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"?
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.
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.
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.
While it's true that increased competition among market makers have driven spreads down, decimalization was also a factor. For example:
http://www.sec.gov/news/testimony/052401tslu.htm
"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.
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