
How to not get ripped off by High Frequency Traders - keveman
http://www.chrisstucchio.com/blog/2014/how_to_not_get_ripped_off_by_hft.html
======
elecengin
Unfortunately, a traditional US retail investor does not have the flexibility
described here. Lewis describes Electronic Market Makers (EMMs) and Payment
For Order Flow (PFOF) - under these models, your order never actually reaches
a market. It is routed directly to a market making firm (usually Citadel,
Knight, Pershing, or Getco) that fills the order immediately if the price is
marketable and then trades out of the position later. This indirection makes
the whole discussion around your position in the order book somewhat moot.

It is important to recognize that under Reg NMS the market making firm must
fill you at the prevailing market price (the NBBO). While they technically
could sweep the market to move the market price before filling, this almost
never happens for a retail order since they are so small.

For this reason, the whole discussion around HFT "front-running" isn't very
topical to the retail investor buying individual stocks and it barely affects
the cost of execution of funds ($0.43 per $10,000 notional value traded
according to [1])

In summary, the people fanning this flame are not trying to protect retail
investors... If they were, they would focus on the larger scams on the street
(exhorbitant management fees for actively managed funds, for example)

[1]
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1928510](http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1928510)

~~~
thatthatis
It saddens me that people lump Market Making and HFT together. Over the past
100 years, the bid-ask spread has fairly steadily decreased due to technology
and this fact in isolation is uniformly a good thing for retail investors.

[http://www.cxoadvisory.com/5737/big-ideas/trading-
frictions-...](http://www.cxoadvisory.com/5737/big-ideas/trading-frictions-
over-the-long-run/)

Other HFT methods are less clearly on net socially good.

------
gizmo
A few points:

1) This doesn't address the front-running issue. (Where different exchanges
receive the buy/sell order at a different times and HFT can abuse those
microsecond differences)

2) It's a universal truth that people who are better informed are harder to
rip off. So that's not very persuasive. You can't reasonably expect regular
people to know in which situations they'll be paying a premium for a liquidity
service they may not even want.

3) It's completely fair to ask ourselves as a society if HFT groups are making
a contribution to society that warrants the money they make. And if
transparency with regard to HFT trading strategies leads regular people and
sophisticated investors to make different decisions, then that means that the
lack of transparency worked in favor of HFT. Therefore, it's reasonable to
assume much of the HFT profits are just an externality. The decline of HFT is
in part because investors are getting wise to the shenanigans.

~~~
kasey_junk
"1) This doesn't address the front-running issue. (Where different exchanges
receive the buy/sell order at a different times and HFT can abuse those
microsecond differences)"

This is only an issue if your order is large enough to take out the entire
liquidity of one of the exchanges. If that is the case, by definition you are
not a retail investor, you are an institutional investor and part of the value
add you are supposedly adding is your ability to operate in a complex market.

"2) It's a universal truth that people who are better informed are harder to
rip off. So that's not very persuasive. You can't reasonably expect regular
people to know in which situations they'll be paying a premium for a liquidity
service they may not even want."

So informed market participants should subsidize ignorant ones?

"3) It's completely fair to ask ourselves as a society if HFT groups are
making a contribution to society that warrants the money they make. And if
transparency with regard to HFT trading strategies leads regular people and
sophisticated investors to make different decisions, then that means that the
lack of transparency worked in favor of HFT. Therefore, it's reasonable to
assume much of the HFT profits are just an externality. The decline of HFT is
in part because investors are getting wise to the shenanigans."

Agreed. We should also have that discussion around dark pool operators, hedge
funds, and investment banks. While we are at it, lets talk about photo sharing
websites and internet chat services as well.

~~~
gizmo
1) Chris claims "The fact of the matter is that HFT’s can’t rip you off.".
Front-running[1] is an example where HFT's do rip people off, simply because
they didn't know it was going on. When the performance of institutional
investors is harmed in this way that harms everybody with savings or a
retirement fund. Not just the guys at wall street.

2) Straw man.

3) Yes, while we're at it let's change the subject to photo sharing websites
instead. That sounds reasonable.

Edit:

[1] Again referring to the technically legal version of "front running" as
used by Michael Lewis where HFT abuse buy/sell orders arriving at different
times at the exchanges.

~~~
rayiner
> 3) Yes, while we're at it let's change the subject to photo sharing websites
> instead. That sounds reasonable.

The question: "does Facebook spying on teenagers to help Abercrombie & Fitch
sell them crap they don't need add social value commensurate with how much
money they make doing it?" isn't an attempt to change the subject, but rather
a glib attempt to criticize the structure of the question. Since when do we
judge compensation based on value added to society, and if that's what we do,
why don't we apply that approach beyond finance?

~~~
gizmo
I disagree. It _is_ an attempt to change the subject from the object level:
"is HFT harming society and do we need more transparency or regulation" to the
meta level: "if we have to do something about HFT, then why not address X, Y,
Z also?".

It's not a legitimate argument because it can be used to derail _any
conversion_ that criticizes one particular aspect of society.

It goes without saying that there are moral questions to be raised about
facebook acquisitions and compensation in fields outside of finance. But it's
not part of this conversation.

~~~
rayiner
That's not the argument. The argument is: "if this mode of reasoning is valid,
and pursuant to it we must do something about HFT, then we would also feel
compelled to do something about X, Y, and Z as well. But because we don't feel
compelled to do something about X, Y, and Z, that implies that the mode of
reasoning is not valid."

In other words, he disagrees with the premise that compensation need bear some
relation to economic value created. Empirically, that's a premise that we as a
society reject.

------
tptacek
These discussions would be improved if more of the participants understood the
problem of transacting in large blocks of tradable instruments. The impression
HN trading discussions create is that there is a universe in which block
trades are frictionless or even remotely predictable.

In fact, moving large blocks across the market isn't just an annoying detail
of the markets; it's one of the basic fundamental problems of institutional
trading, and a large part of the rationale for the existence of brokers.
Transacting in blocks of stock is to professional trading what the CAP theorem
is to distributed software development.

One of the most famous and approachable books about market structure is Larry
Harris' _Trading And Exchanges_. The book is like the TCP/IP Illustrated of
money. It is supremely readable and written in a style that software
developers in particular will find congenial. You can get a Kindle version of
it right now. I feel extremely comfortable recommending it. It is a great
read.

The example of trying to move a large block of (fictitious) Smithsonian
Industries is one of the opening, motivating examples the book uses to outline
the challenges of trading. The inheritor of a huge chunk of Smithsonian
Industries needs to sell 900,000 shares of thinly-traded stock. The example
continues:

 _Goldman 's block brokers face the following predicament. If nobody knows
that they have stock to sell, they will not be able to sell it. However, if
too many people know that a large block of stack is hanging over the market,
speculators will push the price down. The Goldman brokers thus must be
selective when approaching potential buyers._

The motivating example Lewis gives in his book is of a trader at a large
investment bank who, based on their $2MM/year salary, is presumably being paid
handsomely for the service of figuring out how to move blocks like that
without having the market shift out from under them. In Harris' example, the
Goldman traders research other owners of Smithsonian Industries and approaches
them privately and individually in the hopes of placing much of the block
privately at a small discount. In Lewis' example, the handsomely-paid trader
sees a spot price in their blotter screen, expects to push a single button
(no, really, that's how Lewis frames it) to sell at that price, and is
outraged when the price moves.

There's an interesting debate to be had about HFT and, particularly, the
conflicts of interest between broker-dealers and exchanges and dark pools. But
it's hard to have that discussion if you start from the belief that
institutional trading is supposed to be easy. The opposite is true.

------
PaulHoule
I think people forget how much front running happened in the bad old days on
the stock market floor, how the NYSE organized a cartel that kept trading
prices high, and that the bid/ask spread is usually a lot less than it used to
be.

One thing people don't say much about HFT is that the HFT practitioners got
the exchanges to add undocumented order types that let them, in some cases,
take advantage of people who do limit orders as the author of this post
describes. The best description of this is at

[http://www.amazon.com/The-Problem-HFT-Collected-
Frequency/dp...](http://www.amazon.com/The-Problem-HFT-Collected-
Frequency/dp/1481978357)

Often when I trade stocks I like to set a limit order at a price that might be
a percent or so better than the market rate. Since the price fluctuates, odds
are pretty good that I'll get my fill. Now if it is just the normal Brownian
motion, it's a good thing that I get my fill, but if the stock is getting
hammered by an external event that is driving it way down I might have hit the
limit for the wrong reason and be unhappy I got the fill. In situations like
that, HFT traders have an advantage with their special order types.

I think the normal retail investor who buys and holds for a while is not hurt
terribly by HFT and flash crashes(unless the market is depressed because of
the fear of HFT) but you can definitely get burned if you use stop orders. If
a price goes down quickly, that can trigger your stop order, causing you to
sell at a bad time.

------
kasey_junk
As usual Chris does a good job of explaining in simple terms how the markets
actually work. The one thing I would have liked to see in this article is a
discussion of the pro's and con's of paying for liquidity vs execution risk.

From my perspective it is almost always better to have sooner execution with a
liquidity tax than an order floating in the market but I'm not sure how to
quantify that as a retail stock purchaser.

------
logfromblammo
I am not a finance expert. What would happen if you traded stocks using a
continual series of discrete uniform price auctions?

Each buyer enters a sealed bid consisting of the amount he wishes to buy, and
at what price. Each seller enters a sealed offer consisting of the amount he
wishes to sell, and at what price.

When the auction interval ends, the secure settlement system orders the bids
and offers, and calculates the common settlement price such that every bid
higher than that price can be satisfied with the offers lower than that price.
Every unit in the auction is traded at that one price. Unsatisfied bids and
offers could be set up to roll over to subsequent intervals, or to expire.

The settlement system takes a fee from all trades, as a fraction of the amount
a buyer was willing to pay, but didn't need to, and a fraction of the amount a
seller got in excess of what he wanted. The marginal buyer and seller, who
were not pleasantly surprised by the interval's settlement price, pay nothing.

There is no opportunity for front running. If you bid lower than a major
institution, your orders will be filled after the institution's orders. You
can't re-sell to it at a higher price because it already has what it wants.
Trading speed is irrelevant. All that matters is that your orders are in
before the settlement interval closes, which happens on a human scale.

Why would such a system be unsuitable for our modern finance system?

~~~
kasey_junk
What scale would you use? If we choose 15 minutes, then day traders who sit at
a computer screen all day have an advantage over people who have to work.

Ok then, how about once a day. Well then people without kids have an advantage
as they have more time to research this stuff.

Not to be overly sarcastic, but you can't pick a discrete time period that
doesn't have trading speed as a component.

~~~
logfromblammo
If you set your orders and offers to roll over through multiple intervals, you
don't need to babysit them.

You are absolutely guaranteed to pay _at most_ what you bid, and to receive
_at least_ your reserve price. You could leave them in the system for a
thousand years and never be disappointed in your trade.

I can set my bid at what I think a company is worth to me, and simply leave it
there until the clearing price is lower.

I would probably set the interval to one hour, with 24 auctions clearing per
day, and each tradable item settling at a different position on the clock, so
as to not overload my servers at any given time.

~~~
kasey_junk
Right now you can get the same guarantees about price with a simple limit
order.

If you don't care to watch each time period, why do you care what the time
period is. If I am happy to set my price and let it roll throughout the day
without change, then the existing system works just fine for me.

The issue comes from wanting to take new information into account to change
the price I want to get. In that case, I do need to see the results of each
auction and adjust accordingly. Once I allow for that any time period you set
is unfair for someone. We just need to decide on the balance what time period
has the best price discover/least overhead/is most fair to the participants we
want.

My hypothesis is that the current system does this best.

~~~
logfromblammo
My hypothesis is that the current system is most profitable for the people
running it.

Using continuous trades, the difference between the price someone _would_
accept/pay is usually very close to the price they _do_ accept/pay. That's
because arbitrageurs are continuously taking tiny little bites from the
theoretical benefit of trade to the buyers and sellers until everyone is
almost indifferent to trade, regardless of the actual price they had in mind.
The trades are spread out by time, such that each one can be attacked
separately (by a sufficiently fast attacker).

The system is set up to consume the big triangular areas on the supply vs
demand chart that do not actually impact whether a trade takes place.

If you settle multiple trades at once rather than a continual series of
individual transactions, there are fewer opportunities to take a bite out of
other people's trades by being a very fast middleman.

Also, the only way to test your hypothesis is by comparing it against every
other possible trading system. So I'd probably start off with a less ambitious
claim, like "the current system is more fair than what Log from Blammo
proposed." That way, it could be tested just by setting up the competing
system and watching what happens.

~~~
kasey_junk
I actually think there are lots of trading schemes that could prevent speed
being a major advantage, but discrete time auctions are not one. They just
change who gets the time advantage. The only way to remove time advantage from
the field would be to make it so that order time was not calculated in fill
priority. There are markets that do this currently (pro-rata markets give
larger orders priority over smaller ones regardless of order time). There are
also markets that have tried randomized matching and other esoteric methods.
Not many people liked trading this way so volume dried up.

If we really wanted to remove time priority, my favorite way would be to add
near infinite price increments. Then if you wanted to pay for priority you
could in an explicit way.

I'll buy that my hypothesis was overly broad. Let me rephrase it to, "The
current system is way better than the previous system, and I've heard no
systems that don't have obvious flaws as compared to the current system."

~~~
logfromblammo
It isn't just about time. If someone knows what you are _willing_ to pay, they
can engineer their trades such that you pay exactly that. When the system
itself is not paid unless you pay less than you were willing to pay, there is
a built in incentive to not reveal that information to potential middlemen.

In that context, trade speed doesn't matter. If arbitrageurs cannot profit by
breaking your trade up into two trades with themselves as middleman, it
doesn't matter how fast they are.

Aside from that, any system where trades can occur faster than information can
enter your eyeball, process in the brain, and shoot down your arm to click a
mouse button is one that unfairly disadvantages the unaugmented human
participant.

------
krastanov
Isn't the entire point, that the anti-HFT folks are trying to make, that if
HFT is abolished then we will still have liquidity? As in "Liquidity is not
created by HFT. HFT are just an intermediary between the actual providers of
liquidity and the rest of the market".

This is a sincere question, because I really do not understand how HFT
"creates liquidity" when they are just buying low and selling high.

~~~
vbuterin
They are nevertheless buying higher than everyone else and selling lower than
everyone else. Otherwise their orders would never get filled.

~~~
krastanov
Yeah, but if they (the HFT) are not there the only thing that seems to change
(in my naive understanding) is that there is no "tax" on liquidity, but the
liquidity is still there.

------
liricooli
For anyone interested in more information, I׳d recommend reading the comments
in these two threads [0,1] from Marginal Revolution blog. Two HFT traders
wrote thoroughly about HFT. I׳ve never read such an interesting and broad
online discussion about HFT. I actually spent most of yesterday׳s afternoon
reading these threads.

[0]
[http://marginalrevolution.com/marginalrevolution/2014/04/mat...](http://marginalrevolution.com/marginalrevolution/2014/04/matt-
levine-on-michael-lewis-and-hft.html) [1]
[http://marginalrevolution.com/marginalrevolution/2014/03/new...](http://marginalrevolution.com/marginalrevolution/2014/03/new-
michael-lewis-book-on-finance-and-high-frequency-trading.html#comments)

------
gopher1
If you're not a pension fund or other large investor, HFT's don't care about
your orders.

------
fsk
The premise of the post is false. If a large limit order is resting on the
books, that's an implied option for the HFTs.

If you place a large bid at $10.00, the HFTs will buy at $10.01. If the market
starts going down, they sell to you before the price crashes more. If the
price goes up, you never got your fill.

Limit orders don't protect from HFTs exploiting you. What happens is you
either don't get filled (price drops to $10.01 and goes back up), or the price
drops to $9.99 or less.

------
rbc
I personally use limit orders. I think there is an important distinction in
deciding how much will be paid for a security. It makes you think about what
the security is actually worth, separate from what the market order book is
saying about the security at any particular time.

------
dbrower
Can someone explain why any of these is a bad idea? (a) completed transaction
tax; (b) regulatory fee on offers/cancellations; (c) insertion of random
delays into offers/cancellations;

All could increase friction and reduce the speculative/arbitrage
opportunities, while having little effect on those wanting to trade to hold
for periods exceeding seconds.

There is a belief that the churn of HFTs/Arbs is enhancing liquidity for
"real" investors. There ought to be reasonable questions what amount of churn
is useful, adequate, and whether some frothy levels should be constrained in
some way.

Is there any way to decide when things are excessivly liquid, in ways that
lead to undesirable effects?

~~~
kasey_junk
Any tax you propose will reduce the amount of the taxed thing and introduce
unintended consequences. So we have to ask why do you want less transactions
or orders? It won't reduce HFT activity for instance. It will just mean that
HFT systems will only make more profitable trades. That means higher bid/ask
spreads and higher risk limits leading to higher volatility. It also may have
the unintended consequence of consolidating more volume into smaller firms.

That doesn't seem to be in anyone's best interest.

As for latency games the issue is not the overall latency it is fifo priority
matching. Without changing that bouncing trading signals off of mars won't
help.

~~~
dbrower
I think a reasonable question is why we consider /more/ transactions a good
thing, if a large fraction of them are for holding periods in small number of
seconds.

I think I am questioning the fifo paradigm, which creates these arbitrage
opportunities, especially when there are multiple fifo queues representing
multiple markets. It is not clear to me that batching things in 1 sec
increments, and randomizing the our ordering would be bad or unfair.

I also don't see why a modest fee that would make short-hold transactions for
tiny gains is a bad thing.

Structuring the system to reward HFT latency advantages seems opposed to
stability, if one believes that the market is for actual investments.

HFT seems to be a second order phenomenon that games the system, and may have
come to dwarf what could be called legitimate investment.

At what point is there "enough" liquidity, and when is "too much"? I suspect
the people who do HFT and other arb techniques think there is no such thing as
too much, because they profit on the churn. Others see this as producing
nothing of societal value, extracting real money from the system that could be
used for other purposes.

~~~
kasey_junk
"I think a reasonable question is why we consider /more/ transactions a good
thing, if a large fraction of them are for holding periods in small number of
seconds"

I don't want to put words in your mouth, but can we at least say that
transaction count is not what we are actually interested in? In a vacuum we
(larger society) don't care a whit about the number of transactions that
occur?

"It is not clear to me that batching things in 1 sec increments, and
randomizing the our ordering would be bad or unfair."

It is clear to me that batching things in 1 sec increments would be as unfair
to someone as the current system (I'm sorry to not back this up, but I've been
doing a ton of commenting about it in the last few days and don't have the
patience I did). It's possible that this unfairness is "better" for society
overall. I don't know how to quantify that.

"I also don't see why a modest fee that would make short-hold transactions for
tiny gains is a bad thing."

My "expert" opinion on market making strategies is that this would increase
the bid/ask spread and volatility in the market. Further my opinion is that
this is a bad thing for retail investors and market makers, to the advantage
of large institutional investors. I don't have the stamina to prove this
assertion.

"Structuring the system to reward HFT latency advantages seems opposed to
stability, if one believes that the market is for actual investments."

This is a common simplification that I think deserves a lot of thought. Many
folks on Hacker News think that the market is for "investment". Usually they
equate this to "bootstrapping enterprises that aren't viable without external
money". This is an obvious bias for an internet forum dedicated to startups to
have. In reality, the vast majority of market forces are not about that. They
are about risk mitigation. So when you say that HFT "dwarfs" legitimate
investment, are you saying it doesn't provide a valid mode for bootstraping
enterprises, or are you saying it doesn't help with risk mitigation?

Your answer to that question means a lot for how we debate the topic. A
similar answer is available for your assertion that HFT is a second order
phenomenon.

As for when is there enough liquidity? I'd say when people stop paying for it.
Which hasn't happened yet. Paying for liquidity is reaching a saturation
point, because it has gotten so cheap. This is most obviously demonstrated by
the massive loss in value that HFT groups have had in the last 5 years. If
anything we have too much liquidity, and that comes from someone who's
paycheck comes from an HFT.

~~~
dbrower
Thanks, I appreciate the answer, and am trying to be more informed.

On transaction count, I think "we" /may/ care about transaction count, if the
majority of transactions are shams or gaming the trading system. To the extent
that the value of the transactions turns up in statistics like GDP, then they
distort "our" view of economic activity. Perhaps that is a problem with
metrics that include such transactions rather than their existence.

Let's table discussion of batching or randomization.

In terms of volatility, I will proffer that HFT and program trading go hand-
in-hand in my mind, and that program trading at high frequency seems to be a
volatility amplifier. It's not yet clear to me why added damping friction
automatically leads to wider spreads and volatility as you indicate. I accept
I may be uninformed on the matter.

When I speak to "investment" I think more of capital gain and dividend than of
capitalization from public offering. Over not long periods, the value of
shares traded "long" usually greatly exceeds the value of the offering. That
is the majority of "investment", and doesn't really relate to bootstrapping
startup-ness.

I think there is a fair discussion to be had about amounts of liquidity and
risk mitigation. Some reasonable questions are about whose risk is being
mitigated, at what cost to whom else, whether all affected parties are willing
participants or if they are left no viable alternatives.

The argument is that the "risk" being mitigated is a derivitive of "true"
investment, and should be of a lower aggregate value than the underlying
security. When the mitigation is exceeding the value of the asset, then that
suggests the system is out of balance. Relate to aggregate CDO valuations
exceeding the value of the underlying securities.

I'm not saying I accept that argument, or reject your point about risk-
mitigation. I'm trying to understand the forces that should balance, and how
one might judge them.

I'm not sanguine about the claim that payments for liquidity are proxies for
the will of an informed market, since I'm not a Chicagoan who thinks the
market is always right by definition. There can be market failures, and it
seems possible that "over liquidity" may represent a market failure.

thanks.

~~~
kasey_junk
On the transaction count issue, I agree that there may be some societal good
to removing sham or gaming trades from the markets, but that is not what a
transaction tax targets, it targets all transactions whether they are shams or
not. Further a transaction tax raises the cost of entry for all market
participants, without providing any disincentive to those making sham trades.

It's possible that HFT is a volatility amplifier, it's hard to judge though
because HFT rose when other macro market forces were driving huge amounts of
volatility into the markets. One thing I think most people will agree on is
that market segmentation and electronic access drove down the price of trading
dramatically for everyone and enabled a variety of extremely useful investment
vehicles for the "retail" investor (I'm thinking of ETFs especially). Any
system that has market segmentation and electronic access will also enable
algorithmic trading. My opinion is that it is foolish to throw out all the
positive benefits in the name of some artificial "fairness" between human and
computer traders.

Chris Stucchio has a good explanation about the mechanics of market making at
[http://www.chrisstucchio.com/blog/2012/hft_apology.html](http://www.chrisstucchio.com/blog/2012/hft_apology.html)

Understanding those mechanics we can see that any added costs that the market
maker bears must be reflected in their trades and will eventually drive them
to increase their spread on the order books. If enough of the market makers do
this it will increase the spread which is the biggest driving cost in trading
after operational costs.

Capital gains and dividends are a mechanism to make capital aquisition
possible. They happen to be the attributes of the capital markets that you are
most interested in but there is nothing sacred about them (in fact lots shares
lose capital and many companies don't pay dividends). For many other market
participants hedging against inflation risk is vastly more important than
dividends for instance. My opinion is that we should enable a system that
allows for as open of access as possible to these markets for as cheap a cost
without bias towards whats most important to any class of market participant.
It is also my opinion that HFT actually does these things and that is why they
are so scary to hedge funds and big banks.

I am also not a Chicagoan (well in an economic sense) and you are right over
liquidity may be some sort of market failure. As someone who sells liquidity I
will tell you that the price of it is currently being propped up with
legislation. If it weren't for the sub-penny rule the spreads on some commonly
traded instruments would be much smaller than they currently are. I'd also say
if you figured out a way to remove some of the liquidity in the system without
increasing my costs I'd appreciate it as this whole competing in an efficient
market thing is for the birds.

~~~
dbrower
Thanks, I appreciate the discussion.

------
hawkharris
I just started learning about high frequency trading. I was interested to
learn about some of the lore surrounding the field. While digital algorithms
are relatively new, trading algorithms, in a conceptual sense, have existed
for at least hundreds of years. I don't usually throw around links to my own
content, but I think this is relevant: [http://codyromano.com/using-pigeons-
as-algorithms/](http://codyromano.com/using-pigeons-as-algorithms/)

------
001sky
Author would benefit from a closer reading of the M. Lewis piece. It's well
researched far from trivial. What's interesting about it is that it tells the
story of how outsiders modeled the various ways to rip off <institutional>
traders. They did this first and the empirically pattern-matched observed
behaviour. They then did both physical and social market-micro-structure
studies.

Lets take a look at this section (From attached article):

 _The fact of the matter is that HFT’s can’t rip you off. You are never under
any obligation to do business with them. In spite of that, lots of
sophisticated investors voluntarily pay HFTs every day. An important question
for all the critics of HFT to grapple with is, “why do sophisticated investors
voluntarily pay for something useless?”_

This comes right after the section on why people don't adopt obvious
strategies (use limit orders, etc):

 _Why doesn’t everyone do this?

This is an obvious question to ask. The answer is, quite simply, execution
risk. Execution risk is the risk that you place an order but your trade never
actually happens._

The Analysis Lewis outlines in his book shows that HFT is specificially
engineered <to create execution risk>. It engineers artificial scarcity (the
opposite of liquidity). Empirical study from Lewis's book:

 _Finally [The Trader] complained so loudly that they sent the developers, the
guys who came to RBC in the Carlin acquisition. “They told me it was because I
was in New York and the markets were in New Jersey and my market data was
slow,” Katsuyama says. “Then they said that it was all caused by the fact that
there are thousands of people trading in the market. They’d say: ‘You aren’t
the only one trying to do what you’re trying to do. There’s other events.
There’s news.’ ” <If that was the case, he asked them, why did the market in
any given stock dry up only when he was trying to trade in it?> [emphasis
added] To make his point, he asked the developers to stand behind him and
watch while he traded. “I’d say: ‘Watch closely. I am about to buy 100,000
shares of AMD. I am willing to pay $15 a share. There are currently 100,000
shares of AMD being offered at $15 a share — 10,000 on BATS, 35,000 on the New
York Stock Exchange, 30,000 on Nasdaq and 25,000 on Direct Edge.’ You could
see it all on the screens. We’d all sit there and stare at the screen, and I’d
have my finger over the Enter button. I’d count out loud to five. . . . “
‘One. . . . “ ‘Two. . . . See, nothing’s happened. “ ‘Three. . . . Offers are
still there at 15. . . . “ ‘Four. . . . Still no movement. . . . “ ‘Five.’
Then I’d hit the Enter button, and — boom! — all hell would break loose. The
offerings would all disappear, and the stock would pop higher.”_

This is why it's being investigated by the FBI, in addition the other issues
(front running, NPI, etc).

 _" There are many people in government who are very focused on this and who
are concerned about it and who think it breaks the law," an FBI spokesman
said. "There is a big concern that high-frequency traders are getting material
nonpublic information ahead of others and trading on it."_

~~~
Permit
Your example does exactly what the author recommends you not to do; cross the
order book. In your example, you're supposed to place a limit order at 14.99.

~~~
jcampbell1
That doesn't do anything. Then you never get any shares, and the market moves
higher because there is a 100,000 shares on the order book and the market will
move higher for legit reasons.

The way not to get scalped, is to place the order in a way where it arrives at
all the exchanges at the same time, that way the HFT guys and their microwave
data links can't peek at your order on BATS, and then beat you to the other
exchanges.

The accusation is they see the 100,000 share order hit BATS, 10,000 get filed,
then the HFT guys buy 90,000 shares on the other exchanges before your order
gets forwarded, and you are stuck paying the HFT guys $15.02.

~~~
harryh
The HFT guys aren't buying 90,000 shares on the other exchanges. They're just
updating their ASK price on those exchanges to slightly raise the price to
reflect the new information that just hit the market. If someone wants to buy
100,000 shares RIGHT NOW it's a good sign that the price should be going up.
Katsuyama/RBC were used to their proprietary information staying a secret that
only they knew for longer before the HFTs jumped in and made the market
respond faster.

That might be a bummer for Katsuyama/RBC but it's great for everyone else on
the market who now benefit from a price that updates faster.

~~~
jcampbell1
How do you "update" your ASK price? They are either front running by buying
the shares at $15.00-$15.01, or, if they are their own orders, then they
cancel them. It is the same thing.

If someone wants to buy 100,000 shares, and the market says there are 100,000
shares available at $15, the order should complete at $15.

~~~
harryh
You update your ASK price by canceling your order and submitting a new one
with a different price.

> If someone wants to buy 100,000 shares, and the market says there are
> 100,000 shares available at $15, the order should complete at $15.

As long as they submit their matching order while my bid is still on the books
that's fine. But why should I be required to keep my order on the books for
any longer than I want to?

~~~
jcampbell1
You should be able to cancel you order at anytime. What you shouldn't be able
to do is to stiff other people's trades, and then use a microwave antenna to
change your order before the other person trade arrives.

~~~
harryh
What you think is happening in the world is not what's actually happening.

What's happening:

1) A large block of shares is traded on exchange #1.

2) HFTer notices #1 and very quickly updates the price at which they are
willing to buy/sell on exchange #2. No one has any sure knowledge of trades on
their way to exchange #2. They can guess. They can infer. But they aren't
seeing any actual trades before they hit the exchange.

~~~
001sky
Please explain how you would do this in an open outcry market.

You're talking about front-running the trade inbetween the "sell" decision and
the receipt of the signal at the exchange. In otherwords, your bid/offer is in
bad faith. I can advertise a car for sale and then when you walk in remove the
price and mark up the trade. You cannot do this in an open outcry market.
Because it would be subject to retaliation (of various kinds).

Providing bid/ask indication in bad faith is NOT liquidity. Liquidity is not
layering a trade to double the volume.

HFT does not increase liquidity. It increases volume, at best. But so does
front-running. The bait and switch issue and the front-running issue not
interchangeble, but they are closely linked.

Market micro-structure is difficult to discuss because most people are
completely ignorant of the mechanics. Its easy to pass of volume for liquidity
and to disquise front-running as "market making" or speculation. It is clearly
distinct.

~~~
harryh
Market makers are in the business of selling liquidity. They're saying "maybe
no one else wants to buy/sell this stock but here I am and I always have a
bid/ask on the table." You don't have to trade with them. But a lot of people
do every day.

Why do you think those people are trading with market makers if they're doing
such shady things?

I don't think you really understand the business that market makers are in.
They aren't in the business of trying to front run people. They're in the
business of making a penny a share on all the trades that go back and forth.
But they face a big risk. When they're busy buying/selling for $50.00/$50.01
what happens when a big & smart hedge fund guy comes along who has new
information and knows the price should really be $50.10. They try to buy up as
many shares as possible at $50.00 and suddenly the market maker is fucked
because they're no longer market making in a stable market.

So the market maker has this big challenge where they have to do a good as job
as possible detecting the big & smart hedge fund guy and quickly adjusting the
price so they don't get squashed. If they can't do a very good job they have
to increase spreads so they make more money in the steady state to make up for
their bigger losses. If they do a really good job in this detecting they can
lower spreads.

It turns out that HFTers are really good market makers. You can see this
because they've successfully competed against each other to the point that
they can lower spreads all the way to a penny (a 10x reduction of where they
used to be!).

When you look at it this way you can see that market makers aren't trying to
screw the big traders, they're trying to avoid getting screwed so that they
can better serve everyone else by offering lower prices (lower spreads).

The nice side effect of all of this is that price information gets better
communicated to the market faster. If you happen to be randomly selling your
MSFT when Mr. Big & Smart shows up you're more likely to get the best possible
price due to all the information being correctly communicated to the market.

~~~
001sky
You're missing the point that front running is capital efficient and ~zero
risk. There is no discussion of hedging strategy and cost, etc in your reply.
It seems plausible that (unobserved) front-running profits could easily
subsidize (observed) low-spreads as loss leaders.

~~~
harryh
What front running? Are you talking about arbitrage between exchanges or
something else?

~~~
001sky
Anything that starts after "buy/sell" electrons are entered into a book [#]
and includes a pricing mark change before "fill" hit my account. This set of
trades is broader than what you might imaging, but specifically I'm interested
in any trade that (1) has information incorporation; and (2) dependent logic
based on (1) and (3) requires sequential execution (ie, fronting). It is not
enough to say these trades are not observed. They have to be shown to be
impossible (or unprofitable). There is reasonable evidence that they are both
possible and profitable in Lewis's book.

# This includes both voluntary and involuntary disclosure.

~~~
harryh
OK, well I haven't read the book (only the NYT excerpt so far) but I am highly
skeptical that such trades are happening. I will read the book though, and
reserve judgement until then.

------
Sniperfish
Nanex explains this stuff better than I will so I'm just going to link to
their research (tl;dr summary of [1] below). I will accept not all HFT
participants are obligated to follow any or all of these behaviours, but they
are argued in defence of all HFT activity which is patently not true.

1\. They Provide liquidity, false. Or at least works on a definition of
liquidity that is not what would generally be used by other market
participants (institutional or retail) - specifically see pinging or using
orders to determine interest [2]

2\. Tighten spreads, false. Attributable in the largest part to reg NMS not
directly to HFT. Spread volatility has increased.

3\. Lower costs, false. Cheap trading available via discount brokers before
HFTs and additional costs to other market participants operating in HFT
innundated environments are ignored.

4\. Studies showing positive of HFT cherry pick and are of inconsequential
detail, no conclusions should be drawn without deeper analysis of the data

5\. Nannex guys just have an axe to grind repudiation

Plus ignores any other negative side effects of super-high speed trading such
as stock specific flash crashes, data overload, and locked / crossed markets.
Appreciate some of those can also be attributed to the proliferation of
protected markets post Reg NMS.

[1]
[http://www.nanex.net/aqck2/4594.html](http://www.nanex.net/aqck2/4594.html)
[2]
[http://www.nanex.net/aqck2/4592.html](http://www.nanex.net/aqck2/4592.html)
(appearing to violate SEA 9.a.1.A)

------
Mikeb85
Dunno, I for one value the service HFTs provide. They're the reason that I, as
a small investor, can unload 50,000 dollars worth of shares in a couple
seconds.

Have you ever traded a stock market with low liquidity? You can have a market
sell order sitting all day... I'd rather pay the small HFT toll, I still make
plenty anyhow.

~~~
adamgravitis
HFTs aren't really helping your situation at all. Other forms of liquidity
generators might be, but HFTs are exploiting microsecond-level arbitrage
opportunities. I've never heard of a small investor with sub-second execution
requirements. In fact, I'd be curious why you needed to execute 50,000 shares
in a few seconds at all. From my perspective, I'd be thrilled if I could sell
a few shares over several minutes as long as I were confident I was getting a
good price.

~~~
kasey_junk
That is a completely inaccurate generalization about what HFTs do. There is a
class of HFT that does latency/venue arbitration but it is a very small niche.

The vast majority of HFT volume on the other hand is traditional market
making. This HFT market making is much more efficient and fair than human
market making was. It is driving down the bid/ask spread to the thinnest
possible levels (at least the thinnest legal levels). This is the single
biggest driver to you getting the best price.

Being a retail investor right now is the best it has ever been and HFT systems
are a large reason why.

------
panzagl
There is a lot of 'unless you're selling 100000 shares in a hurry you
shouldn't care', but if an HFT 'rips off' a pension fund I very much do care-
even if I'm not personally affected I'm sure the added cost will be passed on
to the state somehow.

------
whyme
It's sad that I as a retail investor need to spend my valuable time focusing
on how not to get screwed by the exchanges that have introduced a side
business which does not serve the functioning of the market and instead
corrupts it.

~~~
harryh
You don't actually need to focus on this. As a retail investor your going to
get filled at NBBO (National Best Bid and Offer). The people writing things
that make you think otherwise are selling irrational fear.

It's no different than how local news makes people think that crime in the US
is at an all time high by reporting on it all the time when, in fact, crime
has been dropping for decades.

Don't buy what the fear-mongers are selling.

------
meric
You still lose with Limit Orders. Here is how. I also propose how to actually
not get ripped off.

The bid price is $100, the offer price is $101.

You want to buy, but you don't want to cross the spread.

You're worried the $101 isn't actually there - i.e. if you place an order to
buy for $102, either the $101 order will get pulled by the HFT trader, or the
HFT trader will buy the $101 order and sell it to you at $102.

The article suggests placing a limit order without crossing the spread. i.e.
Put a limit order at $100.

So you put the limit order at $100. It sits there, and doesn't move.

10 minutes later, another company in the same industry announces below
expected results due to market conditions. As this company is in the same
industry, its stock price is negatively affected.

Before you have time to cancel your $100 limit order, the HFT trader has
already parsed the negative news and short sold the stock all the way down to
$99.5, taking your order with it, you're recorded to have sold at $100.

You lose either way.

The continuous limit order market is where HFT has a lot more edge than you
do. You can try to avoid placing market orders that cross the spread, as well
as avoid placing limit orders that linger for too long and get taken advantage
of.

There's a call auction in the morning before the stock market opens every day.
No market orders are allowed. Everyone places limit orders and everyone
executes at one price. There is no spread to cross. As long as enough other
investors participate in the same call auction, it'll be a lot more difficult
for HFT traders to take advantage of your order. (Frequency doesn't even come
into play since call auctions are discrete markets, not continuous - there is
only 1 open price. This negates the HFT trader's speed advantage, since speed
is rendered irrelevant)

Just regurgitating stuff I've learnt with finance at university.

~~~
umanwizard
Your example doesn't make sense to me. Why would you place an order to buy for
$102 if there is an offer for $101 ?

~~~
jessaustin
Prices move, so traders add a bit of leeway if they want to be sure the trade
will execute. The worry with HFT is that the price will move solely in order
to screw over this particular trade, rather than as a reflection of overall
market conditions.

