
How the Robots Lost: High-Frequency Trading's Rise and Fall - nohuck13
http://www.businessweek.com/articles/2013-06-06/how-the-robots-lost-high-frequency-tradings-rise-and-fall
======
Lagged2Death
_One of HFT’s objectives has always been to make the market more efficient.
Speed traders have done such an excellent job of wringing waste out of buying
and selling stocks that they’re having a hard time making money themselves._

One of its _objectives_?

Those philanthropic high-frequency traders just wanted to make the market more
efficient for everyone? Sure they did. Sure they did.

~~~
cynicalkane
You can say that about any industry that turns a profit. _Those philanthropic
$MEMBERS_OF_MONEY_MAKING_INDUSTRY just wanted to make $THING_INDUSTRY_DOES
better for everyone? Sure they did. Sure they did._

Making money is not a character flaw. Otherwise, many prominent members of
this board would be horrible people.

~~~
cma
Your caveat doesn't apply if they aren't helping markets be more efficient.
HFT is basically a latency arms race ripoff scam. Whoever pays more for faster
lines and closer access to the datacenter takes the cake. Thousands of PHDs
are working on this instead of real stuff.

Say this is the makeup of market participants: all of them are normal
merchants buying fruit for their shops but 2 are latency arbitragers.
Shipments of fruit don't always come in because sometimes the sail boat
crashes into something.

The latency arbitragers hire high speed skiffs to go scout for the ship before
it arrives. If one of them sees that a shipment of oranges are missing, he
rushs back to game the unsuspecting others in the market: orange prices are
going to go up so he buys them on the cheap.

Because nothing gets better with two competing arbitragers. They simply
compete with each other on hiring out more skiffs and paying for elaborate
faster ones. Or signaling by latern along a chain of ships.

None of this helps the market; all other participants lose out. With
competition between the two arbitragers they end up wasting most of the money
buying faster ships. Ships that could be used for.. rescuing crashed orange
ships? Many other things as well. The worst government bureaucracy couldn't be
more wasteful.

Markets aren't efficient even in theory if there is an information asymmetry.

I hope you can see the analogy between my example and things like:

* deploying more and more servers to literally turn our energy into waste heat (they could be simulating protein fold or something)

* paying trading exchanges extra for in-house servers (this is just a complete scam)

* Digging hundreds of miles of new fiber line to save 2ms of latency over the existing line (with no plausible consumer benefit because the old lines had plenty of dark fiber and the new line is monopolized by whomever pays the most)

* Setting up microwave (lantern?) relay towers to get from New York to Chicago a millisecond faster

* Making markets more likely to have a major crash by forcing developers to use C++ to eek out a couple milliseconds over safer alternatives

You can make a little bit better case for electronic market making.

~~~
minimax
You are conflating market making and latency arb, which are not the same
thing. All of your points apply to latency arbitrage and you haven't said
anything about market making.

As long as there are profitable arbitrage opportunities, people are going to
go after them. The profits from latency arb aren't infinite and things will
hit an equilibrium when the profits line up with the costs. Incidentally, I
don't think latency arb is a bad thing. The arbitrageurs keep prices in line
between exchanges, so you don't have to worry as much about getting a crappy
price at one exchange when a better price was available at another exchange.

~~~
cma
No I'm not, I clearly said "You can make a little bit better case for
electronic market making." But if you think market making has no major latency
component, you are living in the 70's.

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macavity23
Nice anecdote about Knight Capital:

 _"When the market opened on Aug. 1, a new piece of trading software that
Knight had just installed went haywire and started aggressively buying
shares... By the end of Aug. 2, Knight had spent $440 million unwinding its
trades"_

I'd love to know more about that particular launch. A hole in _somebody's_
test suite!

~~~
chollida1
One of the prevailing theories from <http://www.nanex.net/> is that when
Knight went live they also put their order simulator live as well.

The thinking behind this theory was that a simulator would keep adding
liquidity to a fake market for testing a market making algo.

During the day that Knight lost their pants nanex saw that while their algo
was taking liquidity someone else was constantly providing it, ie the bid ask
spread didn't really open up that much and the price held relatively flat.

This meant that someone else was constantly adding liquidity that Knight was
taking away. The thinking was that Knights market simulator was the one
sending out the live orders to add liquidity.

TL/DR Knight crossed themselves many many times in a few minutes.

See <http://www.nanex.net/aqck2/3525.html> for the acutal details

~~~
mcphilip
As an example of why Nanex is worth listening to, here is an article [1]
describing how Nanex claimed Monday's ISM manufacturing data was leaked 15
milliseconds early, leading ultimately to an admission by Reuters that it
caused the leak. Eric Hunsander, a software developer at Nanex, went so far as
to hint to Reuters that they should check their NTP settings since a drift of
15 milliseconds is allowed by default [2].

Eric is very interesting to follow on Twitter [3]. He highlights mysterious
HFT related events on a daily basis. My only complaint is that his articles
and charts, in particular, are very difficult to interpret. As an outsider to
the HFT industry, I don't know where to find the resources to learn enough to
interpret most of Eric's insights.

[1] <http://www.cnbc.com/id/100792260>

[2] <http://www.nanex.net/aqck2/4306.html>

[3] <https://twitter.com/nanexllc>

~~~
ansible
_... claimed Monday's ISM manufacturing data was leaked 15 milliseconds early
..._

While I'm peeved that as an adult I'm still not able to purchase an affordable
flying car (though I was able to afford a tiny flying robot recently), there
are days where I do think I am living in the science fictional future
anticipated in my youth. Reading that CNBC article... this is one of those
days.

------
Mikeb85
HFT basically involves an arbitrage. The more competition there is, the less
profits are made. It's simply a case of the market becoming more efficient, so
the arbitrage opportunity is gone.

Meanwhile, consumers of market makers (ie. normal investors) benefit from
being able to make any trade in a split second, for very little cost. In the
end, it still requires a human element.

------
T-hawk
_"According to Rosenblatt, in 2009 the entire HFT industry made around $5
billion trading stocks."_

Where does this money come from? The industry doesn't actually create any
wealth. There must be a greater fool who lost this $5 billion to the HFT
industry. But who is that? Who became $5 billion poorer to make the HFT guys
that $5 billion richer? Is the article just counting the total profit of HFT
winners and ignoring the HFT losers?

This is not rhetorical, I really want to understand this.

~~~
dustingetz
if i want to buy 1000 bitcoins at $121.46 to hang on to for a while, and while
i'm buying the price goes up to $121.50 because a HFT is trying to frontrun my
purchases, i'm not going to stop buying, its still worth it to me at the
higher price. those few pennies, in aggregate across billions of trades, can
add up.

~~~
gd1
If you want to buy 1000 bitcoins then cross the spread, take out the best
offer, and buy 1000 bitcoins. If, on the other hand, you want to stick a bid
into the market in the hope that someone else will cross and take your (lower)
price instead... then yes, other participants will react to that.

------
yummyfajitas
tl;dr; Competition between HFTs has reduced margins on market making to near
zero.

Wonderful news for consumers of liquidity, bad news for sellers of it.

~~~
crusso
That and this sad kicking in the groin of a system that's working through
technology issues as it should:

 _Democrats in Congress would go further. Iowa Senator Tom Harkin and Oregon
Representative Peter DeFazio want a .03 percent tax on nearly every trade in
nearly every market in the U.S_

Politicians just have to get in and start pecking for some extra revenue and
attempt to give the illusion that they're going to help.

~~~
ihsw
Interestingly Sweden tried a 0.5% tax in 1984:

> During the first week of the tax, the volume of bond trading fell by 85%,
> even though the tax rate on five-year bonds was only 0.003%. The volume of
> futures trading fell by 98% and the options trading market disappeared.

Needless to say, 'tax avoidance' became the norm (especially since it was
exceedingly easy to circumvent) and it was later repealed in 1991.

[1]
[http://en.wikipedia.org/wiki/Swedish_financial_transaction_t...](http://en.wikipedia.org/wiki/Swedish_financial_transaction_tax)

~~~
crististm
law of unintended consequences

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nohuck13
So, there's a correlation between HFT and volatility. Yup.

Causation is hard though.

"Trading volumes in U.S. equities are around 6 billion shares a day, roughly
where they were in 2006. Volatility, a measure of the extent to which a
share’s price jumps around, is about half what it was a few years ago. By
seeking out price disparities across assets and exchanges, speed traders
ensure that when things do get out of whack, they’re quickly brought back into
harmony."

There's been academic research that HFT market making dampens intraday
volatility [1]

There have also been findings in the other direction [2].

I suspect to the extent you're talking about market making, the first version
is true, but you almost never see it in articles like this. Maybe it makes for
poor sensationalism.

[1]
[http://www.wsuc3m.com/HFT_and_Volatility_Final%20Brogaard.pd...](http://www.wsuc3m.com/HFT_and_Volatility_Final%20Brogaard.pdf)

[2] <http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1691679>

------
peterjancelis
Awesome. Capitalism working as intended. There was an inefficiency in the
market, people exploited it and low barriers to entry now make the profits
disappear. Our stocks are now better priced as a result.

~~~
javert
Yeah. I see this article as an amazing validation of HFT to all the naysayers.

------
chiph
_Iowa Senator Tom Harkin and Oregon Representative Peter DeFazio want a .03
percent tax on nearly every trade in nearly every market in the U.S._

The camel's nose is heading towards the tent.

~~~
omni
Explanation of this metaphor for people like me who had never heard it before:
<http://en.wikipedia.org/wiki/Camel%27s_nose>

edit: fixed link, whoops

~~~
kgermino
<http://en.wikipedia.org/wiki/Camel%27s_nose>

------
programminggeek
I'm sure it's been done, but I know there is a place for longer term automated
trading as well. Computers have an advantage over the super short term, but
even on the short, mid, long term, there is money to be made in finding holes
based on human behavior over time, which still drives a big chunk of the
market.

------
X4
The implicit claim is that your trading engine won't beat established trading
engines and because of volume.

Both can be falsified, by inventing a better trading engine and getting
foreign capital into it. Yes the margin for profit isn't that high anymore,
but trading engines+trading markets are one card in the stack one can fight
with. There is no holistic solution to making maximum profit, except
succeeding when others fail. That's why innovators are always rare goods,
because capital herds dry it out.

------
ott2
Another key point: "the SEC is sharing information with the FBI to probe
manipulative trading practices by some HFT firms" and now has the
infrastructure to detect anomalies.

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glitchdout
I get why the need to always be one step ahead pushed trading firms to
automation. Still, for some reason, this makes me incredibly sad. Maybe it's
because I don't fully understand how the world and the economy work. Why does
it have to be this way?

~~~
minimax
We use technology to improve efficiencies in every industry in the world, but
when we use technology in the capital markets people freak out. I don't get
it.

~~~
Nursie
Huge volumes of money, a perception of it being gambling and playing with
numbers rather than productive work, the possibility of screwing over
basically the whole of society when it goes wrong, privileged positions for
the entrenched traders (people that outsmart the algo-traders get arrested,
massive costs to get the millisecond co-lo advantage on HFT etc), total
divorce of algo/HFT from the idea of actual investment in companies based on
what they do...

There are some reasons that people are suspicious of the entire world of
finance. HFT and algorithmic trading really exemplify all of the issues some
people have with the money markets in the first place.

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benjamincburns
[http://www.businessweek.com/printer/articles/122900-how-
the-...](http://www.businessweek.com/printer/articles/122900-how-the-robots-
lost-high-frequency-tradings-rise-and-fall) \- one page version.

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radikalus
HFT Profit = f(Noise/Signal) - g(Tech Costs)

