

Should High-Frequency Trading Be Banned?  - cwan
http://www.freakonomics.com/2011/03/28/should-high-frequency-trading-be-banned-one-nobel-winner-thinks-so/

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cynicalkane
A while ago someone made the interesting point that the costs of HFT are not
being accounted for, from a free-market perspective. Exchanges typically
charge for completed trades, not for orders, so traders can flood exchanges
with very large amounts of orders. In practice, traders that flood exchanges
will face penalties--but that only slows the arms race.

The natural economic question is: if HFT traders are making more orders than
is efficient, who loses? The answer almost certainly has to be the exchange,
and those traders who are losing the time race to HFT's order-spamming
advantage. But when Joe the Consumer places an order on the exchange, he
always get the best price--it's hard to imagine a way Joe, or even Joe's
Mutual Fund, can anything but benefit from HFT.

~~~
baltcode
So they should have a very small fee for orders as well, proportional to its
actual cost, but not high enough to dissuade people experimenting with pricing
as long as they don't cost other people anything.

~~~
yummyfajitas
Typically there is a (very low) order fee - off the top of my head, I'm not
sure if it's levied by the broker or matching engine.

There is also a limit on the number of orders one can place. Your broker will
typically demand fill rates of at least 0.5-1% and will impose limits on the
number of orders you can place in a rolling window.

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HockeyPlayer
Not in my experience. Most HFT shops only pay if an order fills; and if they
are adding liquidity to stocks, they get a rebate.

If your messages/fills ratio gets REALLY wacky, the exchange might complain.

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grandalf
Absolutely, and all traders should be required to use rotary dial phones to
even the playing field further. While we're at it, speaking into the phone at
faster than 200 words per minute should also be banned.

~~~
tzs
I'm leery of HFT, but not out of concern of a level playing field. Consider a
market for some commodity. Start with the simplest market--people who produce
the commodity sell directly to those who use it. Let's also assume external
factors that affect the supply and demand for the commodity are stable over a
long period of time.

After a number of transactions have been done, and the information about these
has spread among the buyers and sellers, the market should converge on some
price for that commodity, which will then be stable.

When some real world event happens that affects supply (a late snow wipes out
newly planted crops, for instance) or demand (Justin Bieber turns vegetarian
causing millions of teen girls to give up meat), the market will adjust to a
new price.

A key thing to note here is that the price depends on real world events and
the knowledge the actual produces and consumers of the good have of those
events.

Now introduce intermediaries who trade in the commodity, but do not product it
or consume it. They speed up the rate of transactions, and help the flow of
price information, and so arguable help the market settle on the correct and
stable price--basically the price you'd have in the direct market adjusted to
take into account the increased transaction cost of having an intermediary.

Since the correct price economically ultimately depends on the factors that
affect supply and demand (the weather, Justin Bieber, and so on), my concern
is that if trading by intermediaries becomes too fast you can get to a point
where the price is not being driven by the real world factors, but rather by
traders reacting to other traders.

In other words, could HFT make the feedback loops that allows a market to set
prices too strong? Feedback as a control mechanism in general is a good and
useful thing, but too much feedback and it can become self sustaining, and the
output of the system depends less on external inputs than it should (or even
not at all).

Until there's solid analysis showing that HFT can't lead to the bad kind of
feedback, I'd rather see it approached cautiously.

~~~
grandalf
I think your argument is essentially an argument against speculation. All of
the fears you cite apply equally to any form of speculation.

The problem is, many things count as speculation -- a farmer who produces a
commodity buying insurance against a poor crop is ultimately a futures
contract.

The way I think of HFT is that it's like increasing the fidelity of a
recording from 11 kilohertz to 44.1 kilohertz. There are a lot more
intermediate data points, but the underlying rationality (or irrationality) of
pricing trends will be the same.

Before HFT, it was more likely that a bid/ask spread would be higher ...
reflecting the risk aversion of the market making firm... With HFT, that
spread decreases b/c the liquidity is offered as part of a small timeframe
strategy which may or may not pay off.

If you weren't concerned with that short timeframe, then it makes no
difference to you whether your order was filled by one party (a traditional
market maker) or 100 parties (each a different HFT algorithm).

I think to assuage your fear I'd probably just say that it's very difficult to
move large numbers of shares at a price that's all that different from the
previous price... So any HFT algorithm will necessarily be dealing either with
largely uncontroversial prices or very small share volumes.

Considering that, I think the overall risk of rogue algorithms leading to a
harmful feedback loop is not significantly increased by HFT, and HFT was
mostly a scapegoat in the recent crash.

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dalore
Why can the banks have high-frequency trading, yet still not have instant
transfers between accounts?

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secretasiandan
One creates directly attributable profits with little, if any, ongoing
exposure. The other creates little, if any directly attributable profits.

Furthermore, if the transfer is from one bank to another, the sender wants to
hold onto the funds for as long as possible to earn more interest.

Lastly, most retail banks probably still run ancient code that is not as
conducive to innovation.

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dclaysmith
Or a $.001 tax per transaction.

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Consultuing
Let me begin by saying that I likely do not understand even half of what HFT
is.

For me, they key part that I fail to understand is exactly what value HFT adds
to non speculative market participants. The only explanation I've heard so far
is that HFT adds "liquidity" to the market, but I don't get how. Let V be the
value HFT adds to non speculative players.

If V is above zero, then allow HFT to continue. If V is zero or negative, my
proposal would be not to ban HFT, but to restrict it to transactions made
between HFT players. Then let them play in their casino all they want until
one player is left. If this suggestion cannot be implemented because HFT needs
the rest of the market to make profits, then I highly suspect that V is less
or below zero and that HFT is really one of the Casino owners.

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baltcode
I don't get it. If the flash crash brought down the market drastically for 20
minutes, only to pull it back up, this only points to an opportunity for a
more intelligent algorithm to be allowed to correct that and make money in the
process. I can understand this as being an example of the state of the art
being pretty dumb/gullible to multiplying its own noise, but I don't
understand why this would be bad. Didn't the algos selling during the low and
buying stocks later lose money?

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yummyfajitas
_Didn't the algos selling during the low and buying stocks later lose money?_

Not necessarily, many trades were broken (mostly trades near the low).

If you sold low and bought halfway to the high, you probably made money since
your sale was broken (but not the buy).

~~~
baltcode
So the problem was that the trades were broken, not HFT per se.

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CJefferson
My main annoyance with HFT is that it clearly is a "game". A few times
algorithms have misbehaved badly, whole blocks of trades have been rolled
back.

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baltcode
Well, if the algos can make money they should also be allowed to lose money.
How else would you have efficiency?

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MarkPNeyer
How about a tax on capital gains that is inversely proportional to the time
the financial instrument is held?

The biggest cost HFT imposes on the world is the brain drain - there are so
many super intelligent people working in the arms race that is electronic
trading. Imagine if all of those smart people were doing something productive
instead of helping people buy and sell options 1 microsecond faster.

~~~
baberuth
I find the "talented people not fulfilling their potential" argument terrible.
That's often cited as one of the costs of HFT, but its really true of a lot of
human pursuits.

It just so happens that the prevailing sentiment is that finance, and HFT in
particular are particularly immmoral, so its a popular notion; I find it as
"bad" that hordes of talented engineers work on optimizing ad revenue for
Google.

Humans will always be underemployed from some perspective ("Oh but she could
be doing X"). Penalizing them for not operating in a way that is consistent
with your (or anyone's) world view is far more sinister.

~~~
pg
The fact that smart people's time is also wasted on other types of work
doesn't mean there is no such thing as wasting time.

Do you really believe it's meaningless to talk about time being misspent?
Would you call it sinister for example to criticize someone for spending their
time murdering people at random?

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joebadmo
I imagine he would call the murdering part sinister, as opposed to the time
spent doing something other than what is optimal.

I agree with the GP that the opportunity cost argument is so wholly dependent
on the judgment of the debated activity that it doesn't really pertain one way
or the other.

That said, HFT doesn't strike me as something that adds value to the economy.

~~~
pg
Baberuth and I are talking about whether it's sinister for A to criticize B's
actions, not whether B's actions are sinister.

~~~
joebadmo
"Would you call it sinister for example to criticize someone for spending
their time murdering people at random?"

I'm saying it depends on what A is criticizing about B. It is not sinister for
A to criticize B's action. I'm not sure if it's sinister for A to criticize
B's misallocation of time spent. It's a weird thing to think about. I think
it's weird to think about because, as was my point earlier, the judgment of
whether the time was misspent is wholly dependent on the judgment of the way
the time was spent.

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mmavnn
How about turned based trading? Once an hour, on the hour, results published
at half past...

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pasbesoin
Something I've favored considering. Put the exchange on a stepped clock.
Randomize order processing within each step.

I don't care if a lot of people lose their financial jobs. Through their own
actions as much as resulting events, they've demonstrated themselves to be
harmful parasites.

Modern society depends upon a degree of stability and predictability. Current
market evolution has been heading in the opposite direction. Time to reign it
in to its role as tool, not goal.

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bartwe
Depends on how you define 'High-Frequency Trading'

