Below a certain time accuracy, all trading is zero sum. The only reason to be able to trade in milliseconds is to beat someone else. No value is created.
Suppose instead that exchanges buffered all orders for, say, 1 hour. At the end of the hour they perform a stable matching algorithm to pair up bids and asks, and execute those trades simultaneously.
Are there any downsides to this? It seems like it would eliminate all of this zero sum behavior, and at the same time, increase liquidity, particularly for people who aren't on a fiber line one block from the exchange. You could additionally require all material information to be released at the top of the hour, to ensure a full hour of analysis before any trades are executed.
At the end of the hour they perform a stable matching algorithm to pair up bids and asks
"A stable matching algorithm" is the real trick here.
Incidentally, the fundamental problem of zero sum behavior here is caused by the subpenny rule. Speed would be a non-issue if you were allowed to bid $10.031 in order to beat the faster guy who bid $10.03. Right now you can only bid $10.04, which is often too high.
"A stable matching algorithm" is the real trick here.
Easy. Assume all orders are limit orders, because non-limit orders don't need to exist. Perform the Gale-Shapely stable marriage algorithm http://www.cs.cmu.edu/afs/cs.cmu.edu/academic/class/15251-f1... Where the preference ordering of each person is assumed to be the order that maximizes their return. (The difference in the limit order prices.)
The actual situation is much simpler since all players have the same preference ordering, but this is just to show that it's easy to find one stable pairing.
As a percentage of enterprise value, what is wrong with even larger minimal trading increments? There is no "valuation" resolution on a $1B and up company, that hinges on 1/0000th of a percent measurements in the residual value of the equity. Unless people arey marking to theoretical models purely for derivative purposes and trying to maintain a dynamic hedge with increasingly perfect resolution and without cost.
The resolution issue on prices is not clear-cut. Liquidity is good, and I'm happy to have it. But infinite resolution (price, timing) trades do not per-se follow. And they ultimately, themselves, have a feedback loop. INstitutionalized front running (changing examples) is not benign liquidity, for example. Dynamic hedging would at least be a legitimate use, but absence its availability should be priced in accordingly in seperate markets.
I don't care who I trade with. No one does. It's anonymous anyway, unless you trade with certain official market makers. Also, I don't care if my one order for 400 shares@$100 matches with 1 person selling 400 shares@$100 or 400 people selling 1 share@$100.
Trade matching is not the stable marriage problem. Get a clue.
>"A stable matching algorithm" is the real trick here.
What about randomizing bids and asks, and matching them on a first-come, first-serve basis?
Let's say you had bids like this 10, 12, 9, 5; and asks like this 11, 12, 10. You randomize the the bids, and sort the asks. Then you do a linear search for the first ask that is <= to that bid, and that's an order. You remove the bid and ask from the lists, and repeat until bids and asks are removed. If there is no ask that is <= the bid, the bid gets popped.
Precisely. Information asymmetry is what allows the exchanges to be profitable. It is a continuous wealth transfer along the information gradient, with the most knowledgeable investors capturing most of the wealth from the least knowledgeable.
As long as this asymmetry exists, the vast majority of trades will constitute a zero sum wealth transfer.
Even every 5 minutes would be great. Or even every 30 seconds. Microsecond latencies don't do much for investing; it's all about trading. Trading (or speculation) even has value so long as it's pulling information from the future to the present. That's the value it provides. If it's pulling the now plus 1ms future to now, I can't see that providing a lot of value.
Currently you can implement "Enter this position in an amount proportional to the portion of that order/those orders that get filled/do not get filled" yourself. You send the first order, you receive the response in a small amount of time, and then you send the order for the hedge. Alternately, you send the order and a hedge of a guessed size concurrently, wait for the order's response, and then adjust the hedge. Five minute or half-hour round-trip times would not be acceptable regardless, so a proposal that seeks to be taken seriously should address this issue.
Some thoughts on addressing the issue: implementing this sort of thing entirely on the server side would be a colossal engineering effort, and probably involve adding new "fill conditioned on state of other order (on a different exchange in a different country)" order types. A naive implementation of these conditional orders as described permits causal cycles where taking the shares causes one to take the shares, and not taking them causes one not to, and then one wonders whether the exchanges (the many worldwide exchanges that are collaborating on this algorithm) should have the order take the shares or not! A similar causal cycle may occur in which taking some shares causes one not to take the shares and vice versa. Regardless of what resolution is chosen for the "paradoxical" case, it will undoubtedly be a significant undertaking for both mathematicians and bakers to discern the correct combination of order types to maximize EV or to minimize risk, and to choose between maximizing EV and minimizing risk each time a position involving more than one instrument is traded.
Alternately, we could allow each exchange to make its own rules. They might end up with rules that are actually possible for human engineers to implement, like "price-time priority".
I meant in particular, it is not okay to have a one hour round trip time between the legs of a single position.
If I want to enter a large hedged position using the same "send some orders, wait for the fills, send more orders to tweak one side to be the appropriate size" procedure, I want to minimize the potential for price movement between the first and second sets of fills. If one hour's worth of information is incorporated into the securities' prices between the two sets of fills, that is a really huge amount of exposure compared to what I would expect today. I would have to be believe that the EV of the position is quite large before accepting one hour's unhedged exposure to get in on it. I could try to get rid of the round trip by using market orders everywhere, but this doesn't actually sound less risky. My belief and knowledge of the trades at some particular time would have to justify entering the position at some unknown pair of prices an hour later.
The great many participants who have not-incredibly-strong beliefs about the value of some hedged position will just not trade. The absence of their trades is a loss of information to the market; the market is less efficient. We probably share the belief that a more efficient market is good and a less efficient market is not so good :)
Enough with the hedged positions though!
Normally for this type of proposal I can just answer "If we do this then spreads will get bigger and that's bad," but here I have trouble doing that, because I'm not even sure if the notion of a spread or an inside price would make much sense once everything is so illiquid. Rather than having a view of the market that is a bunch of orders I can interact with at will, I would instead have a record of all the trades that happened in the last timestep and which orders were intact at the end of the last timestep. This is probably not sufficient information for me to learn the best prices at which I can be certain to buy or sell.
>If one hour's worth of information is incorporated into the securities' prices between the two sets of fills, that is a really huge amount of exposure compared to what I would expect today.
I don't think it's accurate to call what's going on today "an hour's worth of information." Not that much happens in an hour, per stock. It's more akin to an hour's worth of random walk. This is harder to argue, but I think this scheme would cause most of that random walk to disappear. Certainly whatever component of it is second order would disappear, (that is, based on signaling from the price movement itself.)
>I'm not even sure if the notion of a spread or an inside price would make much sense once everything is so illiquid.
If you think of liquidity in terms of "the chances that I can sell without having a large effect on the price of the stock" then I think this only increases liquidity. You're no longer counting on the availability of moment to moment orders on the other side of the deal. You're essentially building a smoothing function into the market.
There would be an incentive to wait for the very last moment to submit your order to such a system to maximize information for that period. However, this would be rarely useful for traders, unless there was some other automated thing, like a secondary market, that determined successful bids and asks.
The problem with low latency trading is it adds liquidity when you don't need it aka when things are stable and removes it when you do aka the market is crashing. Also, from an information theory perspective high frequency trading can't aid price discovery as the algorithms don't directly act on outside information and there assumptions are hard coded.
Market makers don’t directly participate directly in the price discovery process. A high frequency trader, or any sort of market maker, has no opinion or information on whether Apple is a valuable company.
Further buying or selling within the spread does not automatically make money it's as there is risk which that article mostly ignores.
It assumes that they need to trade right now and sell right now which is a false assumption. As to what network engenders do, if you want to really stretch thinks Starbucks barista's aid price discovery by keeping people awake but that's a meaningless definition.
PS: There was a while that I accepted the idea, but consider what happens if bill gates wanted to sell 10 billion in Microsoft stock HFT will be willing to pick up quite a bit, but vary seen there will try and get rid of the stock and the net effect is they don't hold the stock for long enough to matter. Because, really what they do is time shifting not price discovery. Further the reason it works is buy and sell orders without attached prices which makes selling 1/10th of a second sooner cost you money.
Anyone who doesn't need to trade right now is free to place ALO orders, not cross the spread, and collect a few fractions of a cent in rebates. The fact that most traders choose not to get paid to do this should suggest to you that maybe you are incorrect about the need to trade right now.
I have no idea what you are talking about with "buy and sell orders without attached prices" (market orders?). You are correct that HFTs probably do not provide enough liquidity for Bill Gates to immediately liquidate his entire portfolio. So what?
NASDAQ and NYSE offer intraday crosses in addition to the continuous cross.
Having only discreet crosses would not remove the value in lower latency for trading economic releases. There have been a variety of services (like Pipeline) that have services to facilitate large block trades. I fail to see how this would increase liquidity.
This research is done by the same guys at nanex that broke a story earlier this year about another early release of prominent data, ultimately leading to Reuters acknowledging that it was responsible for the leak:
I've read a lot of articles like the OP and the zerohedge one. What rises out of noise is not so much 'good' or 'evil', 'correct' or 'incorrect', or even 'legal' or 'illegal' but an continual sense of anger that person A is getting away with cheating and I want to cheat too but can't because of condition Y. I suppose at some level its "fair" only if everyone can cheat.
I watched a very strange film, a comedy, called Kung Fu Mahjong  in which the central theme are ladies that play Mahjong. And what struck me, perhaps as a westerner, or perhaps it was intentional, was that everyone in the movie cheats in some way or another, and everyone knows it. It reminded me of the kinds of things you would read about in the HFT blogs and forums. You could make a 'Kung Fu HFT' movie with the same theme.
The bottom line is that I have very little sympathy for these guys. As the 'early release' scandal broke and then was documented it felt like more crap to shovel out of the door and not like any sort of progress toward a more durable system.
Market microstructure is such a massively complicated topic that few insiders, much less the SEC, thoroughly understand it.
For instance, after NASDAQ went down for 3 hours on August 22, the SEC asked the NYSE and NASDAQ for a detailed timeline of events. Each exchange blamed the other. The SEC's response? It told the exchanges to cooperate and please fix the problem, declining to make any further public comment .
Trading at high speeds is like the wild west right now with little to no threat of law enforcement.
It's rigorously documented in public repositories. I used to build trading systems that were highly reliant on (a) how microstructures were supposed to behave and (b) the expected variability in that behaviour. Figuring (a) involved poring over thousands of pages of technical documentation - tedious but doable. There is also help from the OCC, Finra, BIS, Fed, and the exchanges' helplines. Judging (b) is more complicated, and grows more uncertain the newer a particular structure is. But again, doable if tedious.
The tediousness could be relieved by centralising market microstructure documentation. But given the frequency with which we change rules, it may make more sense to have an expanded class of lawyers or risk managers who are dedicated to understanding and promulgating the documentation.
I wouldn't go so far as to say the SEC, Finra, or the Fed Market Surveillance teams don't have a strong handle on microstructure - they have smart people. The SEC's job isn't to manually fix problems. It would be troubling if every time an exchange went down the SEC felt compelled to issue a new rule.
Market microstructure is such a massively complicated topic that few insiders, much less the SEC, thoroughly understand it.
It's actually not super complicated. A limit order book is a straightforward thing. If you can do FizzBuzz, you can probably whip up a toy implementation of a matching engine in an afternoon. People think it's complicated because of all the FUD (c.f. the comments on this story), but the basic mechanics of how a modern exchange operates are remarkably simple.
> I'm referring to market microstructure in terms of the complex interactions amongst exchanges, the impact of Reg NMS, etc.
I've heard that the financial interconnections are remarkably similar to ecologies. Would be interesting to get some more of that tooling for analyzing ecologies like fisheries available to financial regulators.
What you defined is not market microstructure, but the platonic ideal of a matching engine. The microstructure of a market is defined (by a Wikipedia source) as: "the study of the process and outcomes of exchanging assets under a specific set of rules. While much of economics abstracts from the mechanics of trading, microstructure theory focuses on how specific trading mechanisms affect the price formation process.”
That is fantastically complicated. As you say, anyone can write a matching engine.
Daytraders using etrade.com are not even competitors to large firms who spend tens of millions of dollars setting up expensive equipment inside the NYSE datacenters that operate at the millisecond level.
I think his premise is that people are mad because they can't compete because they don't have the resources (money) to do so. If they were able to execute trades as fast as the big guys, they would be perfectly fine with the practice continuing. Since they don't have the cash to compete they are upset because they see someone else making money where they cannot.
So you (or parent comment) is saying somebody with limited resources can't effectively compete with huge corporation with resources several orders of magnitude bigger - and somehow this is unfair?
I imagine anybody owning a bike should be able to compete with UPS in delivering packages, and the fact that UPS owns a fleet of trucks, planes, warehouses and complicated logistics software just makes it all unfair. If only one would be allowed fairly competing with UPS by having them deliver packages as slowly as single guy on a bike, or alternatively if the government would create a bike that could fly like a jet plane - that would be fair.
I imagine one guy with a saw should be able to fairly compete with a logging company, and one guy with a bucket and trowel should be able to compete with construction corporation, and one guy with a screwdriver should be competing with Boeing and Lockheed Martin.
When that happens, I think we could take comparing a guy using etrade.com from his macbook with trading division of JPMorgan Chase. Until then - yes, they're playing in different leagues, as it always is in the world. There's nothing unfair about it.
It's stuff like this that makes me amused by the reverence geeks approach the Kobayashi Maru scenario. Yes, everyone cheats, but what's actually important is that no one feels cheated. That's where the anger comes from.
Thinking sideways is a natural thing to encourage. A particularly subtle and cunning piece of underhanded trickery, once the cards are on the table, is impressive and laudable. The real trick is to not be a dick about it; when you win, you need to learn to share your winnings, to communicate that it's just a game and it wasn't personal and you weren't trying to hurt the others.
The problem isn't that the banks and funds and such are cheating. The problem is that they're causing damage and failing to genuinely express remorse over that damage.
a corporation will not feel remorse. It isn't a person, despite them having the legal powers of a person. They, like water flowing down a river, will find the most efficient way to extract profit, or die trying.
Profit making isn't a bad thing - its only bad when the extracting of profit isn't aligned with interests of society.
Banks do serve a useful purpose - dont get me wrong. But i think lately, the value a bank is adding to society is somewhat deminishing, compared to the burden they weight. A bank makes its profit by "taking on risk" of loaning capital to someone who doesn't have it, and extracting the surplus generated by the capital (ala, as interest on the loan).
This is ok, as long as the capital is used to generate "real" wealth - that is, production of goods and services. I feel that at times, a lot of loans are not used to generate product and services, but to "gamble" (ala, stock market?, buying and selling as a middle man ?). The process a bank goes thru to loan money creates extra currency, and this extra currency, imho, is what causes inflation. In fact, so much of economic activity is now tied to bank loans, that a failing bank means collapsing a corner of a table.
But i have no solution - as long as the illusion of stability is maintained, the system works. When it breaks, its chaos, but so far, all chaos has been prevented by either bailing out, or some other form of tax payer funded activity. Meaning, some people/organizations are using this as an opportunity to profit as a parasite of this system.
If you look at the proposals for moving bank ownership to governments, that's precisely the point. Instead of profit for profit's sake, they expect such banks to profit specifically for the local geography's sake.
I'm not much of an advocate for this solution because, frankly, I don't understand it well enough. Insofar as I do understand it, I feel that it's worth supporting it, or at least being more widely considered. My lit review of reasons not to do it turned up no convincing objections (and I've asked different groups for help several times over the past 5 years).
The reason to be 'mad' is actually a seperate case. There is an unethical nexus of power between the government, the news conduits, and the establishment on wall street. The markets are not "going up" because companies are improving the world. The markets are "going up" because the fed is making decisions (which its entitled to do) which subsidize poor performance. That is step (1). The next reason that people (should) be mad, is that absent arbitrary volatility (in an of itself annoying -- see #1), favouritisms (corruption) by the media is expressly against US public policy (viz Reg FD...and others) dating back almost a century (at least to the 1930's). That is step (2). The thrid reason to be mad is that Institutional traders have structurally boxed out retail to capture profits, physically. That is, through infrastructure. Not only does infrastructure advantage not add any value, its really only properly leveraged with co-opted agents and quasi-corruption in layers (1) and (2). That's layer (3). Basically, a shit sandwitch. Pardon the French.
Nobody is (or should be) mad with people trading on fundamental performance and clean, authentic risk-taking.
Having zero days of trading losses in a quarter is easy -- just arrange your trades so that your risks are highly asymmetric. For example, you could sell billions of dollars worth of options tied to the fed rate; you'll make a small amount of money every day until the fed rate changes... and then you'll lose lots and lots of money all at once. Odds are that you'll have several quarters of consistent daily profits first though.
You (and the article) are assuming that all trades are created equal. At 95% accuracy you can easily never have a losing trading day. Plus given the massive amount of derivatives you can "mark to market" when convenient and end up with no losing trading days.
Couple factors that make your 2% i.i.d. loss probability unlikely:
(1) Banks carry hedged books. You expect to win more frequently than 49 out of 50 times if you're instantaneously buying and selling FX in different regions, or delta hedging an option book.
(2) The riskier assets also tend to be illiquid. This delays loss recognition, not necessarily out of deviousness, but because nobody realises the loan in question is a dud until someone tries to market it.
(3) Market returns are not i.i.d. They are correlated. This makes streaks more likely.
You are assuming that profits on successive days are uncorrelated.
And in any case, all you have proven is that we can reject the null that the distribution of JP morgans daily returns this year, was different to the distribution of their daily returns in previous years.
Let's leave guilty-by-rejecting-the-null-in-an-artificial-model to the courts and not let their logic infect HN too. All that's been shown is that JP Morgan have had 0 days with a trading loss. No one has actually shown they did anything wrong, or even explained what they might have done wrong.
The question which occurs to me is who took the other side of this trade. You would think market actors would know enough to say, "If somebody suddenly wants to buy my stock right around 2pm and I haven't yet integrated the Fed info, it means my stock is more valuable and I should not sell."
Awesome analysis. Keep in mind that while it tells a very compelling story, that it isn't necessarily proof that there was a leak.
All it would take is for one major player to take a view on what was going to happen without hearing the fed data in an attempt to beat the market. Other algos then see that and act on it, playing the other players instead of the data, as algos are known to do frequently. All of this could happen in the time it takes for the actual data to get there.
There were tons of people who expected yesterday's announcement to turn out just as it did. I'm not saying that's what happened, just that it's a possibility to keep in mind before jumping to conclusions.
The Fed's decision was a very big surprise to most, from what I've read. Just google "taper surprise" to see for yourself. Also, this was a massive move upwards, so the argument is that over a billion dollars of bullish bets made at the exact same milliseconds is hard to explain away as another contrarian play that payed off well.
Still, skepticism is healthy, and it's possible that no scandal is involved.
The mainstream financial headlines generally regurgitate what the Fed wants to message. While certainly 'most' were surprised, many weren't.
Tapering was dependent on econ data, which simply hasn't been there to support it. I know plenty of people who were betting that it wouldn't happen, myself included. Good overview of why from before the announcement here:
Yes - most journalists/analysts prefer to be wrong together than wrong alone, so there is usually a lot of groupthink. The previous fed minutes suggested that most members wanted to wait to taper, unless data improved, and data didn't improve. It seemed obvious to me that the taper was nowhere near a done deal.
You're right to be skeptical but your alternative does not stand up to scrutiny. If a player indeed had a strong bite, milliseconds after the announcement would be the worst time to execute. This is a time where almost all the liquidity goes away as market participants stand pat. If you had such a view, you would build your position over time, and certainly not incur the huge cost of making large trades at the lowest point in liquidity.
> All it would take is for one major player to take a view on what was going to happen without hearing the fed data in an attempt to beat the market.
But why would they wait then? "Guessing" or working with known public information is perfectly legal. They should act upon that data immediately. A leak is much more likely, as they would be afraid of an investigation when they "guessed right". They were almost certainly trying to trade as if there were no leak, but they forgot to add the slight delay.
When I first started reading the story I was afraid I wouldn't understand it. Nanex took great care in explaining the phenomenon here with very accessible language. The charts are still mostly indecipherable to me, but the story makes it clear. If the situation really is as straight-forward as they make it out to be, someone has some explaining to do.
The Fed announcement may or may not have been known, but the fact that there would be an announcement at a given time was known. The market always jumps one way or another at the last moment before an announcement, because it's the last chance to place your bets in what is essentially gambling. There was no information propagation delay because there was no information. Sometimes the blind consensus guesses right, sometimes wrong.
If you actually had leaked information there's no reason you'd need to wait until the very last moment, that's when people who know nothing place their bets and their actions would be more likely to mess up your scam than cover up for it.
Indeed - it's worth noting that on the non-farm payroll figure (which is closely watched by markets) this month, most markets jumped in the wrong direction a split second early, before violently reversing.
True. I try to make such disclosures whenever there's a chance it could influence what I'm writing. I decided this comment didn't need one. I put a tremendous amount of effort into writing accurately, concisely, and without commercial or other influence. Feel free to google me. I'm beefman here and on Wikipedia, Carl Lumma or clumma everywhere else.
I'm no expert, but if both Chicago and New York are synching their clocks to NIST(Gaithersburg, MD) or the Naval Observatory (Washington DC), the a message from Washington sent at the same instant, should arrive at the same instant, as measured in local time.
A more 'science' way to make the claim that Nanex is making, would be to compare the same products on other Fed meeting dates.
Any time synchronization protocol I know of takes into account network latency and attempts to compensate. As measured by perfectly synchronized clocks against the same reference source (leaving aside for the moment that there is no such thing), the received timestamps of a message originating from one location and being received by two locations at different lengths of cable from another will reflect the difference in the time it took to get from one to the other.
It would be nice to hear a little bit more about how the FOMC results get into the electronic news feed. If anything, it seems more fair to release the news simultaneously in NY and Chicago so that traders in NY couldn't pick-off market makers in Chicago and vice versa.
Good question. I can't find any specific information about how the FOMC statement gets parsed into cyberspace, but as recently as 2011, a malfunctioning printer significantly delayed the FOMC statement release  since the press in the Treasury lockup room couldn't get access to physical copies to write articles about it in time for the a scheduled 2:15 ET press release.
A FAQ on the Richmond Fed's website  says that FOMC statements are released on the federalreserve.gov website  at 2:15 ET on the final day of each FOMC meeting. Unless there is an alternative statement provided elsewhere by the Fed, I assume that the FOMC statement is parsed by machines checking for differences in language use with the previous Fed statement -- doing a diff on successive FOMC statements is a common practice when reporting on a statement release .
As far as I'm aware, the exact time of release of the FOMC statement can vary by a few seconds. Nanex seem to have assumed that the release comes from Washington, but I would guess that one of the agencies that receives the embargoed data has permission to distribute it at multiple locations simultaneously. That seems like the simplest explanation for Chicago and New York reacting at the same time.
Ole Roemer, a Danish astronomer, proved suspicions of many such as Empedocles (490-435 B.C.) that light has a speed. 1676. C/o Speed of Light: Case History. http://www.is.wayne.edu/MNISSANI/A&S/light.htm Ug easy sensationalism via namedropping.
Now, in another 50 years, I look forward to fingerprint analysis of a scale 1/1000th as fine: we caught you obeying the the speed of light, but you forgot to compensate for relativistic drift in X fashion. GUILTY!
That would be very bad if they did. When you have hammer that huge, everything starts looking like a nail, but this kind of power is switched to easily from going after the "bad guys" to going after the guys that inconvenience people in power. We're watching it happen right now.