

U.S. Proposes Ban on ‘Flash’ Trading on Wall Street - mhb
http://www.nytimes.com/2009/09/18/business/18regulate.html?_r=1&hp

======
quant18
"When buy and sell orders come into an exchange, they are first flashed to
those paying to see them for 30 milliseconds — 0.03 seconds — before they are
available to everyone else."

One thing I don't understand about "flash trading", and what I've never seen
an explanation of in the media: How does this interact with price-time
priority?

In a regular old auto-matching system, if the spread is two ticks wide and a
buyer sends an order to lift best offer (instead of just improving best bid):

1\. If you had a sell order at best offer in the front of the queue the time
the buy came in, you're matched, and it doesn't matter if you try to cancel
your sell a nanosecond later.

2\. If you had no sell order, it doesn't matter if you improve the sell price
a nanosecond later --- you're not matched.

So does "flash trading" change either of these? Or is it just a fancy name for
"getting market data real fast" --- similar to what you'd get by colocation,
but artificially enforced (e.g. they delay everyone else's data by 30ms so the
"flashers" can see it first)?

(edit - formatting and grammar)

~~~
Devilboy
I found this article useful:
[http://www.nytimes.com/2009/07/24/business/24trading.html?_r...](http://www.nytimes.com/2009/07/24/business/24trading.html?_r=2)

It has a timeline diagram which explains it well.

~~~
quant18
Thanks. So the exchange really are messing with price-time priority in
exchange for cash? Wow ...

But then why would any non-flasher ever place a single order on these
exchanges? Couldn't a boycott could solve this problem without any legislation
--- they could just go to an alternative venue which wasn't selling them out
in exchange for more fees?

\--- Appendix: Bear with me while I think out loud so anyone can point out
mistakes I'm making.

Time n-1, Order #0: Some seller posts an offer of size N > 5000 at $21.00. (It
has to be $21.00, otherwise Order #2 would have nothing to buy at that price).

Time n, Order #1: Mutual fund sends buy 5000 "at market" (i.e. fill me at any
price from here to the moon).

Time n+1, Order #2: Would-be flasher sends buy N at $21.00.

Time n+2, Order #3: Would-be flasher sends sell 5000 at $21.01 (and prays that
no other flasher beats him to it).

Time n+3: Repeat from time n-1.

Under normal price-time priority, #1 matches #0, #2 matches #0 and becomes
best bid, #3 doesn't match anything, and your new market is $21.00 / .01. The
total traded volume is N. (The would-be flasher is now long N - 5000 and has
to trade out at a loss of fees + stamp duty, so the first time around the
total traded volume is 2N - 1, but that doesn't happen again: he either stops
doing this shit or goes out of business).

With "flash trading", #2 matches #0 (despite #1 having time priority) and #3
matches #1 (despite not even being in the market at the time #1 arrived). The
total traded volume is N + 5000. The exchange earns some extra fees, the
flasher gets the arbitrage profits, the mutual fund gets screwed, and the
sellers (#0) don't care either way because they were willing to trade at
$21.00 all along. Weird.

~~~
frig
Yeah, we're getting ever closer to the era in which:

\- you step out to home depot to buy a $20 hammer

\- when you get there "The Flash" (of dc comics fame) figures out you're
looking to buy a hammer and buys _all the $20 hammers_

\- he leaves a post-it note saying "if you want a hammer meet me in aisle 7"

\- you get there and he offers to sell you a $20 hammer for $21

\- either you buy it or you don't; once you've made your decision he returns
either (N-1) or (N) hammers back to the store (30 day return policy and all
that)

\- if you head over to lowe's instead well he is "The Flash"

Not an exact metaphor for "flash trading" (as sketched it's riskless) but it's
imho a relevant thought experiment.

At the individual level the winners and losers are pretty obvious. At the
systemic level it's unclear any actual efficiency is gained; differentiating
between actual "efficiency gains" and "red queen" scenarios is tricky.

------
newsdog
About time. It's total cheating and should never have been allowed.

[http://bellringer187868.wordpress.com/2009/07/25/the-
bingo-b...](http://bellringer187868.wordpress.com/2009/07/25/the-bingo-bin/)

~~~
andylei
> The programs can gauge market response and, using pre-programmed manoeuvres,
> called algos (for algorithms), catch the demand before the public (that’s
> YOU), grab lots of it cheap, enter and cancel hundreds of small orders in
> order to find out the public’s limit for a stock’s price and dump all it’s
> holdings to them at a penny below their limit, but above what the computer
> paid for it, for a small ($10,000, say) profit, in a matter of seconds.

This isn't flash trading, this is just high frequency trading. All the stuff
mentioned in this paragraph about "cheating" has nothing at all to do with
flash orders. bellringer seems to suggest that high frequency trading is
"cheating". This argument that guys with faster computers and better
connections are beating at home traders is nonsensical. If I tried making cars
at home in my garage, of course Toyota is going to beat me. They have state of
the art factories, trained engineers, and years of experience. Toyota isn't
cheating. Similarly, Goldman Sachs, along with lots of smaller guys, has huge
computing clusters, blazingly fast and connections and they're going to beat
you, a guy with a laptop at home. But it's not cheating.

~~~
lsd5you
Do you really consider that a useful analogy?

Cheap cars are useful. A super liquid stockmarket is a zero sum game in which
everyone is encouraged to participate but a few sharks basically have extra
cards.

Its really not obvious why such a responsive market is necessary, it is simply
said to be a good thing and a progression, yet it moves at speeds that clearly
do not reflect the underlying fundamentals.

~~~
sp332
Why do you say the stock market is zero-sum? People put money in & take it out
all the time.

~~~
joezydeco
Because the stock market doesn't generate money. Money changes hands based on
rising and falling values, but the money hasn't just appeared out of thin air,
nor is it destroyed.

------
justin_vanw
Simply force purchasers to hold stock for at least 6 months, or some other
long period, so that fundamentals will have to be carefully looked at. Buying
a stock signals confidence in a companies stock price for the duration you
expect to hold the stock. If you make people hold it longer, the signal
becomes more meaningful. Finally, market manipulation becomes much less
rewarding, since you can only flip your money twice a year (profit from
manipulation is % gained each time * capital * number of manipulations), and
you can't foment at all really.

Perhaps it would also be helpful to put a 5 (or more) day delay on any sell
orders. I would personally be in favor of a 2 year delay or more. Currently,
if you get really bad news (like a companies only drug was not approved,
making the company worthless) you can sell the stock immediately via a market
sell order, and get whatever the highest offer is. This is no different than
collecting pre-signed contracts to buy your house, then signing the best one
when you see smoke coming out of the windows. The person offering to buy the
stock has obviously not had time to adjust their order based on the news, and
so you are selling them something they weren't bidding on. If you give buyers
time to adjust, selling on a panic would be completely retarded, since you
will either lose all value (selling into a market with buyers who have
adjusted their offers way down), or the panic will subside and you will get a
fine price, but then could have just held it as you were planning before the
panic anyway. Discouraging panic selling makes prices more stable (does anyone
honestly think that the best estimate of the value of a large company could
possibly vary 50% in a few days??) Also, automated trading triggers would be
eliminated, which would be great. If a firm can setup computers to sell a
stock if it drops 5% in 1 minute, then they are taking much less risk than
someone who has to hear news, find a computer, put in login information, etc.
However, the firm's buy order signals the same confidence as the careful stock
researcher, while in reality they can buy stock with far less confidence since
they are taking less risk.

Both of these measures would reduce market volatility, if not effectively
eliminate it over short periods. This would mean that corporations could
borrow money on much better terms, since their stock prices would be more
stable, meaning that stock is better collateral. It would also mean
shareholders would insist on things like dividends and long term profitability
and planning, since they are going to be holding the bags if things aren't
good in the long term.

~~~
anigbrowl
I'm against flash trading but 6 months (or even 6 days) is throwing the baby
out withthe bathwater. Look, I'm broke - lend me $10/ thanks. OK, I paid my
rent and got paid, here's $11, thanks a lot. That's what liquidity is, and
it's important - with your suggestion everything would become glacially slow
and tiny credit hiccups would become hugely amplified. You should be able to
buy when you see an opportunity and sell when you need cash, even if your need
of cash is to finance another buy.

The problem with flash trading is that its practitioners are in effect paying
the exchanges for the right to join in on a trade after it's been proposed and
they can see whether it has profit potential or not. Sure, they are making
tiny margins of a fraction of 1%, so they say it's not greedy. Good point. But
you can only afford to do that if you've got fat money to participate and to
make up for those tiny margins they're putting up big money on every deal that
does show profit potential.

I find it hard to believe it's been legal up to now. Every time I study it,
I'm reminded of some old movie where a gangster has paid out money for a
private telegraph line to get the results of the horse race while the betting
is still open at a remote location.

I think the long-term quantities you propose like 6 months and 2 years are
absurd, but I agree with your basic premise that too much speed trading
undermines the market's price discovery function and evaluates arbitrage over
considerations of fundamental value. It would be interesting to model this
behavior with an agent-based simulation of a virtual market.

~~~
justin_vanw
Ok, I'm not sure why my post was modded down, it obviously shouldn't have
been.

The market _should not_ be liquid. Liquidity is great, but you haven't
provided any reason it's better that the market be liquid. Your first example
(loaning you money) is credit markets, not stock. And credit markets become
looser if stock markets become stricter, since stock is better collateral for
loans, so here your example supports my scheme.

Credit hiccups would not go away in my scheme, but day to day sensitivity to
credit markets would be reduced if executives were incentivized to look after
long term stability of companies instead of quarterly profits. Do you believe
Ford or Standard Oil, in their heyday, would have been crippled by being
unable to get loans from WallStreet? If a company fails for inability to get a
loan, they have been painting themselves into the corner with bad decisions
for years.

Finally, why shouldn't the stock market be glacially slow? Stock _prices_
could change just as quickly as they do now, since buy orders could be entered
and removed instantly, just as now. The only thing this would prevent is
people flipping stock as short term investments, and so stock _would not_
fluctuate as much, since there would be so many less trades overall. Short
term investments are always (no exceptions) an attempt to game the system or
trade on inside information, and there is certainly no way to profit in the
short term except by fomenting, using inside information or trading far
quicker than the average investor so you can respond to news more quickly. All
of these activities hurt the efficiency of the market, so the market becomes
more stable and prices more accurately signal company health than they do
currently. When you have a stable market, price ratio's can increase since
risk is reduced, and that is good for everyone when it is sustained.

~~~
anigbrowl
IT's true that my first example is a case of credit rather than stock, but I
kind of wrote it as a throwaway example of why you'd want to be liquid.

Rather than a loan, suppose that in the case of being broke I instead opted to
sell something - a book or a guitar or a car, say. Now, would it be fair for
someone to say 'no way, you can't sell that because you haven't owned it long
enough?' I do think your heart is in the right place - managing for the long
term and so forth - but your 6-month hold is extremely unfair to the
individual investor, and would just result in the creation of unregulated off-
market exchanges, like pawnshops for stock certificates. I mean suppose I buy
IBM but next month they are hit by some financial scandal, I have to sit with
my bad investment for another 5 months and watch the price crater as most of
the existing shareholders sell?

 _Short term investments are always (no exceptions) an attempt to game the
system or trade on inside information_

I don't agree. I can think o a wide variety of reasons for short-term buying,
and don't think regulators should be in the business of judging motives. I'm
afraid I think this forceful imposition of long-term ownership criteria would
only cause the market to become bloated and sclerotic and the cure would be
just as bad as, if not worse than, the disease.

------
known
Flash Trading = <http://en.wikipedia.org/wiki/Front_running>

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nearestneighbor
Will this leave a bunch of C++ and OCaml programmers unemployed?

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Estragon
Wall St has too much political power for the government to stop this. If they
can get the Glass-Steagal act repealed, they can squash an inconvenient policy
initiative.

------
steveklabnik
Maybe it's my programmer's mindset... I never really understood why flash
trading is such a problem. If I buy a stock, and you buy a stock the next
hour, is it a problem? What if I buy half an hour before you? A minute? A
second? A us? Where do you draw the line? Why would you draw the line?

To me, it seems like a scrub argument. Note the usage of 'cheating' and 'fair'
in this thread and article.

> Critics say flash orders favor sophisticated, fast-moving traders at the
> expense of slower market participants.

Why shouldn't someone who moves fast have an advantage?

