
Make $377,000 trading Apple in one day? - elleferrer
http://finance.fortune.cnn.com/2013/08/30/latency-arbitrage-costs/
======
kolbe
I hear a lot of complaining about the HFT business, and there is plenty to
complain about, but I think every so often we need to take a step back and
remember what the alternative is: Insular, inefficient, corrupt, pit-based
trading.

We now complain about a few pennies being scraped off of each order, which
stings a little, but read Reminiscences of a Stock Operator to get some
context about the dollars that used to be scraped off of each order by pit
traders. Today, if you're trading a low dollar stock like Bank of America or
Zynga, the vast majority of the money you're giving up to make a trade goes to
brokerage, rather than to market makers like Getco.

Where computers are involved in trading, there will always be an edge to be
gained from writing better, faster programs. We can take some steps to de-
emphasize making programs that have a speed advantage (e.g. assign random
latencies to all entered orders, or to bring all orders in each stock to trade
on a single, specially-designated exchange), but I'll take computers over pit
traders any day.

~~~
sergiosgc
The alternative to HFT is not pit based trading. False premise.

The fact that brokerage is too expensive is a straw man in this discussion.

------
AndrewBissell
"Hendershott walked away with almost $377,000 in theoretical profits by
picking off quotes on various exchanges that were fractions of a second out of
date."

LOL, classic. If I just _pretend_ I get filled on every order, I make a
hojillion dollars, see?

~~~
dchichkov
LOL - it was probably a bug in his sim, some future information leak most
likely. Getting your timestamps right is always tough.

~~~
AndrewBissell
Even if you get the timestamps exactly right, predicting whether you
_actually_ would have been filled at the exchange on a given simulated order
is fraught with error (almost always in the direction of overestimating
profits). Anyone who thinks this can be done with simple simulations or "a
one-line algo" is speaking from a position of severe ignorance.

~~~
dchichkov
Simulating the fill rates correctly is tough. But getting the timestamps right
is also tough. Exchange timestamps are crap. If these there used - that's a
possible future leak right there. Standard PC hardware? Remember, that a
standard PC clock gives you something like 50ppm. That means - yes - 50
microseconds per second drift. One need their own boxes with stable clocks,
GPS, or otherwise synchronized. I doubt that this professor had access to that
kind of infrastructure.

------
jellicle
Intervals of a few milliseconds? You could peg prices every few seconds,
minutes, or hours. A trading interval of one trading session per hour would be
fine. Put in all your offers to buy or sell, trading closes at 10:00:00 and
then all the received trades are matched up and executed. Once per hour, once
per minute, any interval works fine for the USEFUL purpose of the stock market
(allocate capital). It just happens to kill off the non-useful purpose,
gambling.

While you're at it, tax all stock purchases.

All HFT is front-running the market and should be banned.

~~~
30thElement
How many times does someone need to explain that enforcing fixed-interval
ticks is a bad idea for people to stop bringing it up on HN?

In the current environment, you own shares of MidCap Inc. They release a
really bad earnings report, the company looks like it'll just keep sliding for
the next few months and you want out. You see what the price as of 5 seconds
ago is is (5 seconds since you're only human), put yours in at just below that
and 10 milliseconds later you've sold your stock. You got a fair price and you
aren't stuck holding a bad stock.

In your proposed 1 hour ticks, you still own MidCap and they still release a
bad earnings report. You still want out, but since trades execute once an hour
you have no idea what the price is after this earnings report. You put in an
ask at a slight loss (you don't care about the loss, you just want out), wait
45 minutes and... Fuck, everyone put their asks lower than yours. Half the
book clears and everyone who didn't get their ask thinks "I really don't want
to be holding onto this crap stock". You re-list at a 25% loss, because you
really just want out and the average trade was a 15% loss anyway, and so does
everyone else. You better hope the book gets completely cleared this time, or
that stock is gonna hit the floor.

That's all not mentioning the fact that 1 hour ticks wont eliminate HFT and
the desire for low-latency (who get's priority when there are 2 $33.55 bids on
the book? The first one placed?). And half of HN will be grumbling about how
the exchanges take all this profit when the bid/ask spread is negative.

~~~
firebones
Aren't all of those problems solvable?

1) Use ticks less than an hour. Say, one second. Or even one minute--however
long it takes to settle an auction. You will quickly get a sense of the price.
2) If there are multiple bids on the books, randomize priority at the bid
level. The goal is to remove HFT, not create a new HFT with more granular
resolution.

~~~
30thElement
Lowering the interval makes the effect less pronounced, but it's still there.
When you have fixed intervals the order book will keep increasing in size
until the trades execute on the 1 second interval or whatever it is, and the
book will be larger than for our current instantaneous ticks. Larger book
means wider spread, as basic game theory says when you have more participants
you need a stronger hand to have the same odds, so if you want that trade to
execute you put it way outside the last price. HFT firms narrow the spread and
take the difference as profit, as they don't really care if 1 particular order
executes so they play closer to the last price.

Randomizing the execution order makes the spread even wider, because now you
need to beat everyone instead of just tying if you want to guarantee
execution. And again, the HFT firms don't care if any particular order
executes. Although randomizing the order would probably reduce the incentive
to co-locate, but I'm guessing the larger firms would still want quicker
access to the last price, just in case.

Also, in all of this I'm assuming no one outside of the exchange can view the
actual book, just the last price. If you let people see the full book, as they
can now, this is all a wash anyway as they'll just "trade" by placing and
cancelling orders right up until the next tick.

------
dkhenry
I would like to point out this was a theoretical operation done by this
professor. It looks to me there are a few errors in his conclusions (
specifically about the risk associated with what he was pretending to do, and
the nature of market making ). Also he didn't actually make an algorithm to do
the trading and back test it, he just assumed that "with a good algorithm" you
could do this.

Also the fact that this is represented as a broad threat to the market is just
false. This only effects day traders and other HFT's. Yes the long term
investor might also be hit by this to the tune of 0.01% per transaction, but
the liquidity provided by HFT's almost makes up for that.

Make the system better, but do it so that the market functions more
efficiently not so that people who aren't you will make less money.

~~~
jellicle
> It looks to me there are a few errors in his conclusions

What errors are those?

> Also he didn't actually make an algorithm to do the trading and back test
> it, he just assumed that "with a good algorithm" you could do this.

What kind of algorithm do you need? He's able to buy stock at $100 when he
already knows that a second later, the stock WILL BE at $101. The risk is
zero. The algorithm is a one-liner.

> Also the fact that this is represented as a broad threat to the market is
> just false. This only effects day traders and other HFT's.

Not at all. It's a tax on every other participant in the market, on every
transaction they make. Every time you buy or sell anything, you make less
profit because someone is front-running you.

~~~
AndrewBissell
> Every time you buy or sell anything, you make less profit because someone is
> front-running you.

The whole front-running charge w.r.t to HFT is such nonsense. When you send a
market-taking order to an exchange, there's no way for an HFT trader to see
that order before it hits the market and game it. On the other hand, if you
want to get cute and work the bid or offer, then yeah, someone who can process
and react to the market data feed faster will have an advantage over, say,
some overpaid fund manager who's just trying to mimic the S&P 500 and is still
getting his data from a Quotron machine.

------
lifeformed
How much is he starting with to make that $377k? If I had ten million dollars
to play around with, I could easily make that in a day. That figure it
meaningless if it's not relative to something. What % return is it?

~~~
bjcohen
Paper is here I believe:
[http://faculty.haas.berkeley.edu/hender/NBBO.pdf](http://faculty.haas.berkeley.edu/hender/NBBO.pdf).
The 377k number is at the bottom of p. 10. Since he believes there's no
capital at risk, the starting amount is unimportant.

~~~
t0
But if he's making $0.0001 per share and he can only use his capital once
every 3 days due to clearing, it is important.

~~~
bjcohen
I could be wrong, but I don't think that's how settlement works. Making a
market would be impractical from a capital perspective for any players. I
would assume DTCC nets out its exposure to each clearing member, at the very
least.

------
npad
I've been wondering - couldn't you just impose a small delay, say one or two
seconds, on each order - forcing everyone to wait a moment to get their order
on the order book.

Seems like that should eliminate high-frequency trading altogether?

Betting exchanges use this idea to prevent people doing time-based arbitrage
on live sporting events. For example, to prevent one guy who's watching a
match live in the stadium gaining an advantage against someone else watching
on TV, where the pictures are delayed a few seconds.

------
ISL
The economist's preferred trade stoppages don't eliminate the advantage of
trading fast, they only reduce it somewhat. If the stoppages are a little out
of phase globally, they may actually increase it.

When buying and selling stocks on timescales of weeks to years, HFT doesn't
effect my strategies nor outcomes in any meaningful way (except to provide
exact pricing at the moment I send in a trade).

~~~
pbhjpbhj
Why not have it lock-stepped - every n time units the trades on the table are
performed?

~~~
gaadd33
You would have to have it synced across all global exchanges, if it wasn't you
end up with a similar position that we are in now every n time units.

~~~
pbhjpbhj
You wouldn't need it synced except to the unit of the lock-step. Lock it to
one trade per hour and you've got an hour's leeway. The deals are arranged and
lodged with the exchange. The exchange processes all deals received by the
lock time; deals remaining entirely private until that point. You could have
one trade per day allowed - that should cut high-frequency trading down
somewhat.

Of course that's not going to happen because high-frequency and the arms race
allows extraction by traders of the maximum value away from producers and
towards their own financial cabal.

------
nohuck13
Translation from cable-news-speak: Henderschott used paper trading to estimate
an upper bound on the amount of money to be made by _all arbitrageurs
combined_ trading AAPL on BATS for one day. He assumed perfect execution as an
estimation tool and this was not an error. He's not claiming that he would
have made $377k, he's estimating the size of the pie.

Re: the intermittent auction idea: Having an intermittent auction doesn't take
speed out of the picture, but it forces traders to be really fast at the
moment before the auction instead of all the time. Lots of exchanges have
opening and closing auctions where we can see empirical data. Some exchanges
try to solve last-moment problem by having a randomized start time for the
auction: you know it will be between, e.g. 3:25 and 3:30, but not exactly
when.

That said, Henderschott is a really smart guy and I haven't read the paper.
I'm curious to see what his suggested solution looks like. I was at a talk he
gave a few years ago and someone asked him about this, and I understood that
he was against the auction idea for pretty much the standard reasons. I wonder
what's changed.

Aside, "Latency arbitrage" is an oxymoron. Latency is more or less the
defining characteristic of arbitrage. Just because we're using computers
instead of carrier pigeons doesn't mean the situation is somehow changed.
Saying "latency arbitrage" instead of just "arbitrage" seems like a rhetorical
device to paint HFT as something new and dangerous, rather than as a
continuation of stuff that has always happened. There are plenty of
substantive things to debate about HFT, but using scare words doesn't improve
the quality of the debate.

Anybody interested in this stuff should read former high-speed trader Chris
Stucchio's (yummyfajitas) awesome blog posts and HN discussion. Part 1 here:
[https://news.ycombinator.com/item?id=3852341](https://news.ycombinator.com/item?id=3852341)

------
biturd
It costs me x dollars to place a trade, how are they getting around a trading
fee? Or do not all people have to pay trading fees?

~~~
dkhenry
As I understand it if you never have your trades "cleared" you never incur any
cost.

When you trade the price to have the trade cleared through a clearing house is
built in. When big firms trade they only need to go to the clearing house to
square up their books.

~~~
kolbe
Exchanges charge. HFT firms don't pay a broker, but thy still have to pay
exchange fees. Most don't clear themselves, too, so they have a clearing fee.
Also, some small FINRA fees. And this is not to mention that the right to be a
market maker often costs a lot to begin with.

~~~
dkhenry
yes but do they have to clear all the trades or just at the end of a session ?
I was under the impression that you could pool your holdings and clear them
once instead of for each individual trade.

Also I thought exchanges charge for access not for activity. So Its a fixed
fee to be able to talk to the exchange,but I can send in as many orders as I
want.

~~~
AndrewBissell
Most exchanges now charge on a "maker/taker" basis, where liquidity-taking
trades (lifting an offer or hitting a bid) are assessed a fee, while
liquidity-providing trades (working a bid or offer which is ultimately filled)
are paid a small rebate.

~~~
dkhenry
So that's the exchange side, what about the clearing. As I understand it
that's where the bulk of the cost comes from.

------
GigabyteCoin
> playing one stock (Apple (AAPL)), Hendershott walked away with almost
> $377,000 in theoretical profits

OK... I'm waiting for tomorrow's story that states he actually gained $377K in
profit trading his own money using that algorithm.

Until I read that article, this is all hearsay.

------
GoldfishCRM
Darn. I thought I was going to make 377 000 dollars a day. That would have
been around $94M trading stock. Now I have to work for a living... Instead I
got this article about fair game. Whats up with that=)

------
nraynaud
Why don't the pension funds use HFT too if it works better?

~~~
Daniel_Newby
Indirectly, they are. The market price is the average predicted price by all
the HFTs. The high-frequency shops are picking up pennies in front of a
steamroller so that the rest of us can ignore short term fluctuations in the
price.

This does not help pension funds all that much. A pension trader might decide
to acquire a $1.5B position in some stock that usually trades $250M a day. To
avoid being a market mover, large investors take weeks or even months to
adjust their positions. HFTs arbitrage between the milliseconds, while
retirement funds arbitrage between _seasons_ (to the extent that they
arbitrage at all, rather than investing for a share of the profits).

~~~
nraynaud
part of me thinks they'd better go the traditional bank route and just
directly lend the money to companies/people (somehow it's also an active
investment). They could tell their customer: "we financed this bridge, we
financed this company, we financed this farmer's crop" and when there is a
loss, they could explain that the company failed or the bridge could not get
off the ground for some reason or the weather was bad for the crop. I don't
think the current level of indirection is useful, and I don't think computer
shakes the hand of the customer saying "let's build this road".

~~~
Daniel_Newby
The indirection is useful when exit time rolls around. If you directly finance
a bridge in a city that wins a major new factory, you have to figure out how
to market and sell your share of their improved taxing ability. If you bought
a government bond, you simply issue a sell order priced to account for the
lower risk of default.

