

Study: High Speed Trading Hurts Long-Term Investors - ad
http://online.wsj.com/article/SB10000872396390443931404577551633192136866.html

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ChuckMcM
Gah what a stupid article. Consider its foundational point:

 _"Pragma measured the effect by comparing the volume in certain stocks with
the time it takes to execute an order. Longer execution times typically result
in poorer results, since a stock's price can swerve away from where it was
when the order entered the market. Such an effect is known in the industry as
a "shortfall.""_

If you are a "long term" investor you don't sell stocks to capture a few
pennies here and there. You buy at price $X and hold it for a while, maybe you
put in a stop order [1] so that if the shares start heading for the floor you
will automatically exit. You set a value you want to see for your 'gain' and
you set a limit order [2] when the stock starts getting close. The limit fires
and you exit the stock. Even if it keeps rising and rising.

The basis for the claim in the article is that some HFT house might buy your
stock when it hits the limit order price, because it is predicting it will go
higher and then instantly resells it for a bit more than your price. You've
cashed out already (closed your position) and they skimmed a bit of cream off
the top. You didn't 'lose' any money at all.

For those not familiar with stock trading:

[1] A 'stop' order tells the firm holding your stock that if the stock drops
below a certain price (the stop price) to automatically sell the security. So
if you buy a stock at $10/share and you don't want lose more than 20% on it
you might set a stop order for $8/share.

[2] A limit order goes the other way, you tell the broker that if the stock
ever gets to a certain price to sell your shares. So if you are looking for a
10% return on your $10/share stock you might put a limit order in for
$11/share. (or $11.25 if you want the 'net proceeds' to be $11/share).

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stcredzero
_> If you are a "long term" investor you don't sell stocks to capture a few
pennies here and there._

Yes, but I'm still certain that high frequency traders are siphoning value off
long term traders when the latter have to transact.

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ChuckMcM
I would be interested to hear the sequence that makes this true. Lets say I
put a limit in on stock FOO at $32 and it fires and I get my $32 * n dollars.
What did the HFT do to siphon value off my trade? Or off the stock for that
matter?

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squires
I'm not involved in HFT, but I imagine the following scenario is plausible:

You place a limit order to buy FOO at $32

Someone else offers FOO at $31.90

A HFT algorithm buys FOO at $31.90 and immediately offers it at $32

You buy FOO at $32 from the HFT algo

So you have lost potential profit on the transaction even though you
technically hit your limit price.

~~~
yummyfajitas
_You place a limit order to buy FOO at $32

Someone else offers FOO at $31.90_

At this stage, the matching engine observes that you want to buy at $32, and
someone is willing to sell at less than $32. You trade directly with that
person at $32.

It's actually illegal for any matching engine to match the $31.90 bid, they
must cross trades at the NBBO.

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nvarsj
This comment from the article pretty much sums it up:

"This study treats correlation as though it were cause and effect. The fact
that HFTs choose to trade stocks with bid-ask spreads of two cents (instead of
one cent) does not mean that the HFTs have made that spread larger. The high
liquidity provided by HFT has to let anyone with a market order receive a more
favorable price than they would in the less-liquid market without HFT. HFT is
simply improvement of the labor of market-making through the use of machines.
For the past three hundred years, virtually every mechanization which improved
the productivity of labor was fought by the establishment. This is no
different."

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chrisaycock
The Pragma report [1] that the WSJ refers to investigated when a TWAP algo
would need to "cross the spread". Ie, when the order book is really deep, then
it takes so long for a passive order to execute that crossing the spread
becomes necessary.

This effect has nothing to do with HFT firms. In fact, the referenced white
paper doesn't even mention HFT at all! So it's odd that Pragma's CEO would
make such a remark to the WSJ.

It's even odder that the Pragma paper doesn't mention the numerous other ways
of executing a passive order, such as pegged orders, pro-rata venues, low-
rebate exchanges, or even crossing networks. The authors describe a totally
out-dated view of how liquidity is accessed for a stock like BAC.

[1] <http://www.pragmatrading.com/research/research-notes>

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JumpCrisscross
A similar logic applied to value investing would conclude long-term investors
result in under-valued stocks.

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SeanDav
Not sure it still applies as I have been out the trading game for a little
while now, but in the past the big HFT's had a 20 millisecond window where
they were allowed to see the market orders before anyone else. Thus they could
see say a big buy order coming in and pull their offers or even take out the
offers themselves, knowing that the buyer would have to pay up. This has the
effect of raising execution costs for the company trying to accumulate stock
for their long term positions. Obviously the same techniques would apply to
the long term investor trying to close a stock position by selling.

This was effectively legalised front running of the market, something that
would normally get you sent to jail. In the name of liquidity, exchanges
allowed this and of course they got paid big bucks by the big HFT firms.

The whole trading game is pretty corrupt. You would expect that given the
amount of money sloshing around. For example we knew about market manipulation
in LIBOR for many years. It was an open secret but now the regulators are
"discovering" it because the political climate is such that fewer people are
prepared to live with the big banks excesses.

Still there is plenty more ongoing manipulation going on in trading even as I
write this. I am awaiting the day that the regulators will "discover" these.
Some of the bond markets for example have proportional fill executions. So if
you have the best price and are first in the queue, a big institution can come
along and show an order in vast size, which they have no intention of trading,
just to get a fill of the fraction they actually wanted. You of course are
left high and dry with just about nothing of your order filled because
proportionally it was tiny. It is an amazing sight to behold how these vast
orders come along just as the market is about to move and then instantly
disappear. It is clear to any trader that someone is working on inside
information, but everyone (read: big money)is in on the secret so no one is
telling.

~~~
paperwork
>in the past the big HFT's had a 20 millisecond window where they were allowed
to see the market orders before anyone else

As far as I know, flash trading was an optional feature, designed to be used
by those who wished to shop around their order in a somewhat private network,
before sending it to the wider market.

> This was effectively legalised front running of the market

If you say flash orders were abused, I'll take your word for it, but it wasn't
designed to be a way to front-run. Its purpose was actually to help.

~~~
yummyfajitas
_If you say flash orders were abused, I'll take your word for it, but it
wasn't designed to be a way to front-run. Its purpose was actually to help._

And at least 30-40% of the time, it did help. Anyone with a flash fill rate
lower than that was kicked out of the ELP program.

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yummyfajitas
I don't get it.

Some long term investors are placing passive orders to squeeze out an extra
penny on their investments. I.e., they are running a strategy that's a mix of
long term speculation and market making.

Unfortunately for them (but fortunately for the purchasers of liquidity), they
are getting crowded out of the liquidity selling market by people who focus
solely on selling liquidity.

What's the problem here?

~~~
javert
_What's the problem here?_

This is a hypothesis, but the answer is probably something like: Lots of
people want to demonize free markets, and HFTs are particularly easy to
demonize because it's hard to see how they add value (although they do), but
easy to see that they are ethically self-interested (which people also
unjustly demonize).

My recommendation to HFTs to counter this would be (a) do a better job
explaining the mechanics of how you're providing a valuable service; (b) do a
better job supporting capitalism in general, on a moral level, in the public
sphere of debate. Otherwise, you're gonna have to pack up shop and move to a
more free country pretty soon (if there is one).

~~~
yummyfajitas
_My recommendation to HFTs to counter this would be (a) do a better job
explaining the mechanics of how you're providing a valuable service;_

Shameless plug:

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

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

<http://www.chrisstucchio.com/blog/2012/hft_whats_broken.html>

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rogk11
An analysis of who makes profits when HFT's trade.
<http://www.nanex.net/aqck2/3519.html>

an interesting analysis - results towards the end "The Final Score"

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grandalf
_long term traders have trouble quickly buying and selling the stocks._

If you're a long term investor, and the particular minute of the day when you
make your transaction makes or breaks your strategy, then you were effectively
just flipping a coin with your long term strategy.

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milfot
To come at this from a slightly different angle.. any situation in which an
agent gains wealth without creating wealth is at the expense of the market.

Two questions, first are HFT's creating wealth? second, are HFT's gaining
wealth at the expense of the investors or the producers?

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thrill
Any agent who gains wealth has taken a risk (of loss) that someone else has
not.

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magixman
It seems to me that the 800lb Gorilla in room is the impact of HFT on
volatility which is not really covered here.

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koof
We should really tax all stock trades at .001% or something.

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leoh
Definitely. Could help the economy, too.

