When you think Facebook/Instagram, you think "Damn, those guys got lucky as hell". When you think automated trading, you think, "Hey, it can't be that hard", and start firing up your IDE and rolling out code to talk to an easily provisioned API.
Sure, it may take months to lose your shirt selling a photo service to Face/Goog/Apple. You can lose everything overnight with automated trading.
My father used to trade commodities for a living in the pit at the CME many moons ago, and when I was growing up I would be his technical side when he was trading out of our suburban Chicago home (setting up FM receiver/satellite dish/etc for real time quote data, staying up late nights with him running through trading scenarios in Tradestation on Win3.1 with data downloaded in bulk from Knight Ridder, and so forth).
Something very important I learned from him was: "The market can stay irrational longer than you can stay solvent." With a startup, you can hit bottom. In the right market, bottom is much further down than you can ever see.
I'll take it ad absurdum: You can lose everything in a second by not looking left and right while crossing the road. Or even by looking left and right while crossing the road, when someone else is driving recklessly.
It is possible to attempt HFT with not much more risk than stating a new InstaFaceGoogApple service. Put $10,000 in your margin account, and use a broker that practices proper margin checking. Tada! You're not going to lose more than $15,000 over that. (Yes, you can lose more than you put in your margin account, but not by much).
While that's more, upfront, than InstaFaceGoogApple, it is comparable to the 4 months of salary that you're going to forfeit while building the InstaFace service. And unlike most InstaFace apps, you have immediate market feedback, which can only be a good thing.
Note: Instagram did have immediate feedback from the public at large, forcing them to scale much earlier than they expected - but they did not have a feedback as to the financial value of their proposition. In fact, it wouldn't take much for instagram worth to be zero. Read, e.g. http://www.jamesaltucher.com/2011/02/my-name-is-james-a-and-... - a $100M acquisition back then is like a $300M acquisition in today's valuations; not Instagram but definitely nothing to ignore.
> With a startup, you can hit bottom. In the right market, bottom is much further down than you can ever see.
That's true. But you still have to remember that 90% of startups fail, and of those that succeed, many are just moderately successful. And yet no one keeps yelling "but most startups lose money!" at every HN story.
> When you think automated trading, you think, "Hey, it can't be that hard", and start firing up your IDE and rolling out code to talk to an easily provisioned API.
Which is what we should address, and these "it's a gamble" warning do not. When you see Suzanne Vega singing, you might think "Hey, it can't be that hard to sing". Many people do. And yet, they grow out of it, usually without trying to publish an album (and failing). This should be no different.
The point is you are lured into crossing the road, when you absolutely didn't have to.
In order to open an account with the neccessary infrastructure to engage in HFT one must be an accredited investor (typically means having a net worth of 1 million dollars or more) and the cheapest brokers typically require a minimum deposit of $500,000.
Not to mention the overall costs including hardware, co-location, market data and other vendor costs are on the order of 45-50k a month.
With $10,000 you can't even open up a normal day trading account as the law required a minimum deposit of 25k.
As long as we're quoting Keynes, let's also remember this gem from a letter he wrote to the regents of King's College about the performance of their endowment's portfolio (which Keynes managed).
"The management of stock exchange investments of any kind is a low pursuit, having very little social value and partaking (at its best) of the nature of a game of skill, from which it is a good thing for most members of our Society to be free; whereas the justification of Worlaby and Elsham lies in its being a constructive and socially beneficial enterprise, where we exercise a genuine entrepreneurial function, in which many of our body can be reasonably and usefully interested. I welcome the fact that the Estates Committee-to judge from their poker faces and imperturbable demeanour-do not take either gains or losses from the Stock Exchange too gravely-they are much more depressed or elated (as the case may be) by farming results. But it may be useful and wise nevertheless, to analyse from time to time what is being done and the principles of our policy."
Edit: Worlaby and Elsham was a farm that the endowment owned.
Didn't your father teach you about "Stop orders"
You can't have your algorithm cranking away without supervision. And to be extra sure, lots of testing and LIMITS.
Limit the amount and value of orders.
With stocks, worst case: you lose the face value of stocks in your portfolio
Derivatives: you can lose more, even 'infinite liability' (still, it's constrained by the stock market inertia)
So I guess they have a role in limiting losses (which had they not been there would be much bigger)