
High Frequency Trading Is A Scam - Flemlord
http://market-ticker.denninger.net/archives/1259-High-Frequency-Trading-Is-A-Scam.html
======
rottencupcakes
Just so you guys know, there's actually nothing economically inefficient with
what these high frequency algorithmic traders are doing.

With the example they gave, the buyer was WILLING to pay up to 26.40. This
means, in the buyer's opinion, the stock is worth $26.40 per share. The
sellers were willing to sell for anything above 26.10, which was the ask
price. As basic economics teaches us, them trading for ANY amount between
these two prices is 100% efficient. And, in this case, it doesn't matter who
gets the extra money, whether that be the seller, the buyer, or the high
frequency trader.

The trader is doing nothing to hurt the liquidity of the market - they are not
'gaming' the system in any way, nothing and nobody is being 'manipulated'. The
seller sold for a price that they thought was a fair value, and the buyer
bought for a price that they thought was a fair value. The traders are simply
looking to make that 30 cent difference. Although it seems like they are
contributing nothing, it is still economically efficient.

~~~
mbrubeck
Except that they're paying money (both to the exchange, for privileged access
to the low-latency data, and to their own employees/vendors for their software
and hardware) to be the ones who pocket that $0.30/share surplus. That's rent-
seeking, and from the point of view of the economy as a whole it is a
deadweight loss. The resources used on HFT could have gone toward creating
wealth, rather than generating a zero-sum transfer from one market participant
to another.

~~~
tptacek
Aren't the HF traders exposing themselves to price risk, creating more
opportunities for sellers to sell and buyers to buy, and narrowing the bid-ask
spread?

~~~
mbrubeck
Yes, that's a good point - and both my criticism and your rebuttal could be
applied to any number of professional traders, not just HFT systems.

I was mainly focused on this claim from the New York Times article: _"A
loophole in regulations allows marketplaces like Nasdaq to show traders some
orders ahead of everyone else in exchange for a fee."_

If true, this means that the HFT operators are not necessarily taking on the
normal level of price risk, and their incentives aren't necessarily aligned
with efficiency as they would be in a neutral market.

And the point I _should_ have made is that most of our market regulations are
not about efficiency, but about more specific ideas of fairness or
transparency. For example, insider trading does not introduce inefficiency
into a market, but it's regulated nevertheless.

------
lrajlich
If you plop a big limit buy order at $26.40 and the market's at $26.20, you
will wind up paying close to $26.40 because you'll eat through all the sell
offers and transact inefficiently. It's called slippage.

However, what's preventing you from getting f __*ed is that this is a market,
so basically you have 10+ HF shops fighting who can be on the other side of
that slippage. The fact that it's a competitive market ensures you don't get
raped like the guy claims.

------
tptacek
Can I just point out --- knowing full well that this is not a meaningful or
valid argument or constructive comment on the article --- that Karl Denninger
is a huge, notorious Internet crank? He's burned a whole through operating
system teams, ISP markets, the security community, at least two major world
religions, the SCUBA industry, and now this. He has a bias here, and it's
towards controversy he can be self-righteous about.

He may actually be right about this --- he is occasionally right --- but man I
wish there was a credible source that backed him up.

~~~
joezydeco
I do too. I almost feel bad saying I agree with the Yamhead, but the more I
read about HST and the wave of financial types claiming this is all perfectly
legal just makes me angrier and angrier.

Without donning the tinfoil hat for too long, you gotta wonder if that source
code Aleynikov tried to take away from Goldman was a smoking gun. I've never
seen the FBI move so fast. When the hat comes off it's probably just one
mechanic trying to take the toolbox to another garage.

------
bigwill
I think this characterization of HFT is a bit overblown. The activity he's
calling unethical--offering a security at price, getting hit at that price and
continuing to raise your price until you stop getting hit--is exactly what
market makers have always done. This is basic free market dynamics. You offer
at $100, you get hit, you raise your price a little bit, say $100.05, and see
if you get hit again. Don't get hit? Ok, drop your price back down a little.
The same thing happens in open pit trading, it's just a lot slower.

------
BrentRitterbeck
Here's a good thread over at New Mogul on the subject. This type of trading is
not illegal, and it's actually commonplace among the big players on Wall
Street.

<http://newmogul.com/item?id=14134>

~~~
roc
Call me jaded, but 'commonplace' and 'not _technically_ illegal' don't strike
me as a very compelling defense.

~~~
BrentRitterbeck
Please don't try to interpret what I meant. What I wrote is exactly what I
meant to write. This trading is not illegal. This trading is perfectly
acceptable. The only people who seem to have a problem with this are a subset
of the people who don't have the resources to do it. Frankly, the arguments I
have read against it are mostly penned by ignorant folks who simply come
across as jealous.

~~~
ynniv
> The only people who seem to have a problem with this are a subset of the
> people who don't have the resources to do it.

That's likely true, since only a couple of firms can do it, and there are
millions of people's interest in the markets. The NYTimes article this article
pulls from specifically points out that these few firms are taking money out
of the pockets of "slower" firms, like hedge funds. Given that a large number
of people in the country have their retirement funds tied up in hedge funds,
until someone shows otherwise, this is clearly the rich stealing from the
poor.

I understand that those in the industry have a different worldview, but try to
see the bigger picture. The only difference between grossly immoral and
illegal is a few years and a new law. If this isn't illegal, its because the
population hasn't been sufficiently outraged. Yet.

~~~
BrentRitterbeck
I do see the bigger picture. I've worked in the industry, but I've moved
myself outside the industry to go back to school. I do not feel in any manner
that I am being stolen from. When I enter a trade as a retail investor, I
accept that I don't have nearly as much information about my trade as I would
like to have. I wouldn't walk onto an NFL field expecting them to change their
ways simply because I can't bench 400 pounds.

~~~
ynniv
With due respect, this isn't about you, or me. It isn't your money (or mine,
as I don't invest in the market) at stake here. Yes, financials are a
competitive place to be, and you may have a great deal of humility as well as
respect for those in the market. Like it or not, there will be a day of
reckoning, when the average person will realize they are being had and take
their money (aka "the leverage" that makes those commissions larger). That day
will be much farther off if average people feel that they are being taken for
less of a ride.

~~~
BrentRitterbeck
What I'm about to say is not pleasant. It comes from working in several
different parts of the industry.

The greatest thing Wall Street sells is dreams. This will never go away. Every
buy carries with it the thought that this one will go higher. Otherwise people
wouldn't buy. As long as Wall Street continues to allow retail investors to
play in the markets, there will be people who will come along for the ride.

EDIT: Don't get mad at me for saying it. I think I'm doing people a favor by
pointing this out. You won't hear this from many other people.

~~~
ynniv
Certainly not mad at your for saying that... I personally have this opinion of
the markets, and thats why I don't "invest". When I go to Vegas, I have a
great time, and treat money on the table as an entertainment expense. That
said, society has convinced the average person that their retirement money
needs to be in the market (via 401k's). As long as it is the case that
uninformed people are coerced into trusting the market, I will be vocally
angry when they are cheated out of their money.

~~~
joezydeco
I personally have no problem with people investing their retirement in the
market...if the market was directly tied to the economy and the growth of
companies.

But I don't see that market as being ABOUT that anymore. It's become a world
of side bets and arbitrage plays. When an outsider analyst has more influence
over the price of a stock than the company itself, then the market is a game,
not an investment.

For example: a company can show growth, real POSITIVE growth...but
ohmygodholyjebus if it's not EXACTLY what the analysts predicted then the
stock is toast for the quarter. What the hell is that all about? Why do we
play quarter to quarter instead of decade to decade? Because Wall Street is
now about churn. And churn makes commissions.

~~~
BrentRitterbeck
What you are talking about is market efficiency at work. You can't accept some
things about the market and not accept others. The market can be viewed as a
machine that takes information and turns it into a stock price. Previous
information, such as an analyst's predictions, do influence the price of a
stock. If the company releases their earnings, a new piece of information, it
is only natural that the price would adjust to reflect that. What many people
fail to understand, is that an earnings announcement carries with it much more
information than just how the recent quarter was.

Now, with that said, I will say that I don't believe the markets are 100%
efficient. No matter how many papers Sharpe, Fama, French, and others publish,
I will never change my mind. Globally, the markets are extremely efficient,
but there are local inefficiencies. Identifying and exploiting the local
inefficiencies are what makes one really good at making money off of the
markets.

------
ableal
The 'price limit' phrase reminded me of the traditional fish selling method
called 'lota' in my corner of Europe.

It goes like this: the fishing boats come in, crates of fresh fish are brought
to a market area where buyers await. For each crate, the announcer starts with
a high price (say 100) and counts rapidly down ("99, 98, 97 ...") until one of
the buyers shouts out "Soo" to buy the crate at that price.

Not as amusing as bidding up an auction, but this seems a time-efficient
method for finding the buyer's price limit - after all, the fish is not
getting any fresher sitting there ...

------
tptacek
From the article:

 _"If you're wondering how Goldman Sachs and other "big banks and hedge funds"
made all their money this last quarter, now you know."_

But from this article at Bronte Capital (via New Mogul):

 _"Anyway if 10 percent of global stock volume provides 220 million dollars
revenue per quarter then there is no way that a substantial proportion of
Goldman’s trading profit can come from high frequency trading. The numbers do
not work."_

([http://brontecapital.blogspot.com/2009/07/high-frequency-
tra...](http://brontecapital.blogspot.com/2009/07/high-frequency-traders-
phoney.html))

------
jongraehl
John Hempton thinks it's impossible for this to amount to $22billion/yr -
[http://brontecapital.blogspot.com/2009/07/high-frequency-
tra...](http://brontecapital.blogspot.com/2009/07/high-frequency-traders-
phoney.html)

He's not a crank.

------
rwolf
This sounds like the kind of story Technologists love.

Machines at better are stock market trading, so the humans are being replaced
in this industry.

------
stuffthatmatter
When the average investors leave the market because of this, front running
(<http://en.wikipedia.org/wiki/Front_running>), , and the fact that small
number of firms (~400) is involved in 70% of the US trading volume
([http://www.ft.com/cms/s/0/a5f03366-6d69-11de-8b19-00144feabd...](http://www.ft.com/cms/s/0/a5f03366-6d69-11de-8b19-00144feabdc0.html)),
will they ever come back?

~~~
BrentRitterbeck
The average investor is not going to leave the market. I spent time as a
retail broker, and the truth is most have no idea what they were doing to
begin with. I don't think this is going to persuade them to stop.

~~~
stuffthatmatter
Those investors (no idea what they were doing to begin with) already got
spooked by the 60% drop and pulled out of 401k/into bonds. I mean the average
investors who have some knowledge of the market, and have decent capital
(20k-200k) but is just trading normally using online trading services.

~~~
BrentRitterbeck
Trust me, they don't leave. There's something about the markets that make
people think that they can compete against a firm with a multi-billion dollar
IT department, a slew of economists, and direct access to the exchanges. I'm
not denying that the game is in favor of Wall Street firms. I'm simply saying
that this will not cause retail investors to exit the market.

