

The High Frequency Trading Scam (2009) - aliston
http://seekingalpha.com/article/151173-hft-the-high-frequency-trading-scam

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cturner
I read this article when it was first published, and it was what first sparked
my interest in the exchange side of the equities world. There's a lot of junk
information on the internet on these topics, and as a result they're difficult
to read up on. A common error I've seen is articles that imply that flash
orders and high-frequency-trading are the same thing, which is incorrect.

    
    
        "Automatic programs began issuing and canceling tiny
        orders within milliseconds to determine how much the
        slower traders were willing to pay
    

I originally understood this to mean that parties were 'painting the tape' by
causing trades to appear with prices different to what the actual market price
is. But that's not it.

In the scenario described, it's not trades that are being issued and
cancelled, but orders. As in, an opportunity to trade if the other party
matches.

I don't think it would be possible to coordinate a situation of sniffing out
the best price as described here. Markets have queues, and if you want your
order to be filled then you put it in the queue where it sits until you cancel
it or it gets filled. It can only be filled when it's at the front of the
queue. So participants in the market compete for queue spots at each price
point from the moment the market opens.

That would be exchange dependent, but that just emphasises the point. If one
exchange did this and another didn't then the exchange that didn't would get
more business because their prices would be better.

    
    
        A couple of years ago if you entered a limit order for
        $26.40 with the market at $26.10 odds are excellent that
        most of your order would have filled down near where the
        market was when you entered the order - $26.10. Today,
        odds are excellent that most of your order will fill at
        $26.39, and the HFT firms will claim this is an
        "efficient market."
    

Citation required? I don't see how this can be true. If the market is at
26.10, then there will be orders in the queue at price points around that. If
the market is scared, then the spread will be wide, but that's to be expected
and accounted for by the fear, not by conspiracy.

Despite all these problems, the criticism of the flash order culture looks
sound. A flash data stream could give a party the ability to cancel stuff they
have in the queue earlier than they otherwise would, and to get to the queue
faster on new information. It seems wrong that there should be a certain type
of information to be available only to certain parties. I think the major
exchanges have stopped doing flash orders now though. There was a lot of press
about the SEC reviewing it after this article last year.

~~~
andrew1
I don't know if it's the case but if you paid a higher rate of commission/fees
on flash orders then it might be the case that the general market is getting
slightly worse prices but at the advantage of lower fees. Which could make it
beneficial for general market participants. As I say though, I don't know if
this is the case.

~~~
yummyfajitas
Flash orders have lower commissions, and always give the best available
price[1] to the buyer.

The mechanics: best asking price is 10.0 on INET, 9.90 on ARCA. You place a
buy order on INET. INET is obligated to route your order to ARCA (where the
cheapest price is available) rather than filling it at 10.0 locally, and you
get charged 9.90 + routing fee [2].

If INET flashes your order, it gives an HFT trader on INET the opportunity to
fill your order at 9.90. In that case, you pay 9.90 for the trade and avoid
the routing fee.

[1] A better price may be available on a darkpool, but the exchange would not
have routed your order to the darkpool since the exchange did not know about
it.

[2] There are flags you can set so that your order is canceled rather than
routed.

~~~
pheon
a very one sided article there and fails to mention the algos used by _your_
broker to minimize information leakage of your trades... if their large
enough. what gets me is the amount of money HFT market makes make off your
trade is tiny compared to the fist full of cash your broker is taking from
you..

------
grandalf
Wow this essay is totally off track.

There is no such thing as a "market price". To prove this to yourself, write a
simple model of the stock market with buyers and sellers. Every order is a
limit order.

What is the "market price"? Is it the last trade? Is it a weighted average of
the last 10 trades? It doesn't actually exist.

At any price there will be a certain amount of liquidity. If you want to
guarantee that you can buy a lot, then you have to pay extra b/c the counter
party doesn't want to sell low so he hedges by adding a bit of spread.

The same applies to selling. If you want to sell a lot you have to discount a
bit b/c the buyer will want a bit of insurance that he/she isn't overpaying.

The HFT algos do add liquidity b/c if the liquidity were there at the first
price probed, then the algo would never really matter, the desired shares
would have changed hands with some other counter party.

~~~
megablast
Clearly, in his example, there are people out there willing to sell at $26.10.
In the old days, you could put out an order from 100,000 shares, saying you
would pay up to $26.40, and you would get most of these shares at the $26.10.
If there were enough people willing to sell that many shares at that price.

Now, even though there may be people out there willing to sell you the shares
at 100,000, these programs can find out your top price, and they will but the
shares at $26.10, and sell them to you at $26.39, thus making a profit of the
difference. Providing no extra services to you, or the market. They have just
stepped in as the middleman with no risk.

This is how the article describes it, and this is how I understood it. Is this
wrong? I think you are just arguing semantics about the term market price.

~~~
tedunangst
Are the shares worth 26.40? Then you should be happy to get them for 26.39. If
they aren't worth it, then don't make that offer.

I don't see why you should care who sells you the shares. You either want them
or you don't.

~~~
andyjdavis
The ethical issue is that someone is deriving additional profit through an
asymmetrical advantage. It's kind of an interesting ethical question actually.

Personally it just feels wrong in some hard to define way to algorithmically
determine the other sides maximum/minimum price through some process they
don't have access to. I can certainly understand why you would do it but it
just doesn't feel quite right.

I don't think I have an ethical problem with using small orders to sound out
the other party. Where it tips over into being unethical for me is if those
exploratory orders are cancelled rather than fulfilled. I'm surprised its even
possible to cancel your offer once someone else has accepted it.

~~~
nitrogen
It seems somewhat like people inflating bids on eBay by incrementing their max
bid by odd amounts until they hit the other bidder's max.

~~~
varjag
Also, it is of note that such behavior is forbidden on eBay and many other
marketplaces.

Not on stock exchange though.

------
bd_at_rivenhill
One thing this commentator (and others) gets wrong is the emphasis on the
place of flash orders in this process. What they seem to be missing is that
flash isn't automatic, it is selected by the sender. In this example, the
implication is that the buyers of broadcom were disadvantaged by flash orders,
but if flash orders were involved at all, then they would have been selected
by those very same buyers, who would presumably not have disadvantaged
themselves. Flash is an attempt by the more technically sophisticated markets
(DirectEdge and BATS) to provide a service to customers who were tired of slow
execution on some exchanges causing their orders to be faded. Any time that I
see someone complaining about this, I suspect that they either don't
understand it, or that they are being paid by someone at the slower markets
(e.g. NYSE) to spread FUD.

~~~
fr0sty
What is also missed is that most exchanges discontinued flash orders late in
2009. BATS and NASDAQ both discontinued the practice, Direct Edge still allows
them (they are opt-in) and NYSE/ARCA never had them.

------
DavidSJ
Doesn't sound like a scam to me. It's as if you own an apple stand, and
customers periodically come up to you and say they would like to buy some
apples. You offer to sell 1 apple at 20 cents, and they agree. Then you offer
another apple at 25 cents, and they agree. Eventually you get to 40 cents, and
they disagree. At that point, you offer all the apples they could possibly
want at 39 cents, and you make a lot of money.

Your advantage wasn't speed. Your advantage is that the other side was a bad
negotiator.

At the very least, they could have placed an all-or-nothing order. Also, this
analysis assumed the seller had no competition.

~~~
ryoshu
It's more like an apple vendor was offering an apple for 20 cents and someone
stepped in between you and the vendor and offered it for 21 cents. You have no
idea that the person offering the apple for 21 cents is not the real vendor,
he's the only person you can buy from. That's what the millisecond HFT systems
are doing.

The prescient part of the 2009 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."

~~~
theli0nheart
Actually, if you have a limit to buy at 25 cents and a seller still exists at
20 cents, the market maker will fill your order at the lower price first.

~~~
afterburner
But, and someone correct me if I'm wrong, not if the HFT apple trader buys
from the apple seller at the lower price and then resells it.

~~~
grandalf
If course the HFT trader wouldn't sell unless it could profit by selling. They
are HFT traders, not market makers.

Obviously if you are buying shares sold by an HFT trader, you are not buying
them from a market maker, so you are getting a better price than the market
maker is willing to offer.

~~~
cturner
HFT is a technique that's used by many people, including exchanges, hedge
funds and market makers. You're right though - the exchange is obliged to fill
the consumer at the best available price.

~~~
grandalf
I meant market makers in the role of traditional market maker (which could be
HFT but is not HFT as a strategy, merely as a speed measurement).

~~~
cturner
Thanks for correction. On HFT - in what sense is it ever anything other than a
speed measurement?

~~~
grandalf
Well, lately people are using HFT to describe specific sorts of strategies...
mainly strategies that rely on per-trade kickbacks, etc., not just high speed.

------
wglb
This is ancient, wrong, and out of date.

Ah for the days when Karl was mcs.net. A finer ISP there was not to be had. I
wish he were still doing that rather than whatever it is that he is doing
these days, with boldface and intensity.

~~~
joezydeco
Seriously, don't poke the yamhead. You'll be sorry.

------
sireat
I just thought of an analogy:

If what happens in the article is correct, it is very similar to what auto-
bidding shill bots do on auction sites, eBay, they obtain information on the
highest price you were willing to pay for an item.

Is this the price we(investors) are willing to pay for 0.03sec liquidity? I am
not sure it is worth it.

------
JacobAldridge
Interesting, given the date (July 2009). Is there a presumed connection with
last week's 1000 point drop? A mis-order to sell at any price meets the HFT
scam that rapidly, though temporarily, drops to the extreme price (in this
case, $0.00 or $0.01).

~~~
btilly
The connection is not so simple. People who do HFT are painfully aware that
orders get broken, and so all exited the market before the drop really began
going. The 0.01 orders are always hanging around.

However the fact that people have come to depend on HFT to help make markets
means that when they disappear unexpectedly the market is smaller than it
would have been, which makes large price swings much more likely.

------
kixxauth
People need to adjust to the presence of HFT. For many traders it breaks the
model they may have used successfully for some time and they just don't want
to go out and update their model.

As typically happens, they go crying to the government to stop the evil
villains from forcing them to change the way they think about a changing
world.

