gold. It might be useful to society to have a race
between 2 crews to bring up the gold, to make sure the first crew doesn't
dilly dally. The gain to society is $GOLD - 2 x $DIVER_COST, or perhaps
$GOLD_AFTER_LONG_DELAY - 1 x $DIVER_COST. On the other hand, having 10 crews
of divers all competing for the gold is pointless - the gain to society is
$GOLD - 10 x $DIVER_COST, which is 8 x $DIVER_COST less than if 2 diver crews
chased the gold.

HFT is basically the same situation as the race for pirate gold - a lot of
smart people in a race to create a fixed amount of alpha. We might be better
off if they were creating new alpha elsewhere instead of all simultaneously
chasing after the same alpha.

(That's not to say I'm advocating a ban on HFT on this ground. A certain
amount of effort devoted to HFT is certainly a good thing, and I doubt the
government would get things right. I just don't think the market is getting
things perfect either.)

~~~
tptacek
So this argument makes a lot of sense, but you see that it's not the argument
that's being employed against HFT in general, right?

What I see are a lot of people arguing that the HFTs are getting an unfair
edge on other traders, as if some main street stock picker was actually in
competition with an HFT prop trading shop.

My sense of it is that many of the people making this arguments believe that
were it not for HFT's, people would have frictionless access to a real
efficient price for any instrument they wanted to buy, when in fact they'd
just be dealing with a much clunkier and less reliable set of middlemen.

~~~
yummyfajitas
I know this is an uncommon argument against HFT - I've only heard Tyler Cowen
pushing this argument, but it's the one I find most plausible.

As I said, a certain amount of HFT is a good thing. If I thought it was
harmful, I'd quit my job as an HFT programmer and find something else [1]. I'm
just pointing out that there are costs, which don't necessarily outweigh the
benefits after a certain point.

[1] This was a major reason why I quit my job as a postdoc, rather than trying
to become a professor. I believe college is mostly rent seeking and I don't
feel it's right to participate in that.

~~~
Eliezer
So you left academia to become an HFT programmer because you thought academia
was too unproductive in the context of larger society? That's one hell of a
scathing critique of academia and, er, um, I can't help but wonder if the
money might have had _something_ to do with it?

~~~
yummyfajitas
Actually, the money wasn't a major factor. It's piling up, but I literally
have no idea what to spend it on.

Here are my opinions from when I was an academic (I've only been working in
HFT since March 2010, full time since May 2010):

My opinion from 347 days ago: _universities have vastly more problems than
that. They are huge bloated organizations structured around funneling money to
employees (from both students and the government) rather than educating
students. The main reason people still go is for status signaling purposes,
otherwise they would have been replaced long ago._

<http://news.ycombinator.com/item?id=1087281>

From 406 days ago: _a $10 million grant; my university will take about $5
million off the top in "overhead" (to be spent on overpaid administrators,
student stress counselors, the latino student center, and maybe even
education)._

<http://news.ycombinator.com/item?id=969664>

(This was roughly the period when I decided to leave academia.)

From 469 days ago: _The job description of "professor" is certainly a strange
beast: teacher/scientist. It makes about as much sense as
actor/programmer...The perverse incentives this creates are massive.
Universities hire scientists rather than teachers in order to get their hands
on half the scientist's grants. Scientists waste their time masquerading as
teachers... This is harmful both to science (I'm not doing research in class)
and students...Actual teachers are squeezed out, since there is no room for
them._

<http://news.ycombinator.com/item?id=851218>

From 999 days ago: _Another part of the problem is that there is no incentive
for cost control in the university...I'm currently teaching a "Quantitative
Reasoning" class right now. Basically, take Weeks 1-2 of Prob &Stat and expand
it to fill a whole semester (half a semester, due to poor planning and
miscommunication). Some of this is my fault, some of it not...Plus, my
students are all art/history/literature majors, and just don't need it.
Everyone in the room would be better off keeping their $4,000 and not sitting
through my class._

<http://news.ycombinator.com/item?id=166307>

~~~
Eliezer
Fair enough. Well, that'll stand as one hell of a scathing critique of
academia then.

------
beoba
"The ECN is aimed at institutional investors such as mutual funds, hedge
funds, pensions and endowments."

Here's a better solution for us poor people:
[https://personal.vanguard.com/us/funds/snapshot?FundId=0085&...](https://personal.vanguard.com/us/funds/snapshot?FundId=0085&FundIntExt=INT)

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AndyParkinson
Am I the only one who thinks this is pointless? I don't trade billions of
dollars of equities, but I am a long-term investor.

One of my big rules as a long-term investor is that I can't sweat the 1/8ths
and 1/4ths (borrowed from Philip Fisher). The time I spend worrying about
these high frequency traders getting a few extra cents out of me is time
wasted finding great companies that are selling at a discount.

Sure... Its annoying, but if you really are a long-term investor a few tenths
of a percent won't kill you.

~~~
tptacek
Who's to say you're on the wrong side of that 1/8th? HFTs have downside risk
too.

~~~
AndyParkinson
Well, thats true. And humans are loss-hating creatures, so we tend to worry
about that side of things.

I guess what I'm saying is that I don't care either way.

------
jrockway
What exactly is the incentive for reducing high-frequency trading? People are
offended that computers can make investment decisions better than humans?
Computers making trades is not "really" investing?

Markets are based on trading. If there are no trades, there are no markets. If
you want to buy 1000 shares of ABC company, and nobody has 1000 shares, guess
what, the trade is not going to go through. This is what will happen on a
restricted market.

Similarly, high-frequency trading means price corrections occur more quickly,
meaning that when you buy or sell security foo, it is more likely at the
correct price. Now you can argue that nobody really knows the correct price,
but that is orthogonal. (Computers make mistakes, but so do people. There are
some markets that are still not made on exchanges, and they are subject to the
same whims that the equity markets are. Computers are buggy. People are
irrational.)

My guess is that this market is for people with a lot of money that like to
talk on the phone with bankers. They will get a "safe" investment (or so the
dude on the phone says), and Credit Suisse will get a nice cut. Hint: whenever
a bank invents a product, the main idea usually revolves around them getting a
cut.

~~~
grav1tas
> Hint: whenever a bank invents a product, the main idea usually revolves
> around them getting a cut.

Replace "bank" with "just about anybody" and you have a winner.

------
gersh
I think Credit Suisse is just spreading FUD, so they get people to trade on
their own market, instead of some upstart HFT firm. Every new rule and game is
just another money making opportunity for a opportunistic firm.

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sundae79
Actually since it is aimed at institutional investors such as mutual funds,
hedge funds, pensions and endowments this will force you to buy mutual funds
instead of being an individuall long term investor.

~~~
klochner
Research points pretty heavily to you being better off buying a basket of
index funds rather than playing stock picker.

~~~
sundae79
That is a totally different discussion. The title of this article is
misleading since the exchange that they are creating for supposedly, value
investing, doesn't really allows any value investor now, does it? Other than
of course institutions.

------
joshu
I wonder how this is different from, say, Posit?

~~~
jeffmiller
Posit only runs crosses at a handful of fixed times throughout the trading
day. LightPool sounds like it will be a continuous market.

------
hop
HFT has a negligible effect on long term investors anyways, its all on the the
underlying company.

------
tastybites
How can shares of a particular security have two different prices on two
exchanges without a horde of very smart people rushing in to arbitrage?

~~~
tptacek
I can't see how they can.

~~~
yummyfajitas
Near as I can tell, fees will be high enough so as to make the arbitrage
unprofitable.

I believe the mechanism going on here is this:

Big Traders offer to buy at $10.00 on Light Pool. Their offer sits there, and
gets filled slowly over time. Then, for whatever reason the price moves, and a
bunch of speed traders try to sell on INET/ARCA/BATS at $9.99 (perhaps in
anticipation of the market moving down to $9.90). Due to the high fees, they
don't place those orders on Light Pool. The market crosses for a little while,
no trades occur, and Big Traders get the opportunity to pull their $10.00
order from light pool.

However, the article wasn't clear enough for me to be certain.

------
borism
Doesn't Credit Suisse have pretty active HFT desk?

Just another way to shaft their own customers, isn't it?

~~~
andrew1
They're not shafting anyone, no one will be obliged to trade on this market.
People are only going to trade on it if they believe they'll gain some
advantage through doing it - so conversely you could argue that by offering
this service Credit Suisse are doing their customers a favour.

~~~
borism
dear god, how tired I am of this "no one will be obliged" argument!

no one is obliged to have an iphone or credit card too. that doesn't mean that
a lot of people can't have them, and the fact that they got them voluntarily
(or more likely trough carefully crafted advertisement) doesn't mean that
companies providing them can now do as they wish with their customers!

 _believe they'll gain some advantage through doing it - so conversely you
could argue that by offering this service Credit Suisse are doing their
customers a favour_

you're doing your customers _a favor_ when you're actually giving them some
advantage, not making them believe in you doing so.

~~~
andrew1
I'm not really sure what you're talking about.

A market participant will choose which exchange to execute a trade on based on
their analysis of those exchanges. If for a particular trade they decide that
out of all the exchanges, darkpools and this new lightpool available to them
that the exchange that is most suited to that order is the lightpool, then
they'll probably route it there. What do you expect them to do? If you're
going to buy or sell something then there's an associated cost to doing that
whether you do it on the NYSE, in a darkpool, or in this new lightpool.

Credit Suisse don't 'own' any customers, people who trade on this exchange
will have no obligation to trade there, it sounds like you think that there
are people who are forced to trade through Credit Suisse and so will be forced
to use an exchange run by Credit Suisse. That is not the case. If they don't
like what is on offer at Credit Suisse then they can trade directly in a
market, or they can use another broker.

