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Michael Lewis: shilling for the buyside? (scottlocklin.wordpress.com)
197 points by nbouscal on April 4, 2014 | hide | past | favorite | 212 comments

Yeah, Michael Lewis' recent interviews do seem a bit suspect. He is yelling "Hey joe sixpack, Wall Street is eating your lunch!" and then when you hear the details of the supposed "fraud" it all revolves around companies like Goldman Sachs (who work with Katsuyama) whining that they're not getting a fair shake in the world. (Oh right, Goldman Sachs is managing Joe Sixpack's pension fund via two levels of indirection- Oh noes, poor Goldman Sachs!)

Plus, the interviews he's given on 60 minutes and Fresh Air never once mention the terms "market order" or "limit order". If you don't explain those two basic terms at the heart of the HFT controversy, you're not giving people information, you're only giving them disinformation.

That said, there's obviously lots of shady ass shit happening on Wall Street every day, but Michael Lewis is not helping the situation one iota, from the looks of it.

Two other concepts you really want to understand before forming an opinion about HFT: "large block trades" and "bid-ask spread".

Lewis has a drive-by mention of bid-ask spreads in the book (he concedes that they've been decimated, while asserting without evidence that HFT has created a new "shadow spread"), and, thus far, no mention whatsoever of the mechanics of large-block trades. In Lewis' universe, a hedge fund can unload 100,000 shares of XYZ just as easily as you can sell 10 shares of AAPL.

tptacek -- Not to nitpick but isn't this comment is like someone accusing you of having a "drive by" understanding of computer security? He knows what a block trade is, and how to quote a market. Lewis worked on a bond trading desk, and coined the phrase "equities in dallas". So it's not CFA 1 here for him.

To your point: what's missing is the hedging costs. The reason block trades trade out of the market is not just that they are "bespoke", but that there is the inventory hedge risk. It may take some time to build up a position (during which prices can move adversely). And this may or may not need a hedge to protect the holding period (which someone needs to pay for).

Various types of trading strategies have very different risk profiles when compared to required inventory hold/periods etc. And this is a hidden source of economics or cost. Hedging doesn't always scale well, either.

So its very hard (especially as a lay-person) to make inferences about many things unless you are taking into account both profits and risk. As I'm sure you know.

I've reread Liar's Poker at least 5 times (it's what I read when I don't want to think about what I'm reading next, because you can pick it up, turn to a random page, read in either direction, and enjoy yourself for a few minutes).

Read reviews of the book from traders and you will see lots of people scratching their heads the same way I am.

It is confusing that a former bond salesman, who wrote several famous vignettes about how Salomon got its clients into jams by selling them blocks of bonds and having the market move out from under them, would believe the things he appears to believe about RBC's role in the market.

In Lewis' universe, a $2MM/yr sell-side broker accepts a 100,000 share block order from a hedge fund, consults a single blotter screen, enters a 100,000 share order, and is startled and outraged when that order isn't as easy to place as an Amazon one-click order. Egads! The broker has to actually work for his money! Kill the HFTs!

I don't understand what inventory hedging has to do with the point I'm making. Hedge trades are trades. Large hedge trades involve block shopping.

Even Manoj Narang conceded that he noticed the same thing as Brad Katsuyama around the same time: lower fill rates. The lower fill rates only led to scratching of heads. It was the underlying cause of lower fill rates which led outrage (in Brad's case).

The underlying cause is the "perverse incentive" (Lewis's words) of the taker-rebate (reverse of the usual maker-rebate taker-fee). Is there a sensible reason to such a fee structure? Or is it just useful for HFT firms to bait orders and get an informational edge they can exploit against mom & pop's retirement fund?

The same should be asked about esoteric order types (Hide-n-Slide, Post-only, etc). Its cleary a complex landscape with middle ground, but it would be surprising if there weren't cabals and conspiracies hiding in obscure corners.

Large hedge trades involve block shopping

ELI5 version is that you need to pay for (1) working capital. This scales with the size of the block (capital cost). You also need to pay for (2) some lead-gen fees to get the block (service cost). You also have to pay for (3) a hedge on economics while your lead-gen process play's out. The cost of this hedge scales with size (just like capital cost), but also with vol (of underlying) and time (speed of lead gen process).

If you don't cut the deal to cover your hedge (or put one on) you run the risk of massive losses from mino movemnets in the market (ie, if you have a <1% cent spread on 5 mill position and the stock spikes 10%).

So a trade's profits:

(A) scale+fees = Revenues

(B) capital+hedge = Costs

Both the hedge and the capital are proportionate to time.

TLDR when you talk about HFT you are optimizing on time; and thus talking about (B) as much as (A) in terms of profits. Most of the optimization is on (B).

What's unique here is that (B) is blind to the casual observer and to some extent, the market.

But analytically, it influences profits and drives behaviour/incentive structure.

If you dis-regard it out of hand, you're missing an important part of the picture.

I think you're simplifying too much. The example being repeated in relation to the book and IEX is you have a 100,000 order, 25,000 displayed at the same price, say $10, on each of 4 exchanges.

You might think you can fill 100,000 @ $10 and allegedly many people did. In fact if the exchanges were consolidated into one you would be filled.

It seems to me a displayed order should be able to be traded and not behave in a seemingly prescient way by disappearing when the order is made.

In an ideal world would the latency between exchanges serve any beneficial purpose?

Think about CAP theory, and the markets as a distributed system. How is the ideal you're looking for achievable?

It's not achievable (although maybe periodic batch auctions would help), it's a thought experiment as to why this particular scenario isn't quite the same as reacting to a large order in principal. Specifically you cannot decide to remove orders during the initial transaction of a big buyer or seller.

And just in case it isn't entirely clear, one example of 'algo' trading (algo != HFT) is developing an algorithm to sell smaller blocks of shares over a period of time to "hide" the fact that one participant is unloading 100,000 shares so the the price is not driven down too hard, thereby reducing the overall return from selling the shares.

Just to nitpick a touch. One of the real problems with discussions about HFT is that there is no generally accepted definition of what the term means. In general it is some mix of "computers make trading decisions without human intervention", a high number of trades throughout the trading day, & low latency requirements.

The reality is that electronic trading systems have different values for all of those variables. I've worked on a trading system that only traded 4 times a week, had no human operator, but extremely tight latency requirements.

I've also worked on a system that did very high volume of trades every day, that was watched like a hawk by a team of human traders, and didn't much care about latency.

One definition I have heard is "multiple trades per day", but likely the common definition, for the liquidity-providing definition, is "multiple trades per millisecond".

HFT as you read it in most stories/comments is trying to imply is what Mark Cuban is hinting at in his blog post that also made the front page. Being fast or having low-latency does not make you a bad person. Using those advantages to front-run books or other "tricks" are what people imagine when they think of HFT with a negative connotation.

A firm simply unloading thousands of shares in 100 block increments in a number of milliseconds with very low latency technically would be a bunch of "high frequency" trades, but that type of activity is not what is being debated.

HFT does not front-run trades. This is an apparently common misconception.

Mark Cuban misunderstands a lot of things, including Dennis Rodman and High Frequency Trading.

Since you two are both personal friends of mine can I just point out that (a) you both know a bunch of stuff about markets and (b) Andrew works in R&D at Bloomberg. :)

I should have said "allegedly" :) I wasn't making a statement that they do/don't, just that those actions are what are considered the evil behavior.

Ah, got it. Sorry if I was overly blunt.

The way I (as a lay person) read this is:

One side: "HFT hurts the little guy and helps billionaires! Boo HFT!"

The other side: "HFT helps the little guy and hurts billionaires! Yea HTF!"

Reality: "HFT is pretty much irrelevant to the little guy. It helps some billionaires and hurts other billionaires, and this is only a story because billionaires are all talking about it."


How is this true since ETFs were around several years before electronic exchanges came into existence?

Genuinely curious, what is the evidence to support this claim? Why do you think massively low latency trading speed is required for ETFs to exist?

ETF Arb and Latency Arb ensure that the ETF always correctly valued and valued the same across all exchanges.

Incorrect. ETF's are largely never priced at the price of the underlying basket. They often trade rich or under based on the availability, relative borrow rates and liquidity of the individual names. Sure some program trading desks will try and arb based on minute changes but this strategy is not very lucrative. Also the create/redeem cycle of an ETF inherently pegs it's value.

Are you sure you're computing the basket correctly including cash component? For major ETFs like SPY or XLF they basically never trade away from NAV, not even by 0.01. HFTs are why. Authorized Participants can create/redeem in-kind at the end of the trading day. Borrow rates on individual stocks don't matter unless you're trying to put on a partial hedge and carry it. Most of the people playing this game have a market maker exemption and aren't concerned with shorts intraday.

This trade used to be extremely lucrative. I was there. It was awesome. Years ago the ETF and basket NAV would cross one another constantly and you could build a fully-hedged position for a profit if you were extremely fast. People still make money on it, but not as a pure speed arb. Like everything else, the fastest traders and those who execute best win. The fact that it's not as lucrative or easy anymore is indication that the markets have become so much more efficient.

email me.

Nope. For large liquid ETFs they are arbed so the values are in sync.

can you explain how ETF's require HFT? Why is it not possible to maintain an ETF's basket of assets using conventional trading?

HFT seems cancerous regardless of who it helps and who it hurts. Sure it might provide liquidity, but so do traders and the market at large. HFT making money doesn't really service anyone except the people making money, and more importantly it doesn't create anything or provide a service to society at large.

HFT could easily be a form of arbitrage. If we understand a wide bid-ask spread and/or a market slow to react to a large order as being essentially a rent for the large trader, then HFT narrowing the bid-ask spread and allowing the market to react more quickly to the large order takes that rent and divides a fraction of it to the HFT and another fraction of it to whoever is ultimately trading against the large trader.

So instead of this rent (amount of money X) getting all captured by a single player who is necessarily a large, wealthy trader, it gets divided up more broadly. That sounds like a textbook case of arbitrage being in the public good.

HFT does that. Does it also do other things which create rents rather than break them up? Hard for me to say. It's a complicated subject.

The behavior would be illegal if conducted by the exchange itself. Why is it suddenly not simply because the exchange outsources the business model to a third party in return for super-expensive colocation rights?

> Sure it might provide liquidity, but so do traders and the market at large.

What do you think traders get paid in, cupcakes?

I thought they were paid by trading fees? That fee I get charged every time I make a trade.

Market-makers make money off of the bid-ask spread, even if "trading fees" (i.e. commissions) are zero. Basically, the bid-ask spread is the difference between the price the trader bought the stock at, and the price they sold it to you at.

I found his interviews really compelling and thought about getting the book. But I had this nagging thought the whole time -- you know, I've been hearing about HFT for years, could it really be some super-secret cabal? The linked article does itself no favors with its pissy tone. I almost didn't read through it, but I'm glad I did, because I learned quite a bit. As always, the truth is somewhere in the middle.

Michael Lewis is a master of taking something complicated and turning it into a clever narrative. However, this narrative is simpler than, say, Moneyball: bad guys are "stealing" from good guys, there's a detective story about figuring out how it's happening, and there's a build-a-better-mousetrap montage at the end. It's too perfect. Odds are there's a screenwriter crunching this sucker down into three acts right at this moment.

It affects mutual fund managers who many joe sixpack types do have a stake in.

If you think it harms mutual fund managers, can you account for Vanguard saying that it's helped them?

It harms people who trade frequently. Mutual funds, and more importantly pension schemes, should be trading relatively infrequently. If your pension scheme isn't taking long term positions you need to find a new scheme as they aren't investing.

Proper investing, buying a stock in the belief it will go up massively over the course of many years is trivially affected by HFTs. You may pay less than a penny per share extra on trades, but if you're looking for tens of dollars of capital gain do you care?

People who trade more are benefited from low bid/ask spreads. HFT necessarily helps them.

If Wendy's raises the price of their chili because they use an overpriced supplier of beef, nobody would argue Joe Sixpack's stake in Wendy's was hurt.

Instead, Joe Sixpack eats his chilli at another store that is more competent in managing their supply chain, and the Wendy's Corporate takes a hit.

"Joe Sixpack" is a terrible name for the average US stock investor. The median number of shares owned by the adult US public is exactly zero. Most people who own (publicly traded) stocks are already wealthy. "Joe Chateau Lafite" would be a better name.

Source: some Matt Levine article.

Even if this were true, so what? If you have to reach the 60th percentile, or the 80th, before Americans have stock amounts, why is that a big deal? It's clear that many Americans who are not the ultra-rich/utterly-financially-secure types own stock, and own stock in amounts that are relevant to their own financial health.

I don't think it's helpful to anyone's understanding of any situation to try to pretend that tens or hundreds of millions of Americans -- who are on the whole somewhat wealthier than average -- are mega-rich snobs who drink ten-thousand-dollar-a-bottle wine.

You need to distinguish between two ways people are affected:

1) Indirectly via mutual funds, pension funds, and so on.

2) Directly through buying individual stocks on E*Trade or the like.

The second amounts to an expensive hobby (in risk adjusted terms). Whether some people who aren't ultra-rich choose to indulge in such an expensive hobby is neither here nor there, the underlying fact remains that there's no good reason to care about or optimize for their benefit. Yet for some reason so many articles on this subject instead of talking about the funds that are broadly and rationally held, analyze the situation for the small retail investor.

The median Joe Sixpack has a pension fund, which is the crux of Lewis' argument (I agree it's ridiculous.)

You're right, but BARELY:


The rate of stock ownership (including through mutual funds and retirement accounts) for Americans is around 52%, down from last year. So, while the median American owns some stock, it's probably a minuscule amount. Two percentage points lower, and the median American (Joe Six Pack) owns no stock.

EDIT for more related info:

45% of Americans have no retirement savings [1]

1/4 of Americans have no savings whatsoever [2]

[1] http://www.twincities.com/ci_23505006/americans-retirement-s...

[2] http://www.ibtimes.com/over-fourth-americans-have-no-money-t...

Interesting- Thanks.

> but Michael Lewis is not helping the situation one iota, from the looks of it.

Hasn't the FBI been recently investigating this ?

I think "shilling for the buyside" is a bit strong. Lewis aggressively pursued a compelling and simple narrative in a market that doesnt have an easy story. I get the impression he didnt even recognize that the field he decided to plow was a minefield. The HFT debate is complicated and has serious implications: his treatment didn't respect it.

From acquaintances that knew Katsuyama personally, he was described as a genius marketer, not a technologist. Before even Lewis came along, he had crafted a large part of this narrative: the Thor matching technology succeeded on a compelling story. Lewis got sucked in.

The personal reactions you may have seen (William O'Brian on CNBC) are authentic: HFT participants (and those who deal with them) have been villified in an industry already viewed in a negative light. There are some bad apples, but there are also many who genuinely believe that they are doing a service for the market.

I don't blame Lewis for this. I just hope that there is an author that can create a compelling story that doesnt fall for the tired trope of the evil HFT trader. The story exists - it is just very technical and nuanced at times. Unfortunately, many HFT participants have been shamed away from standing for what they believe in so there are very few left to tell the story.

If you want to read a rebuttal and learn more about the markets at the same time, check out this analysis by Larry Tabb - a market research consultant prominent in the US execution technology market: http://www.scribd.com/doc/215693938/No-Michael-Lewis

> there are also many who genuinely believe that they are doing a service for the market

You make it sounds like HFT is some sort of non-profit, community service vocation, like teaching, or fire fighters. Do people actually think this?

Regardless of the merits of HFT, that kind of argument seems very disingenuous. I haven't met a single person engaged in HFT who is doing it to smooth the function of the market or "provide liquidity". They may think it has that effect, but no one is in it for that reason. If anything, it's what they tell themselves to justify skimming money from the other market participants.

You can replace the letters "HFT" in your comment with "any market maker" and come to exactly the same conclusion.

Liquidity has always, always been subsidized by "skimming". The rake market makers take from trades is the cost of liquidity: ie, of being able to buy shares immediately without getting shafted because the only orders on the market are from large traders who are holding out for very high prices.

Have you ever tried to sell a house? That's what crappy liquidity looks like: there are buyers and there are sellers, but nobody is anywhere near agreeing about the price of the goods being traded, and so it takes months to get in or out of a position, and you sometimes have to do it at extremely unfavorable prices.

The problem is that market making is different than the critique, which is that having privileged access to exchange data centers is an unfair advantage that allows rent-seeking. To access information before the general public allows traders to inject themselves into transactions that don't require a market maker.

That fact that no one will defend this practice while vehemently defending "HFT" speaks to an impedance mismatch. We're not talking about the same thing.

They have faster access to exchange data centers because they paid for it. Anyone can pay for this access. They use this privileged access to provide faster and cheaper service to their customers (purchasers of liquidity).

It's no different than McDonalds paying a lot of money to buy a prime corner location to build one of their restaurants.

You can pay for a lot of things, but that doesn't mean it's in the interest of society or the market as a whole. You don't require faster access to provide liquidity, but it sure helps with arbitraging trading activity.

You can pay for a lot of things and that doesn't mean it's not in the interest of society or the market as a whole either. The trading in any one instrument on an exchange is a zero-sum game, but the structure of the market and the relationship between exchanges, buy-side firms, sell-side firms, and retail investors doesn't have to be.

Before electronic trading, the specialists who executed orders on the NYSE floor ALSO paid shitloads of money for their access.

One difference between today and the heyday of the specialist system is that in the specialist system, middlemen skimmed overtly from investors: the bid-ask spread was gigantic, and all that money went to the middlemen.

The increased liquidity/ reduced execution risk changes it from a zero sum game.

You could not be more wrong. Providing liquidity at a razor thin spread is one of the toughest trades out there. Think about it: every passive order I place gives someone the option to trade with me until I can update it. If my price is wrong and I don't update, I will trade every time. If my price is right, I'll trade some of the time if I'm lucky. If I can tilt those odds in my favor by pricing more intelligently/quickly, my trades with uninformed traders slightly subsidize my losses to informed traders.

Someone taking out/arbing a market needs a source of alpha. I need to protect myself from every source of alpha, at least on average. If market makers weren't collocated and looking at many exchange/products for data to price their markets, they would be driven out by fast liquidity takers, forced to quote lower size or a wider spread until they simply stopped getting trades (other faster, smarter market makers could still quote tighter spreads and would take all your market share).

The question is: do you require pricing data in advance of those you are trading with to earn your spread?

If you do, you are not providing a service to the market.

This seems like a back and forth that's quibbling about words. I didn't say there's anything wrong with arbitrage; the critique is the privileged access to market information and the ability to profit off it without adding any value to the rest of the market.

All things equal, I would prefer to trade on an exchange that makes an effort to provide equal access, and one that doesn't artificially inject middlemen into transactions that don't require them.

The way that you think middlemen inject themselves into transactions that don't require them isn't what happens in the actual world. You're worried about a problem that doesn't exist.

Well, Googling for research around latency arbitrage lends me to believe the opposite.

WTF is "latency arbitrage"? All arbitrages are short-lived and latency sensitive. It's a marketing term made up by fear mongers.

Along these lines, a note on so-called latency arbitrage:


You're worried about a problem that doesn't exist.

Even if empirically it is non-observed, its illegal. So it is a problem, just one solved by law. Now, IFF your're willing to assume that nobody has ever/will ever transgressed such a law...you could hold this position 'logically'. But Few would be so unwise "in the actual world" to do so (and would likely prove foolish).

It's illegal if your broker does it. He has a contractual (and legal) obligation to act on your behalf. This is completely different from the kind of thing that Michael Lewis claims is happening in his book.

you think middlemen inject themselves into transactions that don't require them

I'm responding more to this (and more as a general concept).

If given the opportunity, people would do this. So it's useful to dispel the notion that because its "not seen" it's not a problem. It might not always a be problem, but many it is and others it's also "annoying".

Stepping outside of markets for a second, this is why M&A deals have exclusivity and breakage terms. The theory/practive on why you do this involves assymetric information and something economists refer to as "opportunism". Opportunism[1] is exploiting legal abiguity for narrow self interest.

The more complex the legal/transaction structure the wider the attack surface for "opportunism" (because it's proportional with deal complexity). In slow and complex deals like M&A at a certain point it becomes an issue and so safeguards are taken.

In fast and simple deals like buying stock on the box or what not, the scope is very limited. The glaring example is the broker issue you highlight. But as the deal structure gets more complex, this risk rises.

Now, the attack surface for opportunism is proportional to deal complexity as mentioned above. This is legal/structure but also now needs to consider execution and # of counterparties. Limiting counter-parties (ie, middlemen) reduces this "attack surface" (if you will). Because each of them needs to be monitored/paperwork delath with etc. This is why such uncecessary interventions are structured out of deals. Typically by way of convention/courtesy if not expressly by things like ethics codes & stronger (ie, exchange regs+laws).

This is a long way of saying that the institutional integrity of markets hides a lot of problems. This is a good thing. But not to be taken for granted. The cost of undermining these institutions/trust etc. is not insignificant. Because it means you have to solve all these problems again in new ways.

[1] https://en.wikipedia.org/wiki/Opportunism

We've got a system specifically designed to prevent the kind of thin you're talking about.

It's also a system where every single trade is recorded in detail that anyone who wants can look at. No one is pointing at this data showing the smoking gun of the kind of front running you describe.

You're just saying "well, people are shady, so it's probably happening anyways." That's an incredibly weak argument in the face of a stack of evidence on the other side the biggest piece of which is the dramatically reduced cost of liquidity. If such shadiness was happening the cost of liquidity would be going in the other direction.

When talking about crimes people refer to means, motive, and opportunity. You've certainly got the motive part, but you're completely ignoring means and motive.

Then I think we're just getting hung up on the labguage concerning what is 'necessary' or 'un-necessary'. I'd actually be interested to hear about the level of abstraction of your systemic data, just to be more clear on where you are coming from. Again, my comment up-thread was not in any way impugning a particular trade or trade structure. If you are a practitioner, you're well aware of the level of detail required to opine on something so specific. As a general rule though the more complex any transaction is (whiteboard+lawyers) the more legal grey there are. That is a statement I'm comfortable with in general.

What's wrong with arbitraging trading activity?

If MSFT is trading for $50.00 on one exchange and $51.00 on another we want someone to fix that price discrepancy! Even if the difference is much smaller we want that balance to be corrected!

>You can replace the letters "HFT" in your comment with "any market maker" and come to exactly the same conclusion.

You may even be able to replace the letters HTF with "any for-profit profession" and come to exactly the same conclusion.

I think it's fair to assume the HFT traders are rapacious capitalists (as someone who is pro-free market, this doesn't exactly offend me). But motivations don't matter here. It reminds me of the Adam Smith quote, which may only make sense if you've read the linked Scott Locklin essay first:

http://www.econlib.org/library/Enc/bios/Smith.html "It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest..."

OK but if the HFT traders only hold stocks for say a few seconds (or milliseconds) then that means that there is plenty of real liquidity to be had and thus HFT isn't adding value. It's adding volume, but not value.

If the HFT guys are willing to hold stocks for minutes or hours or days then yeah I might concede that they're adding liquidity. From what I understand that's not HFT anymore. But for a second? I can wait an extra second for an order to get filled.

You can wait an extra second and maybe get it filled.

Or maybe the price will move away from you and you'll never get filled (at least at the price you want).

One of the quotes either from the book, or one of the TV interviews, was "if it is illegal if a human does it, why is it not illegal if a machine does it"?

I think it is from an interview on The Daily Show, see here: http://www.zerohedge.com/news/2014-04-02/jon-stewart-hft-its...

The quote seems to be 'The HFTs "function on volume and volatility" alone and "they know the prices before you do... which is illegal if it's a person, but as a computer, meh?"'

So my question to you is, i) explain how HFT serves the same purpose as market-making ii) explain how HFT is not front-running the valid trades

That quote drives me nuts, because it is completely unclear on how anything that computers are doing would be illegal if humans did it.

For decades, humans did exactly what the HFTs did, except much more brazenly: where HFTs take pennies in compensation, the humans took dimes, quarters, even dollars.

That premium wasn't outlawed. No rule was passed to eliminate the profits the middlemen took. No, the premiums were competed down to where they are now.

(I didn't downvote you).

Are the HFTs actually marketmaking, though? Lewis is accusing them of front-running transactions that were already possible, driving up the price slightly of transactions that were already going to happen based on telegraphed intent. This is different from what an actual market maker does, which is provide a counterparty for all transactions and hedge their resulting risk, in exchange for the spread.

EDIT: Perhaps this is just a small piece of what HFTs do, and maybe it's limited to a few bad actors, but being blown out of proportion by the book?

It is a small piece of what they do, and there are a few bad actors in HFT. That said, Lewis literally just gets it wrong on what is happening in his front running accusations. Either he doesn't understand what is actually happening or in an effort to simplify and/or make a compelling narrative he misrepresents the actual market movements that are happening.

The HFT firms have statistically significant deviations in terms of profitable trading days.

For instance, Virtu had 1238 straight trading days of profitability, with no losses.

There are no other firms in the history of Wall Street with such success. Such an outlier deserves a lot of scrutiny.

It might help if you expanded on your views of why Lewis is wrong.

Virtu basically only does market-making which is a low risk trade. You put on small positions with a tiny statistical edge hundreds of thousands of times a day to make the bid-ask spread. It's like flipping a coin that comes up heads 50.05% of the time and betting $1 on it a million times a day. If something breaks or loses too much you exit your risk and turn off for the day. If a stock doesn't work in the portfolio, you take it out. If strategies or markets stop making money, you turn them off. Even if they buy a company that goes bankrupt, their notional position is less than their daily profit firm-wide.

Firms that make markets basically make money trading every day absent technology issues. That doesn't mean the company itself is profitable every day. It costs a lot of money to build the technology and strategies, and for every Virtu out there, there's a dozen failed HFT startups.

We have to be very careful about our terminology when we talk about profitability of trading days. I have not inspected Virtu's trades, pnl statements, or legal documents related to them, so this is less about them specifically than about trade pnl generally.

When most firms talk about profitability of trading day, they are talking about the the profitability of just their trades. That is, if they bought for 1 million dollars and sold for 1 million and 1 dollars. That is technically a profitable trading day. If the cost of entering and exiting that trade cost them 2 billion dollars they will still mark that as a "profitable" trading day, even though it clearly isn't.

That is to say, it is trivial under this accounting scheme to come up with a strategy that has no losses. Just don't trade.

I apologize for not going into more depth about why I think Lewis is wrong. I've explained it a lot in my comments on HN lately and can't be bothered to do it again. That said, if the linked article was more professionally presented and didn't have the weird racial language the points are basically what I would argue against Lewis' premise.

I've looked through your comments on this post and did not find anything that looked like an explanation or refutation of Lewis' claims that HFT were front running. Maybe I missed it or you were talking about another post. Why don't you create a blog post? That way you can point people to it and you won't have keep repeating yourself.

Edited for clarity.

While it's true that increased competition among market makers have driven spreads down, decimalization was also a factor. For example:

"For example, OEA estimates that, from December 2000 to March 2001, quotation spreads in securities listed on the New York Stock Exchange ("NYSE") narrowed an average of 37%, and effective spreads narrowed 15%. An even more dramatic reduction in quotation spreads was observed in Nasdaq securities, with spreads narrowing an average of 50% following decimalization, and effective spreads narrowing almost as much."

Technically, that's an example of a rule that was passed to eliminate the middlemen's profits.

"It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest."

Adam Smith's insight helped launched the enterprise of modern economics because it turned out attention to what matters: results. Benevolence, like self-interest, is neither necessary nor sufficient to produce a social benefit.

So you're right: the motivations of high-frequency traders are irrelevant, except insofar as we can change their behavior by changing the incentives they respond to.

If teaching were as competitive as market making major cities might graduate more than half their students from high school while simultaneously driving down costs. Non profit is not a badge of honor.

Yes. Kind of a good example how competitive systems lead to a better end result for customers. Competitive teaching is something we should actually encourage. Tyler Cowen often argues how the availability of systems to teach to a huge number of students is going to make teaching superstars and bring the cost of teaching down to almost zero because the marginal cost of distributing teaching is almost 0 with enough students.

If more students and their families in major cities understood the benefits of learning in high school and were able and motivated to pursue them -- that is, if being knowledgeable were a badge of honor -- would schools be more likely to respond to them, with an ultimate result of higher graduation rates?

Teaching is plenty competitive- starting teacher salaries are low because there's lots of competition. If you want results though, you have to pay.

Yes of course. All markets are the same. High frequency teachers FTW!

> You make it sounds like HFT is some sort of non-profit, community service vocation, like teaching, or fire fighters. Do people actually think this?

They're doing it to make money, but that doesn't mean they're not helping other people out. My uncle is an importer; most of his time is spent finding something that's cheaper in Korea than it is here and drawing up a contract with a supplier there and a buyer here. Does he do it as a community service? No. Does he take his cut? Yes. But every deal he makes benefits both the supplier and the buyer.

I think it's disingenuous to project motivations for Michael Lewis. Is he shilling for the buyside the same way he was shilling for the Oakland A's? In my opinion, the only thing we know based on facts is that Michael Lewis, the author, has one objective in mind: To sell more books.

In order to sell books, the story and narrative has to be compelling. Is the story of a Canadian guy making millions of dollars at his trading desk quitting his job and starting a company (we love startups!) that may undermine a controversial trading tactic a compelling story? Absolutely. Is the story of Einhorn or Cohen or Icahn doing things like insider trading or activist investing equally compelling? Probably not, since it's on the cover of the WSJ or on CNBC every week.

Michael Lewis does not have a responsibility to educate main street about the nuances of HFT, although as a secondary benefit of his noble pursuit to sell more books, he does shine a light on the topic. In this regard, Lewis is exceptionally successful. He's sparked a debate, he's created controversy, he's made smart people discuss a topic they had previously less interest in.

Think about what Moneyball did for professional sports? Lewis was hardly the first (e.g, Bill James) but he popularized it so we, the general population, could discuss the topic with some conviction and knowledge. If he can do the same for HFT and trading in general, then good job. And he sells more books.

"Is the story of Einhorn or Cohen or Icahn doing things like insider trading or activist investing equally compelling"

Why do you put activism in this sentence along with insider trading? Are you implying that it is morally reprehensible in the same way that insider trading is? Activism is in no way illegal and many consider it a counter against corporate cronyism that can infect public corporations due to the principal/agent problem.

I put them together because they're news items on financial shows/periodicals. I am not confusing the two (yes one is illegal, the other can do good). I apologize for the unintended obfuscation.

Lewis's book examines one kind of HFT, argues that it is objectionable, and takes a look at one method of mitigation. Where this bites is that this HFT method is super common and relatively common knowledge to insiders but not outsiders.

This criticism, that Lewis doesn't take a comprehensive view, is inapt since Lewis's book is not a treatise on HFT and its implications. It is like criticizing a scientist for publishing an article on a narrow topic rather than describing everything in the world in one giant book.

You can say that this method of HFT isn't front-running or that front-running shouldn't be illegal (and back up your case with arguments) but you can't say this criticism of one HFT method is wrong because HFT does other stuff too.

Edit: Source: actually read the book

"There are some bad apples, but there are also many who genuinely believe that they are doing a service for the market."

Believing they are doing a service and actually doing a service are two different things. I agree it's important not to tar the latter of your two cases with the brush reserved for the former, but that doesn't mean sparing them entirely. It simply means selecting a more appropriate brush.

While malicious intent and clueless idiocy may be different from a moral perspective, they're indistinguishable in terms of effect. In either case, it falls to the law to limit these effects. Between the lack of ethics and the general ignorance, both types lack the ability to restrain themselves from harming others, not to mention the institutions we all rely on.

HFT participants (and those who deal with them) have been villified in an industry already viewed in a negative light. There are some bad apples, but there are also many who genuinely believe that they are doing a service for the market.

Without discussing this particular issue, doing evil and feeling evil are two very different things. People who do evil almost never see themselves as evil people, and they almost always justify their actions to themselves. There are no Bond-villains in real life, and if you look for them to find evil you miss its actual manifestations. Those are often quite elusive.

This is a complicated issue and not very well understood as you can see in some of the replies to this comment. The term HFT is used to describe a lot of strategies, and many of them are overall good for the market. Elimination of human specialists and market makers and subsequent tightening of spreads is definitely a good thing. Also, arbing prices between different markets is also a good thing and those with the best technology will succeed there.

But there are HFT strategies that are bad for the market where the HFT algorithms are enriching themselves while providing no benefit to anyone else and actually causing the market harm.

Take a look here for more details on "quote stuffing" and other malicious HFT practices:


Bill O'Brien may not be the best person to quote. http://blogs.wsj.com/moneybeat/2014/04/03/bats-forced-to-cor...

BATS Global Markets Inc., under pressure from the New York Attorney General’s office, corrected statements made by a senior executive during a televised interview this week about how its exchanges work.

BATS President William O’Brien, during a CNBC interview Tuesday, said BATS’s Direct Edge exchanges use high-speed data feeds to price stock trades. Thursday, the exchange operator said two of its exchanges, EDGA and EGX, use a slower feed, known as the Securities Information Processor, to price trades.

The distinction matters because high-speed traders can use powerful computers and superfast links between markets to outpace traders and trading venues that rely on slower market data, such as the SIP.

That's a particularly uncharitable way to put it. Another way to put it is this:

Regulations encouraged a fragmentation in exchanges (a good thing, since they used to be monopolies).

For multiple exchanges to trade in the same instrument, some force needs to synchronize the prices between the markets.

The regulations specify a mechanism by which this might work: quotation feeds for different products replicate the NBBO ("current" best bid-ask) across the markets.

But the NBBO feed is only an approximation of the best feed --- and it has to be, as anyone who has ever built a distributed system must know.

Fast electronic trading can synthesize a BETTER NBBO. If you know what the better NBBO is, you can trade against it, in effect forcing prices to synchronize through arbitrage trades.

The net effect is that the markets synchronize on a more accurate BBO, and electronic trading systems get compensated for doing this based on the profits from the arbitrage trades.

In the ABSENCE of that trading, the delta between the SIP NBBO and the "real" NBBO still exists; it's just money in the pockets of a different set of entities.

In neither case was this money likely to be helping firms that hold long-term positions and make money by allocating capital; the previous crappy NBBO profits were just going to a different set of sell-side firms, who are now angry that they'd been obsoleted.

To me, an extremely telling fact here is that Vanguard's Chief Investment Officer went on the record and said that HFT trading, and latency arbitrage in particular, had been helpful to their trading costs. If that doesn't mean anything to you, do some research into how Vanguard works and is structured.

I'd be curious how much volume occurs like this. I'm in the industry and know of these issues but have never heard of a trade specifically designed to exploit it.

Exchanges aren't allowed to accept quotes that would lock/cross each other, so you'd need something to happen like two guys put crossed orders into a wide book like AAPL almost simultaneously on different markets. They'd have to be crossed by more than a cent since the trader taking them out would have to pay remove fees on both (~$0.006) and the person doing it would have the risk of getting legged if he gets the first order but another takes the second one.

They should fix the SIP but this is not a common HFT technique as far as I know.

For those that didn't click through, the (very entertaining) CNBC interview can be found here:


People ITT are not making a distinction between different types of HFT. Katsuyama and Lewis do not criticize all forms of computerized trading, but specifically computerized scalping that is aided and abetted by exchanges. Their chief complaint is that HFT uses more current prices than the exchanges themselves and they use this to scalp other traders.


This is actually very simple. Natural buyers and sellers do not need intermediaries, but intermediaries do need the natural traders. So if the natural traders can coordinate, they should be able to set rules that favor themselves and disfavor intermediaries. I won't say that what HFT does is "unfair" (capitalism does not contemplate fairness), but I think it's highly ironic that HFT and their supporters are complaining how "unfair" it is that natural traders are working together, and yes, marketing their new exchange.

Very nicely put. Yes it's a bit hilarious.

The HFT folks seem to be saying "you don't have a right to add up all the total amount of asks at a certain price across all the exchanges and expect to get execution at that price" and with a bit of thought I might agree with them. But it is very counter-intuitive. If you see 10,000 shares for sale across 10 exchanges at $54.00 your VERY next thought probably isn't "oh that's actually 1,000 shares, but advertised on all the exchanges so it only LOOKS like 10,000" Once you understand how things works, sure fine.

The counter to that, though, is that the HFT folks don't have any right to have access to order flow. If market participants want to route their orders to a particular dark pool or exchange they have every right to. The "markets are always right" sword cuts both ways.

It isn't only 1000 shares, there is indeed 1000 unique shares on each of those ten exchanges. The problem is that, as soon as the first exchange that you trade on processes your trade of the 1000 shares on that exchange and publicly disseminates that information, that is public information -- and an HFT is totally within their right to pull their remaining 1000 shares on each of the nine remaining exchanges if they so choose. That's why Lewis explains that once they wrote a program to stagger the submission of their orders so they arrive simultaneously to all ten exchanges, they were able to pick off all 10000 shares instead of only the 1000 on the first exchange.

They do have every right to route their orders where they will. It's telling that most of the buy side prefers to route their orders to public exchanges rather than dark pools like IEX.

The buy side doesn't route orders. Brokers route orders, and they aren't required to tell their clients where they route the orders. (Some good brokers do allow traders to direct routing, but I believe it's not common).

Also, there is a network effect to overcome here. Try to give IEX more than a few months before writing their obituary. They haven't even fully launched yet (they are still a dark pool)

The market exists the benefit for the 'buyside' e.g. people who own stock, not for the benefit of the middlemen like exchanges and HFT marketmakers.

You may not like homeowners and think some of them are or should be convicted, but it's ridiculous to say someone is 'shilling for homeowners' when they point out that real estate brokers are overpaid and skimming.

Some more balanced discussion - http://streetwiseprofessor.com/?p=8333



In a nutshell, people who run big portfolios don't want to give away information about what they're doing, and they don't want HFT types to be able to pay exchanges to get first crack at front-running them.

On the other hand there is a legitimate market-making function, and there's a tradeoff between transparent markets and forcing people to share info that lets other people trade against them.

The buy-side is buying liquidity. The sell-side is selling it. That's basically what the terms mean.

It's not particularly meaningful to say that the market exists "for" the buy-side. The real estate market exists for the real estate buy-side, too. But it takes 5 months to sell a house, because nobody is selling liquidity; instead, you have to work through an ineffectual sell-side agent who takes tens of thousands of dollars out of your hide for the privilege.

no, the buy side is long. the sell side is selling things like IPOs, etc. that the buy side might want to buy. sometimes they provide liquidity, sometimes they're just an agent and rent-seeker.

markets, trades, liquidity are a means to an end, not an end in themselves. every trade is a friction and a cost, and only happens because the two sides aren't happy with their portfolio.

"more friction in your machine is generally bad and just creates heat."

"oh, but that's not meaningful, people who make sandpaper and grippy tires are needed to create friction"


Your uses of the terms "buy-side" and "sell-side" do not conform to how the financial community (of which the author of this blog post is a member) uses them. It's not the buying vs selling of securities. It's the buying vs selling of financial services (of which liquidity is one).

Your definition is probably better but I wouldn't expect more than 20% of people in the industry to define it correctly that way. (and the buy side is selling financial services to someone too...the buy side holds portfolios of securities, sell side makes money generating transactions...distinction can get quite arbitrary when you have buy side strategies that involve lots of transactions and selling liquidity)

bottom line is... greasing the wheels of commerce good, making wonky wheels so some goofball can sell more grease services bad.

The buy-side does not become the sell-side when it tries to exit a position.

Buy-side: mutual fund.

Sell-side: market maker.

> people who run big portfolios don't want to give away information about what they're doing...

Then people shouldn't be investing in these poorly-performing portfolios and use other portfolio managers who are more savvy.

These people act like this stuff is MP (my problem, as an average person) whereas it's obviously YP (your problem, Mr. portfolio manager)

Yes, some big portfolio guy wants to be able to sell 50M worth of some stock without the price dropping.

But what if you were buying stock at the same time? Wouldn't you want that information about that rise in supply to be detected and priced into the market as fast as possible?

this guy said it better than me -


I am still reading the book, but it seems like Lewis' main criticism in the book (vs. interviews) is against the so-called HFT front-running of orders that get routed to multiple exchanges. He is careful to distinguish market-making/liquidity providing functions from the multi-market latency arbitrage and spends a good part of Chapter 4 exploring this distinction.

Perhaps his public statements in interviews haven't been so nuanced.

Also, these rebuttals to the book don't really address the front-running issue. Is it simply an unavoidable consequence of the physical reality of separate markets? Should anything be done about it? Is it even still occurring or has competition among HFTs and savvier buy-side order routing eliminated it? I would like to read a rebuttal that discusses this.

One of the more disingenuous things about Lewis' book (caveat: I'm only halfway through, because I'm listening to the audiobook and, on the advice of another reviewer, switched to the book _Dark Pools_ in midstream) is the rhetorical sleight of hand he plays with the term "front-running".

In Lewis' universe, the price movement that happens when an informed trader tries to piecemeal-fill a 100,000 share order is "front-running".

But in Larry Harris' universe†, not only is price movement during block shopping not "front-running", it is the fundamental reason for the existence of sell-side firms; in other words, the challenge of stealthily shopping 100,000 shares of thinly-traded product XYZ is the reason that Katsuyama made $2MM/yr.

Lewis posits that the natural state of affairs is that there's an NBBO for XYZ, and that Katsuyama should expect his equities desk to collect fat fees simply by accepting a block order from a client, pushing a button, and unloading it at the current best bid, whereupon at the completion of this order the price will change to reflect the altered supply/demand condition of XYZ.

But that is crazy. The presence of a 100,000 order changes the supply/demand conditions for XYZ. For RBC to expect to sell 100,000 shares at the current bid, it must expect to get something for nothing: to take the price hit for the increased demand of XYZ out of the hide of whoever is holding it right now.

Before HFT mania, "front-running" meant something very specific: it was a problem of agency. A client/broker relationship existed, and the broker exploited it by trading in front of their client's order. The client had a right to expect the broker to act in their best interests. But the markets as a whole aren't a positive-sum system; in the absence of a contractual relationship, nobody has an obligation to act in the interests of anyone else. A dollar you make on the market is a dollar someone else didn't make.


The specific example given in the book is that an existing ask sized at 100,000 is already sitting on the order book when the buy order goes in at the ask price. The ask then disappears before the order executes. This is very different from the market moving in response to an order that has no market fill.

The 100,000 shares are sitting on the order book at different exchanges. It's not a single block being traded with a single order. That's a critical distinction.

I will refer you to page 96 of the book. The specific example is 100 shares of MSFT asking $30.00 and 10,000 shares asking $30.01. Because of Reg NMS, your broker is required to take down the 100 shares first ("NBBO"), allowing the HFTs to then start buying the $30.01 offer and front run the remainder of your bid. The problem with this requirement, according to Lewis, is the NBBO is priced off SIP rather than direct feeds. I don't disagree with the literal point that you are making, however, there is no need for this kind of intermediation. Why should natural traders pay intermediaries for this function? Why shouldn't they coordinate on an exchange where they don't face this tax?

RegNMS requires exchanges and trading centers to honor the Order Protection rule to route trades to the trading center with the best listed bid/ask price.

I don't think RegNMS requires a broker-dealer like RBC to route its order to any particular exchange.

Brokers already have a duty of best execution to their clients. They are allowed to use their judgement to send orders to any given exchange regardless of the NBBO. That's what enabled RBC to implement "Thor".

I'm not an expert but I believe you are incorrect. What you are suggesting is that the broker could perform a "trade-through", which was allowed under the old ITS rules. Under the Order Protection rule, trade-throughs of even 100 shares are explicitly prohibited. Reg NMS is very strict and that's why it is so controversial. My understanding of Thor is that it does not trade through, but it executes at all relevant exchanges near-simultaneously by delaying order routing to lower-latency exchanges. This prevents HFTs from sniffing your order at one exchange and beating you to the next.

I too raise my "not an expert" flag and await corrections from 'yummyfajitas or 'kasey_junk.

There are a number of possibilities depending on whether you send in a routable order (it's a flag you can set -- route or don't route, and there can be fees associated with routing). What a sophisticated trader would do is send two orders simultaneously taking out the small 100 lot at 30.01 and the 10,000 at 30. The exchange with the larger but worse price order will accept your order if you set the ISO flag, indicating you have sent orders to clear out better priced orders at any market centers displaying a better protected quote.

That's correct. As long as the exchange to which the order is routed is presenting NBBO at the time the order is executed, then the broker is compliant with Reg NMS.

Also note, if that exchange is not offering NBBO, it is bound by Reg NMS to route onward to the actual venue that has NBBO. The exchanges are also bound by Reg NMS, not just broker dealers.

If it were a single order in the book, I'm not sure I see the advantage HFTs would have conceptually had. They're not sniffing individual orders and then outrunning them before the original order hits the exchange; they're exploiting the individual piecemeal orders that are stealthily trying to move the block.

They're hunting down the orders of informed traders who are trying to exploit their own knowledge of the true price of products, and correcting the price on the market before those informed traders can take their knowledge out of everyone else's hide.

The institutional orders get baited to BATS BYX with "taker rebates" (on BZX the fee structure is the normal maker-rebate taker-fee, but on BYX it is reversed). It hits BYX first because the broker's router is programmed to send it there first for that rebate, but its only for a minimal amount of shares. And that's a signal which the HFT firms use to pull or front-run equivalent offers on the various other exchanges.

The other big scam seems to be HFT firms buying a broker's order flow - for hundreds of millions of dollars. For example, Schwab sold its order flow to UBS for 8-year contract in 2005, for $285 million. It was massively underpriced, Schwab is said to have left a billion dollars on the table. And UBS, in turn, sold Schwab's order flow to Citadel for an undisclosed sum. Why is the right to execute a broker's order flow so valuable? Nobody seems to have a good answer, but the obvious reason is that its easy scalping.

I see a lot of heat generated in this discussion, but I don't see an answer to your second paragraph. That's the answer I want to see.

It is the easy scalping he mentioned.

A market maker can only stay in business if they sell as much as they buy and if the average sale price is above their average buy price. They lose money if they provide liquidity in the way of market moving forces.

Market makers try to avoid informed and "toxic" order flow and broker flow is guaranteed source of small uninformed orders that are most likely going to be crossing the spread.

The answer is retail flow has no information - it's the ideal flow for professional market makers to trade against

While it's true that retail flow has no information, it's also true that a broker will obtain better executions if it does not sell order flow to HFTs.



Yes exactly. A lot of people don't seem to understand this.

Interesting side note: Here's a link to an Amazon review of _Dark Pools_. The review claims the name Brad Katsuyama and opens the review with "As an insider in the world of electronic trading..."


I'm liking it a lot so far; it's written by an author who clearly thinks HFT is sinister, but who also seems to think the code behind it is really cool. (Maybe I'm biased, because that describes me pretty well too.)

I quite like Dark Pools even with the obvious bias. I will say that occasionally it gets technical aspects of things completely wrong, but that is pretty easy to do.

Also, as with any discussion about HFT look into the people who are making accusations against it. Most of the time they are ex execution traders made redundant by HFT or failed at HFT themselves.

Basically, I really enjoyed the history part of the book and found the expose part riddled with mistakes, obvious biases and vague terms that could be interpreted in many different ways.

He is careful to distinguish market-making/liquidity providing functions from the multi-market latency arbitrage

I don't think the distinction is as clear as you think. If I'm making markets on several of the US equity exchanges, and I see my entire order on one side of the market at one exchange get taken, I will adjust my quotes at the other exchanges. That's not front running. It's a reasonable market making strategy.

The argument from IEX is that the exchanges intentionally price trades using slower data than what they (the exchanges) have access to. We can call it whatever we want, but natural traders would prefer an exchange that doesn't price match in this way, and have every right to move to such an exchange.


Natural large volume traders prefer an exchange that doesn't price match this way. No one is preventing them from creating a dark pool (which is what IEX is) and they already have any number of dark pools available for this sort of trading.

Turns out many natural traders (Vanguard is the one that comes first to mind). Really like trading in the new HFT world as it is way cheaper than it used to be.

Vanguard is in the business of selling index funds. It's Vanguard's incentive for mutual funds and hedge funds to face unnecessary taxes on their trades. This lowers the returns of active investing versus passive investing. What's bad for everyone else is good for Vanguard.

It's true that IEX is a dark pool, and that other dark pools exist that purport to favor natural traders, but IEX is moving toward an ECN and full-fledged exchange in a staged launch. Other dark pools are highly conflicted, lack transparency, lack technical protections, and the biggest difference is that people seem to trust the principals of IEX and the incentives of the ownership structure.

That trust in the principals of IEX and the ownership structure is precisely what I find so odd.

This article seems like nothing more than an overly long ad hominem attack.

The only critique that matters is whether or not front running of buy orders by HFT traders is real or bull. Anything more is just an attempt to cloud the waters.

Yes, I was also dissapointed by the name calling.

It was especially disappointing when he dismissed the front running as always having been there.

He didn't say front running has always been there. He said market making has always been there. Market making is a valuable service and it's great that it's cheaper than ever.

This was a great article. I started reading the book. Early on, one of the examples given was "Brad talked to a friend of his at SAC Capital" about how HFT firms were taking advantage of information in the markets.

That is the kind of unintentionally ridiculous anecdote which undermines the moral center of this book. SAC Capital, after all, is the same fund which ran into one of the largest insider trading cases in history, which is also about taking advantage of information in a, let's say, special kind of way.

I know a lot about this subject, probably too much to let the judgment fall cleanly in one camp or another on HFT, but with all the hubub right now, I find it might be useful to get biblical for a second - let the person who is without sin cast the first stone.

Is the anecdote really unintentionally ridiculous? Lewis acknowledges SAC's later infamy in a parenthetical (quotation below). And the point of the anecdote is that even a party that went to great (and illegal) lengths to gain an informational edge didn't understand the new phenomenon of latency arbitrage by the HFTs.

Quotation: "He had a good friend who traded stocks at a big-time hedge fund in Greenwhich, Connecticut, called SAC Capital. SAC Capital was famous (AND SOON TO BE INFAMOUS) for being one step ahead of the U.S. stock market. If anyone was going to know something about the market that Brad didn't know, he figured, it would be them."

Of course it's ridiculous. The book makes no actual mention of what SAC did, to avoid cognitive dissonance. Perhaps SAC was infamous for dwarf tossing - not illegal but in poor taste. I don't think the 60 minutes audience would have SAC's transgressions on instant recall. Lewis declines to specify anywhere in the book that SAC was engaged in criminal violations of established securities laws, while he writes an entire book about the evils of HFT, which in large part is mostly an issue of what types of trading we want to permit and not widespread illegal activity.

And did Brad "figure" SAC would know because he knew that SAC pursued informational advantages to the extreme? Did he think that was unethical, crossed a line, so they would know about other activity that crossed the line? That seems like a really strange line of thinking.

It also seems strange that this super ethical guy would attack activity which is legal, but turn a blind eye towards known unethical or suspected illegal business. Did he know about the rumors of insider trading? Did he knowingly solicit business from a firm which he had reason to suspect was engaged in insider trading?

If you think I'm a dork, or too much of a Michael Lewis hater, I encourage people to read this Amazon review, which gets into a lot of interesting small details Lewis got wrong:


This is very close to the blog post I would write if I were going to write a critic of Flash Boys. I'd add the following:

IEXT has a few main selling points. 1 transparency, 2 simplicity, 3 looking out for "investors". The problem is that they aren't any of those things and it is obvious from a simple reading of their technical documents.

First transparency. Their marketing pitch is that as opposed to other dark pools, they are transparent about what is happening on their markets. Yet the first thing they say in their technical documents is "IEX will commence operation as a fully NON- ---DISPLAYED venue." What this means is that their order books is not available for outside audit. They are meeting the lowest hurdle to regulatory compliance by providing best bid/offer and no more. If you think that is ok, let me ask you. If I told you that there was 1 buyer willing to buy at 10.00 and 1 seller willing to sell at 11.00 what would you think the "real" price for that instrument is? What if I told you that there was 1 buyer at 10, 1 seller at 11, 100 million buyers at 9.99 and zero sellers at 11.01? If you think those markets should be priced the same way, IETX is for you. If not, realize that IETX would tell you those markets are the same thing.

As far as simplicity, Flash Boys and the IETX marketing materials make a big deal about all of the order types that provide advantages to market makers, yet they remain silent on those order types that are explicitly there for large institutional investors. Lewis rages against ALO orders yet doesn't even mention iceberg orders which the sole point of is to hide the amount of shares a participant wants to sell. Then he extols the virtue of IETX for only offering 3 order types (which has since risen to 4), yet doesn't explain that in those 3 order types are many variants that only benefit large investors. IETX has literally removed all of the order types that allow market makers to do their jobs, while leaving all the order types that allow large institutions to hide their order flow. One of the most controversial order types out there is an ISO order, which is literally a legislative exemption for large block buyers that allows them to circumvent regulation about the national ticker. IETX offers those sorts of orders, but you will be happy to know they don't support "esoteric" orders.

The most egregious problem in Flash Boys is Lewis' use of the term "investor". He uses this term to make his readers think he is talking about them, after all anyone who is not an HFT, who is long holding a stock is an "investor". Yet the practices he describes as predatory, are really simple market dynamics. If an "investor" wants to buy or sell an extremely large block of shares, that should move the market price. No other marketplace would think differently. If McDonalds buys all the cows in America, beef should cost more. We all understand that. But the giant hedge funds of the world hate this. They want to use their privileged information of demand to make money, and not change the prices of the things in demand. They used to be able to accomplish this because the markets were dumb. They aren't anymore. Price discovery is an extremely efficient (and cut throat business). IETX does its gosh darn Canadian best to undercut that. Literally every rule they have is an attempt to hide demand and undermine price discovery. It's possible that bad pricing is an overall societal good. I'm not smart enough to weigh in on that. I will ask, if they are looking out for the little guy though, why do they have a special order type that insures that big investors don't trade with them (min. qty orders)? They will respond that it is protection against predatory HFT. I ask you though, if the huge hedge funds of the world don't want to trade in small volume with the rest of the informed markets, at the lowest prices conceivable, who do they want to trade with? The answer is large dumb funds, who don't care about trading at inflated costs. I.E. pension funds.

As much as there are a lot of people in the world (many of them right here on Hacker News!) who don't care about the mechanics of how liquidity is provisioned in markets and consequently have kind of backwards views of HFT most of these people aren't, you know, trading stocks.

So here's my question: since the people that are trading do tend to understand these things (if for no other reason that they'll go bust if they don't), won't liquidity providers run away from IEX as fast as they can? How do Brad Katsuyama and his partners think they'll actually scare up enough liquidity to get maintain a functioning market?

I'm a little befuddled by this.

I've actually been thinking a lot about this. So, every other dark pool in existence, has started with the same premise as Brad and his merry band. That is, "man our big investors are getting killed due to good pricing in the markets". So the first thing they do is come up with a variety of schemes to obfuscate the order flow of these big investors. Invisible order books, ice berg orders, preferential routing, min. qty. orders etc.

These schemes succumb to 1 of 2 problems

1) they are trivial to game by market makers. That is, the exchanges make their money on fees, the market makers make their money on finding inefficiencies in the markets, who is better positioned to find the places that a market protection scheme falls down? Of course it is the market makers. This is why you see stories of HFT "pinging" black pools, or creating routing tables, or whatever other wild information advantage that they can come up with. At the end of the day, big brokers/ibanks still get to eat if their schemes don't work, market makers don't.

2) If an exchange actually does find a way to limit market maker profits, they simply stop trading there. The liquidity dries up and the dark pool has to figure out some way to justify it's existence. Usually by relaxing their rules and allowing the tricks described in 1) or by negotiating a preferential deal with a couple of HFT firms that have some sort of price protection involved (which may be as shady as, only screw my clients I don't care about).

Brad, Lewis, and the IETX backers have figured out another strategy. Convince enough of the "dumb" money to demand that their trades be routed through IEX that they can create a self sustaining dark pool. They actually don't care about retail investors. If a couple of thousand of them call up and demand that their broker get on IETX that's fine. They've made the barrier to entry cheap enough that it doesn't cause a lot of overhead. But what they are really looking for is the uninformed institutional investor. The East Gary Fireman's Booster Union, needs to unload 65k of GOOG that some shady Morgan broker sold them. They think of IETX first. There sits Einhorn and his fund ready to hit it for all he's worth. No intelligent liquidity provider there to take any of his execution costs.

It's sort of brilliant and shows why I'm a dumb HFT market maker technologist instead of a billionaire (or millionaire in Brad's case) Wall Street type.

You think they'll succeed with this third strategy? Are there enough gullible East Gary Fireman's Booster Unions to make it work? It still seems a little far fetched to me. How much will regulations protect Mr. East Gary from shooting himself in the foot when the IEX price moves away from everyone else?

PS: You've probably already watched it, but if you haven't you should really watch the YouTube video on the iextrading.com homepage. It's...really something.

I don't know what their success criteria is. Do I think that they will sweep the markets and become the dominate exchange? Absolutely not. Do they have a chance to drive enough volume to the dark pool to keep their backers execution costs + investment less than their execution costs on other exchanges? Maybe. If they do that though they may have another class of problem. Other investors looking to back them. If broaden that pool it gets harder and harder to keep their execution costs down.

An interesting study on the topic concluded that HFT helps retail investors and hurts institutional investors: http://qed.econ.queensu.ca/pub/faculty/milne/322/IIROC_FeeCh...

You don't have to agree with Michael Lewis' views or buy into the story line 100% in order to enjoy the book. The fact is that this is a well-written book that is full of mini-stories and anecdotes that present very realistic descriptions of how electronic markets and Wall Street in general work. Statements like "the market is rigged" are obviously over the top but that doesn't mean that the book on average is not true to reality. Most books about electronic trading suffer from extreme sensationalism, poor writing, and the inability of the authors to understand the subject matter that they are writing about. Michael Lewis does a better job than everyone else. He is a great writer and he is a smart guy who has some financial background and has a pretty good understanding of financial markets. Yes, there is some sensationalism here (he has to sell a good story after all) and there are many errors in the book, and, yes, the author's biases are quite evident, he's picked a side and he's sticking to his story. On aggregate, though, this is probably the best book about the world of electronic trading that I've read.

(Some people mentioned "Dark Pools" by Scott Patterson. Although also interesting, that books was often quite painful to read because it was quite clear that the author did not understand basic financial and programming concepts. "Flash Boys" is much better, in my opinion. Although if you are really interested in the subject, you should read both.)

You basically just said that people should read the book because, even though it's mostly wrong, it's well written.

Isn't that kind of crazy?

I'm not saying that it's mostly wrong. I am saying that it's a biased perspective, but most of the contents is factual. You can learn interesting things about the markets, and about the individuals and the companies involved. However, this is one side of the story. Michael Lewis' facts were gathered from people that were close to him and the people that he could get to speak to him. It's one circle of people with their own agenda. But there are many other views out there. So he is presenting the facts that he knows about and that he thinks are important. But there are things that he is perhaps omitting on purpose, and things that perhaps he just doesn't know or understand. The book is not the whole truth. As with any good book or article, you can learn a lot without having to agree with the author's conclusions or his personal views.

I'd be happy with that outcome if that's what happened.

Instead I've spent the last week explaining to people (including my mom) why the opinions of an exchange bought and sold by folks with a vested interest in not allowing price discovery are painting me as evil.

Add to that the very real fact that for whatever reason, incompetence, bias, or laziness, Lewis has literally misrepresented the way the markets work, and the way participants thought it worked for many years and you can under stand why some of us are upset.

I've seen this argument advanced several times now, but it doesn't make sense to me. Looking at the investors of IEX -- David Einhorn, Dan Loeb, Bill Ackman, Capital Group -- these are some very, very smart people. They're not idiots that were sold a bill of goods by a lying, bumbling team of Lewis and Katsuyama. And while they may have a vested interest via their investments in IEX, it's dwarfed by their interest in reducing slippage on their own trades. IOW, it doesn't seem like they are talking their book. It seems like they are really seeking a fairer market. (Obviously, what's "more fair" to one party may be "less fair" to another)

If something is "more fair" for David Einhorn, Dan Loeb, Bill Ackman & Capital Group, who do you think it's "less fair" for?

I was simply pointing out that fairness is a matter of perspective, and in a sense, arbitrary. If I were an HFT I would no doubt think that IEX would be unfair to me.

I will claim that the proposed solution (IEX) creates a fairer market for the vast majority of market participants.

Or at least they're seeking to avoid having to have execution traders on staff who can manage their order flow.

If your ISP packet sniffed your network and traded against your positions in advance of them coming to market would you have a problem with it? How about if they put up an MITM to get your credntials and then installed a key-logger to make it more effective and faster? One could argue that once you hit "sell" or "buy" your electrons are public information. But others might consider them NPI. I don't think that the issue is completely cut and dry, at least no just yet.

Seems like this book is causing quite the ruckus with certain brokerages: http://pressroom.aboutschwab.com/press-release/corporate-and...

Yet they are more than happy to sell their order flow to market makers who use HFT. (To allow them to trade against it before going to the exchange - as is customary - nothing wrong with that) http://www.schwab.com/public/schwab/nn/legal_compliance/impo...

Seems like they are jumping on the populist bandwagon by claiming "HFT bad!" but I think what they mean is "HFT bad - unless it's from one of the firms we sold our order flow to!"

I would disagree that this would be considered jumping on the populous band wagon, if you've read the article, you'll see that Schwab originally released an Op-Ed in the summer of 2103 echoing similar concerns.

He took a public stance on HFT a full year before the book was released.

Taken directly from the release you linked-> As we noted in an opinion piece in the Wall Street Journal last summer.

http://blog.themistrading.com/talk-to-chuck-about-hft/ http://online.wsj.com/article/SB1000142412788732358290457848...

Can someone explain how HFT would "provide liquidity", which seems to always be the pro-HFT response? To use an analogy, if I want to buy a house and someone is selling a house, how does a third-party buying the house first and selling it to me a slightly higher price provide liquidity?

Saying Alice wants to sell a house, but she needs to sell the house now, and is willing to take slightly less money to get it sold. That's when the HFT comes in says, "Okay we'll buy your house for slightly less than market value, since we're taking the risk that we can resell it." That's Alice crossing the bid-ask spread, and paying for liquidity.

Suppose Alice doesn't want to pay for liquidity. She can just as well say, I'm going to wait for a buyer willing to pay the ask price. She doesn't trade with an HFT and instead takes the risk that a buyer never shows up or that the market moves against her. This is equivalent to an add-liquidity-only order. She won't be crossing the spread, and she therefore she won't pay the bid-ask spread.

It's the same thing if you're buying. If you don't want to pay for liquidity you don't have to. You state your price, say you'll only add liquidity, and when a seller comes along who's willing to give it to you at that price, you'll be matched.

Let's unpack that a little. For most publicly traded stocks, there are always going to be willing buyers and willing sellers, for the right price. Those prices, respectively, are the bid and ask prices. So for example, if you want to trade shares of some stock, the bid might be $100.00 and the ask might be $100.10, i.e. someone will buy from you at $100.00 and someone will sell to you at $100.10.

Obviously if the buyers and sellers hold fast then no trades get made: The buyers are offering less than the sellers are willing to accept. If you want to make a trade then someone has to cross the spread -- either the buyer has to pay $100.10 or the seller has to accept $100.00. This leaves room for speculators: When a seller decides they want to trade right now and they cross the spread, the speculator can buy the shares and then hold them until a buyer comes who is willing to cross the spread, and then the speculator profits by buying at the bid price and selling at the ask price. The speculator is taking the risk that in the meantime the price of the stock may go down and they'll lose money, and that risk is what earns the profit.

But HFT isn't that. HFT is having fast computers sitting in Chicago and New York, so that when a buyer crosses the spread in Chicago at the same time as a seller crosses the spread in New York, the HFTer can arbitrage the transactions with the foreknowledge that both trades will clear immediately. The HFTer is not taking a risk proportional to the profit but rather is profiting from trading with superior information. Moreover, the HFTer is only holding the shares for milliseconds. How does that provide any useful amount of liquidity? Why can't we arrange the exchanges so that if a buyer and seller both cross the spread at approximately the same time, they split the difference and no third party takes anything?

The HFT is taking risk though. Like everything else in markets, nothing they do happens at the same time either. They could miss on one side of the trade if another player is faster, and then they're stuck in a position they might not want.

Also think about this in terms of what happened, the two counterparties got to interact without being in the same place or product. Yes, they could have traded if they were both in the same place, but they weren't. Surely providing that service is worth something. You could buy your meat wholesale, but the grocery store isn't ripping you off by selling it for $1 more a pound somewhere closer to home.

Think about what would happen to others if the HFT wasn't there, too. Prices would diverge and traders on one of the exchanges would be trading away from the real value. By keeping prices in line, information is transmitted from market to market more efficiently. A trader who isn't concerned with cross-market arbitrage doesn't need to connect to and watch multiple markets to get a fair price.

HFTs are obviously motivated by profits, but the level of profit is extremely low for the amount of service they provide. Virtu trades over 5% of the US markets and made slightly over $100 million. They only have a couple hundred employees. Think about how many people were required to make markets globally before technology. Only a fool would argue that we should go back to that system.

> Think about how many people were required to make markets globally before technology. Only a fool would argue that we should go back to that system.

Who is even suggesting that?

Distinguish between the result and the method. Having prices be the same on all exchanges is obviously desirable. But why do we have to reach that result in this way? Why not instead have the exchanges talk to each other and have trades on any exchange automatically go to all the other ones, so that prices are always the same programmatically without having to pay any third party to keep them that way?

So you want a distributed order book with global time priority and atomic execution semantics? Can you explain the mechanics of how this would work? This sounds like a locking nightmare. I think some FX market works this way with matching engines in NY, Tokyo and London, but FX markets can also reverse trades and many markets aren't really continuous (min quote life and books that update on a delay) so locking may not be as big of an issue.

Anyway most HFTs are not keeping prices the same between exchanges. There simply aren't enough times during the day when quotes are crossed to make this viable. Most are market makers or are doing arbitrage/psuedo-arbitrage trades like ETF vs. basket, futures vs. cash, etc. that move liquidity from product to product.

Because http://en.wikipedia.org/wiki/CAP_theorem.

It's a distributed system. You want it to keep working (be available) all the time right? Guess what, you're gonna have to lose some consistency.

For extremely high availability systems like this it is generally better to choose both consistency and availability at the expense of partition tolerance and then mitigate the possibility of partitions with meshed multiply redundant interconnects.

Moreover, you don't strictly need a distributed system. You could instead elect one exchange at any given time as the primary and clear all inter-exchange trades through that exchange.

It's really fun watching you turn into such a pretzel that you want to somehow get around the CAP theorem and/or go back to the days of monopoly exchanges all to get away from the horrible evil of a cost for liquidity of less than 0.1%.

Don't miss the forest for the trees.

Citing the CAP theorem as a reason not to have a distributed system is like citing Arrow's Impossibility Theorem as a reason not to have a representative democracy. Proving the impossibility of a platonic ideal doesn't tell you anything about whether one imperfect system is superior to another in practice.

And you can't hand wave away the fact that the implications of the CAP theorem are minimal on a distributed system with a high level of interconnect redundancy. If you can ensure with high probability that there will not be a partition in the network then you don't need partition tolerance. If against all odds you have a partition anyway then you lose availability, but that isn't a characteristic unique to the CAP theorem or distributed systems -- any system will lose availability if enough redundant components fail simultaneously.

Exchange gateways fail, network lines fail. This happens all the time. In the current system I can still trade if NASDAQ goes down.

> so that when a buyer crosses the spread in Chicago at the same time as a seller crosses the spread in New York, the HFTer can arbitrage the transactions with the foreknowledge that both trades will clear immediately.

Can you explain this in more detail? How does the HFT know that someone is crossing the spread? How is the HFT able to transact with two market-crossing orders after the fact? What financial instrument is being traded in Chicago and NY?

> How does the HFT know that someone is crossing the spread?

So suppose the bid for some particular stock is $100.00 and the ask is $100.10 in both Chicago and New York. They could be different between the two exchanges, but the prices between exchanges will generally be the same or very close to each other at any given time because any significant divergence is an arbitrage opportunity.

Now somebody wants to buy some shares of that stock in Chicago, so they cross the spread and put in a bid for $100.10. They immediately buy all the shares in Chicago that are available at $100.10. Now the ask in Chicago will go up because all the shares available for $100.10 in Chicago have been purchased, so now the bid in Chicago is $100.10 and the ask is, say, $100.20. At the same time, in New York, somebody wants to sell some shares of the same stock. So they cross the spread and make shares available for the bid price in New York, which is $100.00. That seller sells to everyone in New York who is willing to pay $100.00, so now the ask in New York is $100.00 and the bid is, say, $99.90. Both the buyer in Chicago and the seller in New York are still willing to buy and sell more shares at $100.10 and $100.00 respectively, i.e. the new bid in Chicago is higher than the new ask in New York.

The HFTer sees the new prices before most other traders because their computers are faster and closer to the exchanges. As soon as the buyer at $100.10 learns there is a seller at $100.00 or vice versa, they would get together and trade all the shares they want to trade at some price in that range. But the HFTer learns the pricing information first and, before the buyer and seller find out about each other, the HFTer buys the seller's shares in New York at $100.00 and immediately resells them to the buyer in Chicago at $100.10.

Assuming things work the way you describe (they don't, but I'll play along) if there is no HFT involved how would you propose that this situation be resolved?

There is $.10 of surplus here. Who (if anyone) should get it, how, and why?

> Assuming things work the way you describe (they don't, but I'll play along)

By all means educate us then.

> There is $.10 of surplus here. Who (if anyone) should get it, how, and why?

That seems like kind of a philosophical question. Who ever should get any surplus? A better question might be, how can non-HFT traders arrange to capture the surplus currently claimed by HFT?

> if there is no HFT involved how would you propose that this situation be resolved?

The situation now is that whoever is fastest gets the surplus, even though being milliseconds faster provides very little utility. If you remove all HFTers somehow by magic but the situation remains that whoever is fastest gets the surplus then whichever of the buyer and seller can adjust their prices faster would get it. But suppose we go a different way and have the exchanges sort it out: Automatically send all offers to buy or sell to every exchange where that security is traded and allow the other exchanges several seconds to match bids with asks. The highest bid is always matched with the lowest ask on any exchange and the price paid is the midpoint between them. That seems inherently more efficient than creating a huge financial incentive for private actors to shave invisibly small slices from the amount of time it takes to trade between exchanges.

In your example both NY and Chi would be "crossing" the market (bid above offer) which is not generally allowed. The displayed quote on both exchanges is "protected" and another exchange can't lock or cross the market without first dealing with the protected quotes (usually by routing orders to fill against it, see #2 below).

What would have really happened in your scenario would have been on of the following:

1. The orders would have been partially filled and the balance would be cancelled (order were Immediate Or Cancel)

2. The orders would be partially filled and the balance routed to other exchanges which are displaying the same price (Orders were routable)

3. The orders would be partially filled and remain active (but undisplayed) at the exchanges (this is dependent on what order type is used and at what exchange).

> how can non-HFT traders arrange to capture the surplus currently claimed by HFT?

By posting their order and waiting to be filled. In a two sided market your options are to pay up and be filled immediately or to get in line with everyone else that wants to keep that extra $.01 and wait for someone more impatient (or informed) to come along and sell to you. By providing liquidity you take time and price risk (you don't know when you will get filled, if ever, and the market may move away from you requiring you to have to pay more later) and by taking it you don't (but you pay the liquidity provider for the privilege).

"Someone will always be faster." That will always be true no matter what new trading format is being considered. There will always be a way for someone to get relevant information more efficiently and act on it. Always. Slowing down markets or obscuring/delaying quotation hurts price discovery and increases uncertainty. This increases volatility, widens spreads, and in all likelyhood actually tilts the playing field in the favor of high-speed computerized trading rather than away from it.

Yes, one of the things people do is arbitrage price differences between exchanges. That's great though! The fact that people are constantly doing this means that I can trade on any given exchange and be really confident that I'm getting the best price.

Except that the continued profitability of HFT is proof that you aren't getting the best price. The HFTer is getting the best price and profiting by buying from or selling to you at something other than the best price.

No, it's not proof of that.

You misunderstand what HFTs are doing. They are in the business of selling liquidity. You have to pay them for that. Luckily the cost of liquidity (due to automation & competition) has gone down by a factor of 10 which is great for you (and everyone else)!

Brad Katsuyama (weirdly the hero of the Michael Lewis book) is in the business of making sure you DON'T get the best price. The HFTs are working against him to make sure you do.

k, I'll bite. Lets say you want to sell your house in 1935. Luckily, there is a buyer, but he won't be ready until 1946 when he gets back from fighting WW2. Luckily, there is a real estate investor who is willing to step in an buy from you and sell to him. He'll hold the property from 1935 to 1946. During that time he takes the risk that housing prices may go down. He also has to pay operating costs in the form of his office and assistant. This is essentially what HFTs do. They intermediate markets.They have cost and risks. Some of them take advantage of special knowledge of market organization. They know the hot neighborhood. The real question is: Are market intermediaries being compensated fairly for the risk they take? i.e. do HFTs make too much money for the risk and expense they incur while intermediating markets.

I get all that, but does that really apply when the time interval is sub-second? It's hard to imagine the discounted value of the trade changing in a sub-second interval, whereas it obviously does selling 11 years later.

In other words, sure, definitionally it's liquidity, but since the trade would have gone through a sub-second later anyway, it's not meaningful liquidity: the liquidity was already there on a reasonable timespan (again, sub-second) for the seller. Thus, nothing has been gained.

What am I missing here? Do sellers really need additional sub-second liquidity beyond what the market would provide without HFT?

You're missing the fact that the trade would not necessarily have gone through a sub-second later anyways. There is a very real chance that the trade would never happen because the market moves away from you.

If you think you don't benefit from someone else providing a quote, place a limit order of your own and update it throughout the day. Buying the market-maker's quote is basically giving them your trading problem. It's specialization like anything else. You get to do what you're best at. He gets to figure out the cheapest way to exit/hedge the position.

Also very few HFTs have sub-second average holding periods. There aren't many instances where the market trades both sides so quickly. Probably average in the 10s of seconds at least if not longer.

I think it is just the nature of the market mechanism i.e. the rules of the game. Since markets are continuous there is going to be competition. Tick sizes means that participants have to compete on speed rather than price. It seems to me that competition and continuous markets are maybe the best way to keep prices aligned across markets. And, just maybe, the best way to keep costs low for retail traders.

Because they'd be buying and selling when there isn't a buyer or seller.

Imagine if you could have the house off your hands, at market price, in a day instead of listing it for months. That's b what liquidity does for you. Almost all HFT is market making, there's plenty of information about what that means...

I thought the whole point of HFT was to wait for a buyer to signal interest in buying X, and then buy X before that buyer and sell it to him at a slightly higher price. If this is true, then in your scenario you would still have your house listed for months, but a high frequency trader would buy it just slightly before it would be brought without any high frequency traders in the loop.

You'd think that is true from all the hoopla wouldn't you. But that simple assumption is exactly what large buy side investors want you to think and it is false*

*There are some highly predatory algorithms that try to do this. The problem is that if you are fast enough to do this routinely, you are sophisticated enough to do legitimate market making and make more money.

Your understanding of the point of HFT is incorrect. Unfortunately your understanding is a fairly widespread misunderstanding and Michael Lewis book only serves to make things worse.

Maybe start here to better understand things:


The idea is to buy when there's a seller, then sell when there are buyers. This can mean holding on to shares for seconds or minutes. Yes they seek to make money on arbitrage and predict which way the stock goes based on existing bids and asks, but they are definitely creating liquidity by filling the gaps.

>Can someone explain how HFT would "provide liquidity", which seems to always be the pro-HFT response?

You should narrow your question to how the latency arms race provides liquidity, and if it would be different it latency was capped at some amount.

If a third-party is always willing to buy houses (or sell houses it owns), then you don't have the awkward case where I want to buy your house today but you really really wanted to sell it a month ago.

Let's use an example that everyone is already familiar with.

Everyone knows you can get more for a used car if you sell it yourself instead of trading it in. Yet millions of people trade in their cars. Why? Because it's easier and faster.

The difference in price they get from the dealer vs Craigslist is the price they are paying for liquidity in the transaction.

You have to understand that the definition of "providing liquidity" is to always supply a buyer for a security, with the minor qualification that the buyer so provided should be able to immediately turn the security around for a profit.

HFT's are very good at providing liquidity (and obviously so), under that definition.

Market makers provide liquidity because a lot of the time when you want to buy a house no one is actually selling one. Rather than waiting around for someone else to show up to sell you a house the market maker is always there with one to sell.

My concern is that Michael Lewis and his books have great popular appeal. Furthermore, he is jumping on the popular bandwagon of bashing HFT. They lay person will look at these facts and simply conclude that he's right. The problem can easily extend to other buy-siders who dont really full understand (or care to understand) how market microstructure works in the US.

I suppose one could add this book to

The Blind Side -- the story of how one of Michael Lewis's classmates as an Ole Miss booster, gave impermissible benefits to a high school recruit and got away with it.

Moneyball -- the story of a GM with 0 World Series appearances and a .530 WP.

Always good to start out an article critiquing the argument in a new book by showing a picture of the author and making a snide remark about his appearance. Immediately gives you credibility.

I stopped reading at 'potato-wog'.

Why is this downvoted? There are multiple comments in the article based on racial stereotypes which are not only completely unnecessary but reflect negatively upon the author's judgment and credibility. Very ironic considering the article seeks to suppress Mr Lewis's speech.

I also found the racial commentaries problematic and unnecessary. That said, the author is in no way trying to suppress Mr. Lewis's speech.

Disagreement is not censorship.

Only by implication. Calling someone a shill could be considered "only" an attack on credibility, but it's also an implied argument that the speaker lacks the right to speak on that subject.

I did an actual double take at 'potato-wog'. The only people I have run into who use that term for the Irish in normal speech are BNP.

To quote te_chris:

"On most articles like this it just feels like a bunch of doe-eyed, aspirational men who really want to be rich one day, so don't want to spoil the fun for their future selves."


I wonder how many people commenting here have actually read the book? Or have they just been reading articles about it?

This is a very good point. I finished the book today. The most interesting thing to me is that the book pretty clearly (from the perspective of an HFT engineer) comes down on the side that HFT is not actually a villain and that the large banks (especially Goldman Sachs & Credit Suisse) are pretty much the devil (giving Goldman a pass for their last year of non-deviltry).

Yet all the interviews, press junkets, and face time on the Daily Show are saying the exact opposite (to the point that Jon Stewart of all people is extolling the virtues of Goldman).

It says way more about the book selling/exchange building business than it does about HFT.

As an aside; I have been thinking it would be useful to have two new levels of capital gains taxes.

In addition to long term capital gains, and short term capital gains, there would be "intra-day" capital gains and "sub-second" capital gains.

I was thinking the intra-day gains Federal tax rate would be 50% and sub-second capital gains Federal rate would be 90%, but these values are arbitrary.

For both new types of capital gains, LIFO trade accounting would be used.

It seems this guy isn't the intended audience for the book. I, for instance, know that Netflix performance is bad on certain ISPs because of throttling and peering agreements but if someone wrote a narrative about this I wouldn't berate them for telling the public at large about it in words they would understand.

There is a real and meaningful difference between popularizing and fictionalizing though. Some amount of gloss is needed to keep things tidy but if/when that crosses the line then the author is doing a disservice to his audience. This is doubly bad when the book in question is an indictment of the status quo with what amounts to a "call to action" in favor of some new business venture.

If the book was presented as non-fiction "based on a true story" that's one thing, but If the b

Obviously he isn't the intended audience of the book because he knows its thesis is false.

I haven't read the book, but I've followed the chatter and have been listening to Lewis on Bloomberg. I get the impression that many justify HFT by comparing current or past alternatives, however his argument is that HFT is corrupting an otherwise fairer market place. In other words the market should improve and lessen these side businesses that victimize participants and add to the discredit of the exchanges.

If anyone thinks that these side business do not victimize participants you should look back to examples like Knight Capitals glitch that most certainly caused retail investors to lose trust and pull their money from the market, taking a loss. The introduction of non-relevant code is an unnecessary risk that does corrupt the system and does victimize your average investor.

1. http://www.telegraph.co.uk/finance/newsbysector/banksandfina...

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