

The rise of high frequency trading - graphic animation - usedtolurk
http://www.nanex.net/aqck/2804.HTML

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nanex
Hi,

I am Eric Hunsader from Nanex and created this animation using our own custom
software tools and our NxCore data feed.

Our position on HFT can be summed up in the first lines of text below the
image: "It's not high frequency trading (HFT) that concerns us. It's high
frequency quoting". Links are included for details. Our latest paper on HFT
can be found here: <http://www.nanex.net/aqck2/3532.html>

Anyone who has taken the time to really look at the contents of the tsunami of
data that _some_ HFT creates will come to the conclusion that something very
wrong and harmful going on. We've found this is nearly impossible to convey in
text or graphics (with the possible exception of this animation), and sooner
or later as more and more academics get up to speed, they will generally come
to the same conclusions we have.

Our primary business is providing a real-time (and historic ) data service for
U.S. Stocks, Options and Futures. In the course of monitoring our feed for our
subscribers, we run across anomalies that we think need to be published for
the public good or long term health of our markets. We have not received a
dime from any of our analysis and not a week goes by that we don't regret
opening that Pandora's box.

I will check back later today to answer any questions. If you don't receive a
reply for a few hours, it's because we are working at our "day job".

~~~
peteretep
Your data shows the increase in HFQ relative to much lesser increase in HFT
well, but neither of the links I followed to why HFQ is bad gave me much of an
idea, other than "it's extra network traffic".

~~~
lrm242
Exactly. Nanex does not like high message rates because it increases the cost
of running their service. like yummyfajitas and yourself no one can explain to
me why high-rate quoting is bad. Producing pretty graphs showing quotes at
regular intervals doing interesting things is not indicative of bad behavior,
especially when many of those charts include after market data when the depth
is extremely thin. And remember, every venue enforces message rate limits
already.

~~~
muench
The link in the original post labeled "high frequency quoting" led to a page
[1] that makes a more concrete claim. Basically they say that the NBBO
(national best bid and offer) are being manipulated to be small when there is
no trading and larger when there is trading.

I think that's at least a little disingenuous though... If there is no trading
then it makes sense that bids will be increased and offers decreased in order
to 'entice' trades. No trading means the bid/offer are too low/high - basic
econ 101.

As soon as there is trading two things happen: 1) bids and offers are hit,
meaning they are removed, leaving lower/higher bids/offers as the next best.
2) The HFT algorithms know that when there is a lot of trading they should
lower bids and raise offers, because excess demand indicates the bid/offer are
lower/higher than they need to be. Essentially, they are realizing that they
are leaving money on the table.

This all might look like price manipulation to an outsider, but to anyone that
knows what is going on it's just the way markets work. The difference is that
it happens a lot slower in markets humans are used to.

In my mind what would indicate a problem is if bids and offers widen AHEAD of
trading. This would mean the HFTs are finding out that somebody wants to trade
and adjusting their quotes BEFOREHAND. That's front-running and illegal. But I
don't see evidence of that here.

[1] <http://www.nanex.net/aqck/2685.HTML>

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theorique
I like Nanex's work - the company has done a lot of excellent analysis of the
progress of HFT over the past few years.

I'm wondering why there tends to be so much value judgment and moralizing in
this area coming from various sources (such as Themis).

For example: HF traders are taking value from "real" traders ("real" defined
by whom?), the systems are "too fast" (compared to what?) or quoting "too
much" (compared to what?), and so forth.

Exchanges already seem to be penalizing participants with very high quote-to-
trade ratios, suggesting that the existing regulatory and commercial system is
responding to the needs of its stakeholders.

Maybe this kind of reaction is inevitable. I'm sure that there was moralizing
in ancient Greece when some entrepreneur bought a load of olive oil at a low
price in Athens and ran it on a fast chariot to Thessaloniki, unfairly
undercutting the honest merchants of Thessaloniki and pocketing a tidy profit
through their "high-speed trading" … same thing with those who used an
undersea New York - London cable to gain advance knowledge of events.

~~~
Retric
The point of the stock market is to create a liquid market for businesses and
investors. HFT who don't actually keep any skin in the game is just a market
efficiency which is best dealt with by changing how the market operates not
flooding it with 100 billion meaningless buy and sell orders a day.

EX: Put a 24 hour hold after a stock transaction is held before you can sell
and you just killed 99% of HFTing.

~~~
theorique
_Put a 24 hour hold after a stock transaction is held before you can sell and
you just killed 99% of HFTing._

Not just HFT - you just killed some significant fraction of _all_ forms of
trading. Bought something and it's declining? Oops, too bad, you're locked in
- better wait 24h. The arbitrary phase shift of transactions will add massive
amounts of complexity and create a new system to be gamed.

Edit: Also, regarding "skin in the game" - the recent $440M Knight fiasco
shows that firms participating in all forms of HFT are exposed to real
financial risk. They _definitely_ have some skin in the game.

------
Variance
This is an excellent graphic, but the author has a strong stance against HFT
(such as the pages he links to about high frequency quoting) that readers
should moderate with an understanding of what HFT does in an ideal economic
context--the "purpose" of HFT.

At the level of HFT, the decisions being made are too fast and frequent to be
based on the fundamentals of the stocks being traded. Instead, algorithms are
used to make trades based on "technical" analysis rather than analysis of
fundamentals--technical analysis predicts how stocks will move based only on
past movement, not on underlying reasons.

In some cases, this movement is movement that happened only seconds, or
milliseconds earlier. In a market with no HFT, say that there's a stock where
a large sale is made by some investor, driving price quotes down a few cents;
and then a second later, another investor buys a large share, pushing prices
up again to where they were before. This behavior makes stock charts jagged
and gives a certain volatility to prices.

Now, imagine that you could algorithmically predict when a price is likely to
go down and then up again in cases like that, and so you could make a profit
by buying low knowing that the stock price will be back up again one second
into the future. You buy stock to capitalize on this, and if you buy as much
stock as you profitably can, you'll essentially drive the price back up to
where it will be after the original "correction". You end up correcting the
price _before_ the other investor does; and if your response time to the first
investor's sale is fast enough, the time when the stock is underpriced will be
reduced by you quickly buying.

This stabilizes prices, smoothing out the curves, and stable prices are valued
in the market. People are willing to pay money for stability, even at those
small levels; and that amount of money is what HFT is designed to capture. HFT
also makes a benefit by being "first" on finding the right price through its
algorithmic clairvoyance.

Sometimes, obviously, the use of these algos goes wrong. You get a flash crash
with a death by ten billion cuts as the market moves to smooth in some
incorrect way. But HFT is not all bad, and considering how much there is, it's
impressive that it works as well as it usually does. The incidents you hear
about are just like plane crashes; just because planes crash sometimes and
it's big news doesn't mean that air travel isn't safer per mile than car
travel. Similarly, HFT has a powerful smoothing ability that it capitalizes on
(among other things that it does--but smoothing is one of its largest
abilities), and most people who oppose it don't realize how essential price
stability is to the market at those levels given how much non-HFT trading
volume goes on these days.

~~~
jamii
> Sometimes, obviously, the use of these algos goes wrong. You get a flash
> crash with a death by ten billion cuts as the market moves to smooth in some
> incorrect way.

I learned recently that there have been many similar crashes throughout
history, well before even the invention of computers eg

<http://en.wikipedia.org/wiki/Wall_Street_Crash_of_1929>

<http://en.wikipedia.org/wiki/Black_Monday_%281987%29>

<http://en.wikipedia.org/wiki/Friday_the_13th_mini-crash>

<http://en.wikipedia.org/wiki/October_27,_1997_mini-crash>

It seems to be more a matter of market dynamics rather than crazy algos. If
some market shock drops prices too quickly you pass from a stable equilibrium
into panic selling. Market makers will only accept so much risk before they
start trying to offload stocks too, leading to a feedback loop. Lots of
exchanges now have measures in place to break this feedback loop by halting
trading on a stock if the price moves too fast and running an auction instead.

The 2010 flash crash was really only notable in that the move to electronic
trading made both the crash and the subsequent recovery much faster. Panic
selling itself is a problem with the market structure, not with the machines
on the other end.

~~~
Variance
Indeed, crashes happen are nothing new, and HFT algos going wrong are only one
of the billions of ways that it can happen. That's what you get when the
market has ways of deciding prices--through people, machines, or contracts.
It's possible that things can go wrong, but investors acknowledge that risk,
and take responsibility if things go wrong. It's no great moral failing of the
world that the market can go south.

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jcc80
What an amazing GIF. They way the colors work out it reminds me of a fire that
smoldered for awhile and then woke up in late 2008.

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maybesofast
Wow, huge gif hotlinked from imgur with 5TB of used bandwidth.

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amirmansour
What graphing library or tool was used to make these charts?

~~~
aerique
By the looks of it I'm guessing gnuplot.

Here's some other graphs generated by gnuplot from when I still played EVE:
<http://imgur.com/vsNoH> & <http://imgur.com/2pleo>

