On the contrary, equities markets need the liquidity HFTs provide to function well. Before HFTs there were human market makers who played a similar role in equities markets, but charged far more to do it. HFT is a story of efficient technology bringing prices down a lot and shrinking the profitability of an existing industry.
I’m sympathetic to the view that a lot of resources have been poured into making trades happen in 1 nanosecond when 100 or 1000 nanoseconds would probably be fine for all practical purposes. The issue is that people keep finding that letting the fastest system get the trade actually does work better than alternative approaches.
It means people get better prices than they otherwise would.
US markets are pretty bad along many axes (e.g. brokers have an obligation to route flow to wholesalers in an effort to maximize price improvement, but this does not necessarily result in the best price on a per-order basis the way that a limit order book populated by wholesalers and other retail orders would. startup costs to get "fair access" to institutional flow and 0 captive retail flow are multiple millions of dollars because of exchange revenue models. retail maker orders will literally never interact with retail taker orders. etc.), but it's difficult to argue that retail would pay less in fees and spreads if they had to always interact with quotes manually created by humans.
I definitely don't know enough about trading. So please forgive if this is just naive.
From what I gather, the problem is matching sellers to buyers. Sellers list what they're looking to buy, and the price they're willing to pay. Buyers list what they're willing to sell, and at what price. Let's say each offer is valid for 100 ms (that's a reasonably short time span, no immense risk for the entity making the offer).
But I find it difficult to understand where speed (on the level of HFT) ever becomes a factor in this game?
If the HFTs looks at different exchanges and work as gel between them, making the trades between exchanges that otherwise wouldn't happen, that would make sense as a valuable business.
Is that their purpose?
Although, it still seems to me the slower buyer and seller would prefer to come to an agreement alone without the middle man taking part of the profit.
If the trade enabled by the HFT would've happened the next 100ms clock cycle anyway after the buyer and seller noticed each other and adjusted their prices, I don't see the value of the HFT trader. Seems they're just hacking the system.
Most HFTs are market makers, meaning they are willing to buy or sell any of the stuff they trade at any time. They provide the service of assuming risk that they don't really want. If some non-HFT participants show up to a limit order book, they could transact with each other, but it's more likely they will each transact with a market maker. Because of the way limit order books work, they cannot possibly receive worse prices due to the presence of the market maker's orders. If the best price each of them could receive was from the other's order, they would match with each other.
US markets don't work precisely this way for various reasons, but it seems like if the question is "What service, if any, are HFTs selling?" then the answer should be "They are willing to assume risk by taking the opposite side of your trade basically regardless or what your trade is" rather than a rant about US market structure.
"Trading in one market based on price information from another, such that the prices in the two places are in agreement with each other" is actually called out elsewhere in this comments section as a value-destroying activity that reduces liquidity and therefor at the margin causes less sophisticated traders to get worse prices.
If someone is regularly noticing things and adjusting their price in a tenth of a second, it seems likely they are engaged in some form of automated trading.
> Because of the way limit order books work, they cannot possibly receive worse prices due to the presence of the market maker's orders
The (HFT) profit has to come from somewhere. And I'm pretty sure they come from the other market participants. If that's the case, clearly some market participants are getting a worse deal than they'd otherwise have gotten.
At the time scale of seconds, trading is a zero sum game.
Perhaps there's something I'm missing?
> is actually called out elsewhere in this comments section as a value-destroying activity that reduces liquidity and therefor at the margin causes less sophisticated traders to get worse prices.
Yes that's how I also understand it. Is this description incorrect?
> If someone is regularly noticing things and adjusting their price in a tenth of a second, it seems likely they are engaged in some form of automated trading.
I'd consider automated trading and HFT to be orthogonal concepts. I totally see the benefit of automating trading, but I don't see the benefit of HFT. The 100ms number was selected small enough to be faster than any "real" "tangible" "physical" process in the economy, but still way slower than HFTs.
> The (HFT) profit has to come from somewhere. And I'm pretty sure they come from the other market participants. If that's the case, clearly some market participants are getting a worse deal than they'd otherwise have gotten. At the time scale of seconds, trading is a zero sum game. Perhaps there's something I'm missing?
Can you work through a specific example for me? Previously, before automated trading, specialists would make markets in specific stocks, and people who traded with specialists would pay larger spreads than they do now. I've claimed that "being willing to take on risk" is a valuable service worth paying for, and that most people in most markets pay very little for it now, as a result of their counterparties selling the service for very cheap. It is of course possible that some subset of participants could work out deals among themselves and end up with a surplus as a result, in the same sense that it's possible that you could stop going to stores and buy everything directly from suppliers by driving to their warehouses, or start your own stores or whatever.
> > [capturing surplus due to short-term inter-venue mispricings] is actually called out elsewhere in this comments section as a value-destroying activity etc.
> Yes that's how I also understand it. Is this description incorrect?
It's not incorrect, but in your other comment you said
> If the HFTs looks at different exchanges and work as gel between them, making the trades between exchanges that otherwise wouldn't happen, that would make sense as a valuable business. Is that their purpose?
Which precisely describes the activity that you now agree is value-destroying.
> I'd consider automated trading and HFT to be orthogonal concepts. I totally see the benefit of automating trading, but I don't see the benefit of HFT. The 100ms number was selected small enough to be faster than any "real" "tangible" "physical" process in the economy, but still way slower than HFTs.
I don't think this is reasonable. If you are engaged in automated trading and you occasionally place resting orders on a limit order book, you need to be able to cancel those orders very quickly some of the time. The only alternative is that you believe that capturing surplus due to short-term inter-venue mispricings is value-destroying and that *failing to let other people destroy value by interacting with your resting orders when you know that you would prefer that they do not* is also value-destroying. That would be a surprising set of beliefs.
As an aside, there's a proposal quoted elsewhere in this comments section for FBAs[0]. I don't have a sophisticated opinion on these, but my first impression is that if FBAs replaced much of the existing market structure then the need for anyone with resting orders to cancel their orders on very short notice could become dramatically less frequent.
I’m sympathetic to the view that a lot of resources have been poured into making trades happen in 1 nanosecond when 100 or 1000 nanoseconds would probably be fine for all practical purposes. The issue is that people keep finding that letting the fastest system get the trade actually does work better than alternative approaches.