Sunday, July 26, 2009

We Fear What We Don't Understand

"For those who believe, no explanation is necessary. For those who do not, none will suffice." - Joseph Dunninger.

I've resisted writing a piece about high frequency trading lately. Although I have a very good understanding of the subject, I see it as a kinda lost cause to try to educate people about - uninformed people want to believe that computers are front running them, stealing their money and manipulating the markets. People who understand equity trading know that this is just the culmination of technology advancement and competition for spreads, which has resulted in equity bid/ask spreads being narrowed to their lowest levels ever. There has never been a better time for the individual stock trader to execute orders: our bid ask spreads are narrower than ever. A high frequency trader may have a computer program trying to scalp a penny or a fraction of a penny from you - but this is better than it's even been - better than the days of specialists scalping 1/8ths and more.

I left a comment stating as much on Floyd Norris's latest article "What Should be Done," only because he got it precisely backwards when he wrote "In one sense, this is a return to the bad old days. Before reforms, the Nasdaq market kept the bid-asked spread for the brokers. The public had to buy at a higher price and sell at a lower one." On the contrary - high frequency trading has resulted in competition to capture those exact spreads, and has narrowed them drastically.

In my opinion, reaction to high frequency trading is all about the quote at the top of this post if you change the word "believe" to "understand." I will at least try to educate those who do not understand high frequency trading, so that they can form intelligent opinions - although I still fear that "no explanation will suffice."

Joe Saluzzi of Themis trading has gotten a ton of press based on a paper he published about the evils of high frequency trading. It's important to notice that Saluzzi is an execution trader, and that algorithms and high frequency traders make his life very difficult, because no human can do the job as well as an algorithm can. Saluzzi concludes his paper "We also recommend that institutions use algo systems only for the most liquid of stocks. Anything less must be worked, the same as in the “old days.” Institutions need to re-learn how to “watch the tape” and take advantage of, or work around, high frequency traders." Or, institutions can embrace technology and use or develop better algorithms. Either way, Saluzzi's suggestion that it's kosher for him to execute the orders by "watching the tape" to gauge optimal timing, but that it's unfair for a computer program to do the same thing reeks of hypocrisy. The best comment I've read on the subject was this (emphasis mine):

"Frontrunning is trading in front of a customer order. It is illegal. Collecting and analyzing publicly available information and trading based on your insights is legal. And guess what, someone will be the fastest and most accurate in doing this. The result of their actions is to translate meaningful information (strained from a stream of mostly noise, it's incredibly difficult to do) into price changes which make the price more accurate relative to what's knowable at the time. Unfortunately for people like Saluzzi, a 19th century "tape reader", a lot of the information that quicker, more talented, machine-using, more insightful players uncover is information about large size that he's trying to deceptively move without anyone knowing the truth about what he's doing. There's nothing wrong with what Saluzzi is trying to do. What's wrong is crying foul when the one-sided benefit you wanted to obtain is defeated by people who have made a bigger investment in what's important for trading. The big winners in all this are small traders who are not fleeced by large professional size deceptively getting them to buy or sell at insufficient prices. I can understand Saluzzi's campaign against technology and modern information processing, it's his ox that's getting gored. The thing that's truly hilarious is that what Saluzzi wants to be legal, his "tape reading", is just another example of where professionals have an edge over the little guy. But it would never occur to Saluzzi to outlaw what HE does, only what his competitors are doing better than him."

Let's get one thing straight: front running is when someone sees your order and executes ahead of it. It's illegal, and no one is advocating it. What many of these high frequency trading algorithms do, however, is not front running. High frequency trading is about using computers to do what human traders used to do - take advantage of available information (such as orders that are visible in the marketplace) and try to figure out where a stock is going. They do it better than humans can do it. They try to figure out what you want to do, and try to profit from what they think you want to do. They do it faster and more accurately. That's called trading - it's the nature of the beast.

If you put in a limit order to buy 100 shares of IBM at $80.50, and a computer or anyone else immediately bids $80.51 for IBM, that's NOT front running. That's someone willing to pay more for the stock than you are. It doesn't matter if that someone hopes to buy the stock and offer it back to you immediately like a high frequency rebate trader, or if they plan to hold it in their IRA for 50 years. Similarly, if, at the time you bid $80.50 for IBM, stock is offered at $80.51, and as soon as you put your bid in someone takes the offer, that's NOT front running. You had the opportunity to take that offer - you chose not to. This is the first key realization people need to make.

The next realization is that no algorithm can force you to pay more than you want to for stock. One thing the algo's do is "psyche you out" - when you bid $80.50 and you see the $80.51 and $80.52 offers get lifted, you might get nervous and panic. That's your problem. If you put your limit order in and go to the kitchen to make yourself a sandwich, you'll probably find that your order is filled when you get back. Any algo that expected you to panic and lift stock from them lost on their gamble. You can defeat the psychological game by refusing to play it (place your order and don't stare at the screen) - or by lifting the offer in the first place, paying the narrowest spread you've ever paid due to the massive competition by various high frequency trading algorithms to maintain quotes on the inside market.

Let's talk about Chuck Schumer's proposed ban on "flash" orders. Flash orders are a little bit trickier. From the NY Times article:

"When buy or sell orders are submitted to marketplaces like Nasdaq, they are sometimes flashed to a collection of high-frequency traders for just 30 milliseconds — 0.03 seconds — before they are routed to everyone else. In that half-second, (sic) fast-moving computer software can gain valuable insights regarding growing or declining demand in certain stocks and can trade ahead of other market participants, pushing prices up or down.

Although anyone can gain access to flash orders by paying a fee, they are useful only to traders who have computers powerful enough to act on the data within milliseconds"

First, note that ANYONE can gain access to flash orders. Similarly, anyone can gain access to co-located servers at the NYSE to have super fast execution speeds. These are not just available to a select chosen few - they are available to anyone who wants to make the investment in capital and technology. Now, the intent of flash orders is to allow participants in a given market center the opportunity to improve the current bid or offer so that an order doesn't need to be routed away to another market center.

An example: let's say GE is trading $11.45-$11.50 at DirectEdge, but that there is an $11.46 bid on ISLD (an ECN). If you submit an order to sell stock at $11.46 on DirectEdge, they flash this order to select market participants to offer them the opportunity to fill your order - otherwise the order gets routed out to ISLD and you (the seller) have to pay an extra fraction of a penny for the routing. As I tried to explain on some other posts regarding flash trading, this is basically a hyper-speed modernized version of how the NYSE specialists used to verbally quote orders to offer people in the crowd the opportunity for price improvement: "if GE was 11.25-11.27 50k up, and you walked in to sell 50,000 shares, the specialist would say out loud “25c bid 50,000, 50,000 at 26c, SOLD.” Anyone could say "TAKE or BUY'EM" before the specialist said "SOLD" which would result in the seller getting price improvement to $11.26 and if no one interrupted him, the trade was done at $11.25. Markets have NEVER been setup such that every participant has the same opportunity to trade on every quote."

The problem is if systems receiving flash orders can then turn around and hit that bid in front of the seller. That is blatant front running, and needs to be stopped. Here's a quote from a user of flash quotes explaining why he doesn't want them banned - a key point is that no one forces you to place flash orders:

"responding to: "there are different forms of HFT. Flash is clearly frontrunning and anyone who says otherwise is delusional. its designed to cheat "

Not true.

It is designed to keep orders from being routed-out under Reg NMS - which saves the person placing the trade money.

I am a small fry (sole employee of my small stat arb company) placing small to modest sized limit orders directly on ECNs. If I want to avoid paying a route-out fee when my order would otherwise become marketable on another exchange or ECN, the best execution + cost structure that I can get is to first have an order flashed locally to see if I can have a fill on the local ECN.

If a HF trader on the ECN gets the flash and 30ms later fills my order, I avoid paying a route out fee. If no HF trader responds to the flash, or the flash never existed because it got outlawed, then I end up paying a route out fee.

That is the intent behind flash orders. It keeps orders that become marketable more frequently on the local ECN rather than having them route-out....

I keep saying the same thing over and over again... but anyone who cares about orders flashing and doesn't want them to flash should just send the order through a different venue. It isn't rocket science. If you don't like the facilities provided by Direct Edge to execute your market moving large institutional order, then place it on Island.

Why is that so friggin hard?

No one is forced to place any order types that they don't like, or use any ECN that they think disadvantages them.

If your broker forces you to place trades on venues that flash orders and you have no control over it, then you need to get a better broker.

Outlawing an order type that some people actually like to use under certain circumstances is ridiculous.

More constructively - make flash default to off, so that a trader needs to explicitly ask for a flash, and make all brokers who don't pass on fine grain order control to their customers set the default to off...."

I'm somewhat indifferent when it comes to flash orders - on the one hand I don't care if they get banned if they are being prolifically front run, but on the other hand I like the suggestion of defaulting the flash order status to "off" and allowing traders to still flash their orders to try to get price improvement. If traders are getting worse executions on their flash orders because they are constantly being front run, then they will stop using them.

Let be take a brief detour to negate one blatatly erroneous insinuation made in today's financial times article:
"Themis also suggests reintroducing the New York Stock Exchange's curb on program trading that would apply whenever the market was up or down by more than 2 per cent for a day. This constraint was removed in October 2007, which is - maybe not coincidentally - when world stocks peaked."

The NYSE never had curbs that prevented program trading. The NYSE used to have curbs that imposed restrictions on index arbitrage orders, a specific subset of program trading, after market moves of a certain magnitude. The curbs ensured that index arbitrage buy orders had to be executed on a downtick, and that index arbitrage sell orders had to be executed on an uptick. It's basically like the uptick rule for short selling, only it applied to buy orders as well. This had little or nothing to do with high frequency trading, and is completely irrelevant to the discussion, except for the ludicrous assertion that the removal of the curbs somehow may have led to the depression of the markets. If Themis thinks that high frequency traders are manipulating the market higher, they need to realize that the re institution of NYSE index arb trading curbs would have no effect.

While I'm on the topic, let me debunk a few more of Themis's blog posts. Saluzzi's assertion that high frequency traders were manipulating the price of CIT higher so that it would be eligible for a rebate was proved wrong before he even published it, when the price failed to maintain the $1 level. CIT was trading massive volume because it was in the process of basically declaring bankruptcy - not because HFT guys were manipulating the price. Second, Saluzzi's post titled "The Three HFT Horsemen" is perplexing. He alleges:
"The three HFT horsemen are C, BAC and CIT. These three stocks traded 860 million shares today which is 10% of all US Equity volume. Think about that – 3 stocks in a universe of over 5000 U.S. stocks represented 10% of the volume. How could this be? Look at the intraday chart of all three of these stocks and you will see a something in common: an early morning move followed by a flatline with a very tight range (around .05). Meanwhile, while these stocks were flatlining the market was heading higher. The S&P 500 gained around 10 points in the afternoon (or 1%) but these 3 stocks did not move. There was a constant bid to these stocks yet anytime they wanted to lift there seemed to be a constant offer just a few pennies higher."
Never mind the fact that C and CIT are low priced stocks that should theoretically trade in tight ranges: what is the problem with this? As a trader, Saluzzi should be sending thank you notes to the high frequency traders for making sure the price of the stock didn't move much at all - this makes his job easy, regardless of if his client is a buyer or a seller of stock. There was ample liquidity all day, and the prices barely moved. This is a good thing.

I am a capitalist. I like competition in markets. Our competitive markets have resulted in evolution to the point where traders have written computer algorithms that do the job traders used to try to do by hand - profit from stock movements and from what they feel net supply and demand for a given stock is. This is the main reason I'm against most attacks on high frequency trading. SOMEONE will always be the best - the fastest - the closest - regardless of if you ban co-located servers, or install mandatory latency in order execution pipes. Would there be anything really wrong with making sure that all orders placed are valid for a 1/2 second or a full second? No, I don't think there would be - and that might be the kind of compromise that we move toward - but we need to recognize that the playing field will never be level. It never has been level and it never will be level - there is always someone smarter than you, and it would be a shame to try to legislate that edge away.


full disclosure: no agenda here: I do not run a high frequency trading system, and a ban on HFT would not have much if any impact on my life. market position: short the market.


Anonymous said...

KidD - you have out done yourself here - but I must agree - the average Joe will never understand half of what you just explained.

Look back to the CME, when the emini future was introduced - locals "traders using their own capital" arb'd the Big futures against the minis. No one seems to draw the comparison to the HFT. Believe it or not there are always liquidity providers/price discovery mechanisms in all markets.

People who complain about high frequency trading should all pack their bags and work for the Cambridge police department.

Have you ever been to a Charity Silent Auction and there is only one guy bidding on everything? who knows what the public would actually pay for something - i always love to throw out a couple bids to get the guy to pay a fair price. I always have the intention of going home empty handed - just want to see how much pain can be inflicted on the one guy bidding_ how is this differnt from HFT?

You should take note that there is a difference in HFT styles as well - there are synthetic market makers, spread capture, provision/take models, long/short startegies, etc. Not every HFT trader is looking to arb a spread on the screen - some actually have a time horizon longer than 5 ms - some may be as long as 5 minutes - but who cares markets are based on time horizons or holding patterns - they are all based on LIQUIDITY - LIQUIDITY is KING - all markets rely on a complex blend of liquidity providers - anytime you try to break the natural balance of a market place you create a new opportunity to arbitrage the new rule by someone who is smarter than you

Great job - Shumer's office should have done some more home work on the subject


sellside_pov said...

"The problem is if systems receiving flash orders can then turn around and hit that bid in front of the seller. That is blatant front running, and needs to be stopped."

I'm not so sure about this one. I believe if you use a flash order you are trading this risk in exchange for the possibility of a price improvement. It is not like front running where your broker who should be working for you steals a price from you and gives you nothing in return. I could be wrong on this one, not sure.

Anonymous said...

Kid, this is one of your best posts yet. Well thought out and well written and factually accurate (cant say the same for most financial blogs). This democratic financial witch hunt needs to end. All is does is cement how ignorant these dopes are on financial matters. Whats truly frightening is their willingness to speak on the matters with little to no true knowledge. Case in point, Matt Tiabi the new financial journalistic genius to the average, Im assuming you trade daily, what type of trading do you do??

Игры рынка said...

you are right about the quote. However, it is hardly possible to prove any point and both points of view are correct. Everything depends on intention of particular trader/firm. So this debate looks like the gun debate in the US. Both camps are right and wrong at the same time.

Investidor Ninja said...

very nice post

J Willis said...

Although I buy the explanation, I do so reluctantly. Goldman makes huge money in good markets and bad, night and day, when the sun shines, and I suspect long after the sun burns itself out. Nothing can explain their continued success in every kind of market ... except cheating the rest of us. And a $21 Billion haul in HFT sure appears to be the ONE explanation as to how they cheat the rest of us.

Give me a view of everyone's cards at the table, while mine remain hidden, and I'll kick your ass in poker all day long. Goldman is getting a view. How, if not HFT?

Unknown said...

Great post. Would you mind if we x-posted it on Clusterstock with full links back, etc?

Anonymous said...

Finally a level headed explanation of HFT from someone with more experience than just blog reading.

Anonymous said...

Ok, here's something else i heard.

People suspect that this increased speed these people have are giving them the ability to leave(cancel) when they should be executed.

example: there's a bid for fifty thou shares, and you try to hit it for ten or twenty thou. the hft computers are so much faster that if someone trys to hit it with a few hundred shares, they take the trade, but for twenty thou, they see how big it is and cancel and you don't get filled. I don't know if it happens or not, but if it does, and many suspect it does, it SUCKS. should be illegal.

Anonymous said...

You got to be kidding me with this post?

You actually think HFT profitability has nothing to do with front-running? If that was the case, algos wouldn’t get so defensive over front running allegations. After all, why not let the regulators closely scrutinize their business practice and judge for themselves. What's the fear? Think about it, once regulators see the great value added service algos bring to the public, they’ll embrace HFT like bunch of virgin math nerds out of Harvard.

Fritz Jacoby said...

This was fantastic; critical point made as plainly as anywhere I've seen it is that frontrunning is jumping in front of *customer* orders -- in breach of a duty owed to those customers. But when the customers are the ones who are allowing the orders to be routed internally or to other b-ds before going out through NMS system, they are accepting and condoning the practice, not having their interests violated. Thanks for making the point clearly.

John Hempton said...

Kid Dyno...

Can you tell me where (if anywhere) I went wrong with this post?

So many people have called me an idiot that I am sick of it.



Anonymous said...

Some being "best" is fine. Just plot the performance of the players side by side. It sure looks like someone has a great human resources department, IMHO.

Anonymous said...

I'm with you on HFT - if everyone's on the same playing field and you want to trade with fast systems, that's fine. That's a case of doing something that's accepted and trying to do it better.

The flash orders are another thing. Sure, anyone in theory can buy a look at flash orders but in practice that clearly isn't what's going to happen. No one's stopping me from building a rocketship to go to the moon, but you'd lose money if you're betting on me to take off anytime soon.

Anonymous said...

Thank you. Very, very well written.

Anonymous said...

Themis Trading clearly explained, using far fewer words, how someone can use HFT to screw traders over and slowly bubble a market a little higher on high volume. Flash orders are only one part.

Leaving orders open for one second before being able to act on them will still give computers with closest proximity to the NYSE a better chance to dominate due to physics, but the playing field will be leveled a little more.

Caveat B said...

Great write up. Here's my response to the Duhigg piece in NY Times from last week:

Anonymous said...

Clearly, YOU are the one that doesn't understand.

Ignoring the many issues you gloss over (I can't tell if you're being intellectually dishonest or simply uninformed) is the Saluzzi example. No human can compete with a computer that trades at less than 5 miliseconds without a computer. No one. The fact that companies have solidifed their dominance while keeping out competitors (notice the NASDAQ filing?) proves that HFT "can" be a level playing field but currently is not.

I also noticed you talk a lot about flash trading without commenting on computer pings (the existence and practise is well known for those who are truly familiar with HFT and amounts to the same thing).

And they are NOTHING like what MMs and specialists do. Those guys can't just make a profit and then leave at will -- HFTs can.

You also try to isolate examples while ignoring that the HFTs play off each other at such crazy speeds it amounts to not only legal frontrunning but churning. Semantics won't win you your argument with anyone intelligent.

Every argument ends with -- well you don't have to place the order. Is that your best argument? For those attempting to participate in the market obviously they DO have to place an order.

Clearly without proper regulation HFTs have the ability to destroy market integrity and I find it hard to believe how easily you write these very real concerns off considering their are already examples of it.

E.g.Remember a certain bankrupt company trading above $1? The media blamed the short sellers and warned them of potential losses. Would it interest you to know that HFTs kept it above $1 in order to get the liquidity rebate (which doesn't apply to stocks below $1)?

How about adding some new legislation such as-

1.Ensuring the rights of all to participate and contribute "liquidity"(which it currently is not).
2.Make computer trades stick for 1 full sec. to even the technological playing field (not everyone can take up computer space on the NYSE).

HFTs aren't the problem, but a lack of regulation is.

donna said...

Call me when finance gets back around to promoting product and business development, and not enriching itself.


J Willis said...

Donna ?

In other words, call me when investment banks make money for their clients, not from fleecing their clients?

Kid Dynamite said...

anon @ 4:33pm: congrats - you have elicited the first response from me. Are you claiming to actually have any idea on how HFT works apart from what you've read on the internet? and you're also claiming (insinuating really) that HFT is responsible for keeping GM shares trading above $1? Really? I might write another post especially for you explaining how trading works. There is no chance that is what happened - did you learn everything you know about HFT from Karl Denninger? sounds like him...

but please - i'd love for you to try to tell me how high frequency algos managed to keep the price of GM stock propped above $1. When you fail to do so, perhaps it will illustrate to others how high frequency traders also cannot keep the market propped up without accumulating massive positions (which they don't do)...

J Willis said...

Sheesh Kid.

Rule #1 of blogging - don't pick fights with your readers.

Kid Dynamite said...

i tried, J Willis... i tried reallllly hard... I vowed not to respond - I even mentioned in the first paragraph of my post that I knew people wouldn't get it...but i will educate every ignorant reader on the planet if it takes me the rest of my life, especially this anonymous commenter, since he/she claims to actually understand what he's talking about, which is especially scary.

HFT is NOT responsible for GM trading above $1. Fact. I will argue that with anyone, and the point is that when i explain why the assertion is blatantly wrong, it will also serve to illustrate to people how HFT is not making the market go up consistently.

Anonymous said...

kidD and the majority of posters here have never traded their own money. If they had they'd be one of the ignorant "slow" traders. And we know from their vainglory that could never be the case. So most are either HFTers who just got in the business over past 5-7 years or just plain delusional that HFT is being played on the up and up.

Kid Dynamite said...

anon - i assume you mean i've never DAYTRADED my own money. That is pretty much correct - because I learned in my 9 years trading real size how hard it is to beat the market. Now i somehow average about 30 trades per quarter in my personal account - although it certainly doesn't feel like i'm even trading that much.

If you're having trouble competing with the HFT guys, you should find a new game (assuming you're a day trader). There is simply nothing you can say to me that will make me sympathize that you as a day trader are entitled to some profits that the HFT guys are stealing from you. You're doing the same thing - but they're doing it better.

I am not and never have been an HFT trader. I am one of the "slow" traders, and there has never been a better time for me to execute in my life.

Kid Dynamite said...

oh by the way - if anything, i'd be incentivized to dislike HFT. If i were to go back to work at my old job, it would be MUCH MUCH easier if HFT guys weren't competing with me.

Anonymous said...

awesome post KD -h0

Steve said...

Kid, awesome post. Should be required reading for anyone reporting on this topic.

Flash orders are public information so hitting bids based on them isn't front running. And since the "injured party" made the choice to send the order as flash obviously they feel they are getting some value out of publicly tipping their hand.

But like you I don't really care if flash orders exist or not.

Anonymous said...

this is getting crazy now. It is there, it is doable. And nobody will make me believe that all those bankers/hedge fund guys/etc. do not do it. It might be that some really do not. But those who can surely do it

J Willis said...

They don't do "it". They do us. They screw us on a daily basis and laugh all the way to the bank, to the tune of $21 Billion a year.

I'm sorry, but I don't buy it. Our markets are NOT better off when these overpaid SOBs bank $21 B in slamdunk profits a year.

Informative post Kid. But you're drinking the 'effing kool-aide.

Anonymous said...

Kid D...I for one would love to hear your explanation as to why HFT is NOT responsible for GM trading above $1.

Not saying you are wrong, generally curious. TY A different anonymous.

Kid Dynamite said...

re: GM: i may write a longer post about this at some point but the short answer is very simple: the only way to keep the price of GM above $1 when no one wants to buy it is to keep buying shares. That's not what HFT or anyone else does, unless they like losing money.

bidding $1 for GM to collect a .002 rebate and then losing $1 on your GM shares is not a good business plan

Mike Masland said...

How the hell have I not come across your blog until now? Fantastic write-up. Thank You.

Anonymous said...

KidD, you've done your homework. there's not much to add.

narrow spreads require price discovery and lots of trading. They also need to be continuously adjusted to reflect the current state of information. Contrary to what many people have said, the advent of high frequency trading corresponds to an enormous drop in volatility over the last 9 years. The explosion of volatility last fall had nothing to do with HFT, in fact the markets performed extremely well during that period, it was always possible to trade.

From my perspective the blind rage that I see from the blogs was fueled by a completely erroneous figure from the Tabb group that implied a $21B profit by HFT. HFT typically make less than $0.001/share, if they traded *every* share on every exchange that would only amount to about $2B. Even that is optimistic, but it's still a lot of money.

There seems to be a large group of people who are saying that using a computer to trade should be banned. When you point out to them that they probably don't fax their orders in to their broker they effectively say that using one well should be banned. Being fast or smart is somehow equated to cheating or being evil.

I fully invite these people to make the necessary investment to become fast and smart themselves. Failing that I suggest that they utilize the services of a broker who is fast and smart.

There are circumstances where flash orders are not ideal for the person using them. Please don't use them if you don't like them. I assure you that there is no way for a HFT to use them to read your mind. People who say that there is some huge advantage to be had from them don't know what they are talking about. They appeared about 4 months ago and have not changed anything measurable. If they have done anything they have enabled more competition amongst the market makers, some of the smaller market makers were not as adept at using ISO orders.

I don't like dark pools. They are the wild west. I would recommend not using a dark pool or a broker who routes your order through one. If I were to use a dark pool I would carefully monitor the quality of trading through it. If you don't have that ability (and it's not trivial) then don't use one.

If you don't like dark pools don't send your orders to them. I don't recommend banning them.


Anonymous said...

I work primarily with options. I couldn't agree with you more about putting in a limit and staying the course. I'm stubborn. GTC/AON and if it fills great, if not, that's okay too. Every third Friday I take advantage of all the pinning. Shhhh! According to the SEC and NASD, there is no evidence it takes place. Painting never happens either, just in case, you know, you thought it did.

Anonymous said...

I can tell that you have not worked on a trading desk before.Also algos aren't so smart if you believe that they are actually creating value by assembling random info you are way over estimating these things. You gott to realize that if you can't see every single bid offer and "market order" and others can that there is a serious propensity for abuse. Which I have personally witnessed. So if I was offering my BIDU @ 135 and a mkt order came in and got filled 134.9999 by a hft for 600 shares your benefit to the market place is 6/10 of one cent for that order.(also I am basically backstopping this mothers loss with my offer now) Now if the HfT sees a mkt order coming down for 3Xbid it has the opportunity to cancel its own bid order and or execute a sell in advance, or commonly execute on another secondary exchange. It follows this execution with a bid 30 cents lower for the 600 shares and the order is done there. So the cost to the market participant is 180.00 or 30,000 times higher than the benefit provided in the previous trade. So if there are 100 beneficial trades for every front run trade the net cost is 179.40...Now multiply this by a 10 million trades a day using the same ratio of 100 to 1 and you find out the cost of flash to normal people is in the millions per day. Just play around with the numbers..use a thousand to one. You got to understand that these guys are just there to make money. You can't say what you think is happening because you have no clue about how this valuable knowledge is used by everyone who has access. But if you were able to slow the game down to the extreme or just read the tape of the market and the HFT executions all at the same time I am relatively sure you would see the abuses.
By the way assuming that people don't get it sounds like the internet bs from 98. I can pretty much tell you that you need to find out more about odds and how one gains an advantage over another by turning an independent outcome into something more controlled. I give you one more example. Lets play blackjack 2 person but I will keep 1 or 2 face cards for myself and determine when to lay them down. Now this is only 3.8% of the cards but I can shift the win 15 or 20% to my favor. So although I get the 100s of different ways a computer can arb or lay on and remove risk and concede that probably 90 or 95% of these guys may not be abusive the net cost is a cost of $3-25mm per day for the participants who are just executing.
good luck! but wake up dude

Anonymous said...

In response to Anonymous of 10:38PM...

It is you who does not get it.

First, ever since Regulation NMS, there is no quoting of equities in anything other than rounded pennies. So, your first example of 134.9999 is - well - not plausible.

Second, no one ever sees a market order coming down. ECNs and exchanges are just computers that match buyers and sellers. When a market order comes in, the order needs to be filled according to Reg NMS with the best posted bid/ask. Market orders by their nature remove liquidity from an order book, and they are not flashed - rather, they are just executed against what is on the top of the NBBO. The only way to see a market order is to be in the path between the person executing the order and the ECN/Exchange receiving said order (i.e. your broker-dealer, or someone sniffing packets on the network - which is not a realistic scenario inside the data center cages of an ECN/Exchange).

Third - while it was not possible for me to follow your example to its natural completion (because it made no sense), I should like to point out that an actively traded equity like BIDU typically has a bid/ask spread measured in a very small number of pennies. I could spend the time to look at today's tape, but will not since the spread after hours is $1.85, representing 52bp. There is no chance that the order book is going to move 30 cents. Pull up a level 2 quote on BIDU and watch it.

Give KD a break. This was one of the few well written threads on the subject of flash trades, and it is clear that KD does understand at least something about market micro-structure, which is apparently not the case with most journalists covering this story, and certainly not the case with most blog posters.


Anonymous said...

OK you should watch the market trades are getting done at fractional cents all of the time. why don't you check out where fxe closed today 143.951 or goog 453.7340 what are those things after the cent column??? Oh yeah they're fractions of a cent that were executed against sellers or buyers. Watch BIDU it trades with a 50 cent spread frequently and commonly moves 30cents at a time. You got to see that MARKET ORDERS are being flashed. There is no way a bid appears out of the blue for less than a second and execution .0001 cent IN Front of an order. This is not an in house order, which could be executed at parity, so the computer knew the market before the order and also stepped in front of a transaction. just learn that in games of random chance or independent outcomes shifting the odds slightly to one party causes a major advantage that is evidenced over time, similar to a roulette wheel.

Also a lot of these guys will do anything to make Ka-ching and I want you to consider the full depth of that comment.this game is being heavily abused

Anonymous said...

You can have trades execute in fractions of pennies, but you can not post a bid or ask in a fraction of a penny. The sub-penny trades occur due to orders placed with WVAP (volume weighted average price), where the SEC does allow limit orders to improve upon posted prices by less than a penny against those contra-side orders where the system is moving the price. No one can however place a visible quote for a fraction of a penny.

> You got to see that MARKET ORDERS are being flashed

No. Limit orders placed at the inside bid/ask price sent to an ECN or Exchange that supports flash orders may be flashed... but a market order is not.

Not that I am a fan of SA, but this is a good diagram.

> There is no way a bid appears out of the blue for less than a second and execution .0001 cent IN Front of an order.

On that front, you are correct. To be .0001, the order had to have been an order type like VWAP where the matching system is moving the price in the posted order (I believe a peg to mid-point could do the same, but have never bothered to confirm).

No one sees your market order before it hits the matching engines except your broker-dealer. Find another reason to be pissed at those more skilled than you at making trading profits.

Anonymous said...

I'm not pissed.I got over 100 accounts over here up over 55% this year. This is my eighth year of returns I have accounts up over 2000% this decade. So there aren't too many better than me. You got to understand that the odds of what you are saying ( a vwap order appears before it can be shown and is executed .0001 below is like impossible. Like if you told me you could flip a coin 1000 times and get heads every time. You got too address the main agrument I am saying 99% of these trade are no harm and 1% cost the market about 3-25mm per day. Btw I look at a lot of scams sometimes the perpetrator doesn't understand they are a scammer, like robert allen stanford. here is a clip from casino so you learn about odds Three fuckin' jackpots in minutes!
Why didn't you call me?

It happened so quick. Three guys won.
I didn't have a chance.

- You didn't see the scam?
- There's no way to determine that.

Yes, there is.
They won!

It's a casino.
People gotta win sometimes.

Ward, you're pissing me off.
Now you're insulting my intelligence.

You know goddamn well somebody had
to get into those machines
and set those fuckin' reels.

The probability on one machine
is a million and a half to one.

On three machines in a row,
it's in the billions.

What's the matter with you?

Also KD you are a good writer a little heavy on the confidence and maybe a little too trusting of WS. Its the pinacle of a greedy god damn game and those on top are winning it at the moment. not all are good guys

Anonymous said...

HI guy I got one more thing to say to you
these dudes are getting the market order info by pinging which is done 100s of times per second. I guess your gone though

Kid Dynamite said...

there is nothing wrong with pinging. trying to figure out what other people are trying to do in the market is the entire point of the market

Anonymous said...

Kid, you are right on. Human market makers are toast, and its about time. All the complains on this blog are human traders who can no longer compete. Ignore them. They are useless.

Игры рынка said...

lol. you must be joking. let me guess who designed those HFT systems? was it built-in into ms´office software? right, those were guys who tried to exploit something. I do not know what they exploit and if those who know says it say fair I take it face value. But please do not say that human traders are useless. Those systems are useless unless they are taken care of. Within the limits of legally allowed practice

Anonymous said...


I have nothing against your post. It is full of arguments. But the global idea doesn't make sense.

I find that really childish to have something against the HFT. Ok, if traditionnal traders consider that 'evil' then, please let me know:

- How about the small shareholders think about investment bank traders?
- How about the last year ELN's victims think about all those ELN's issuers?
- etc...

Investment Banks actually take advantages over normal people and they do the same thing like HFT does to you.

The world is not fair, especially in finance, only the smartest win. It is a fact. If you don't understand that, you'd better quit the finance.

Kid Dynamite said...

note to all anonymous commenters: if you come on my blog and start your comment by personally attacking me, it will be deleted.

aside: rapid quoting and canceling, or "quote stuffing" as ZH has taken to calling it, doesn't help our markets, but it has absolutely no effect on the individual investor. the INVESTOR can't even see these quotes being entered and canceled 5,000 times a second.

J Willis said...

Calm down Kid.

Didn't Enron, Worldcom, Qwest and a myriad of other frauds also object loudly when critical comments were flung in their direction? The more defensive a person/entity gets, the more guilty they appear. Chill.

HFT is a license to steal, plain and simple. For a financial transaction to be fair, risk needs to exist on each side of the transaction. I'm sorry, but no one can convince me that the HFT trading shops have risk. They make money in good markets and bad, day in and day out. As a group, they pocket over $21 Billion a year in profits. I have never read of an HFT shop losing money. The only loser is the guy on the other side of the HFT transaction -the guy paying the $21 Billion. Collectively, that's the non-HFT US investor. Our pension funds, 401 Ks, IRAs, Coverdales collectively pay a $21 Billion annual tax to HFT traders.

When I read that an HFT shop lost money on the year, I'll buy your points. Until then, HFTs are nothing more than another, and the largest, form of theft from American investors.

Is it any wonder that US Investors are fleeing equity funds? Wall Street can only steal our money for so long, before we wise up and tell them to fuck off.

Kid Dynamite said...

j willis - i have no problem with critical comments. i get plenty of them, especially when i write about HFT. i absolutely do not censor critical comments, but i absolutely will censor comments which attack me personally by calling me names.

i have addressed the issues you mention at length, multiple times, in multiple blog posts.

the market structure has never been better for the individual INVESTOR (contrast that with the individual TRADER - who deserves no protections) - in terms of market access, execution speed, execution cost, and spread.

J Willis said...

And I read your posts and pondered each and every one. The problem is that the mob can also put forth credible arguments as to why prostitution, gambling, and illegal drug distribution should be controlled in our country by a tight group of Italians residing in New Jersey. The mob rakes in the profits, the users get the services. But should it be legal?

Look, I'm not here to engage in a lengthy back and forth debate. It's already been flushed out pretty well here. So this is my final post.

I'm simply pointing out that after reading, researching and pondering all the issues around HFT ... the only one that impacts my opinion is the one of RISK. Do HFT traders have the risk of losing money? And right now, the answer is NO. Every HFT shop is highly profitable and every shop makes money no matter what the hell is happening in the markets. They win, everyone on the other side of the transaction loses, to the tune of $21 Billion a year. That just smacks of an egregiously unfair situation that needs adult oversight, rule change, or some damn thing done to level the playing field. And until it happens, I, and many other Americans, will simply stay the fuck away from the US equity markets. We aren't idiots. We won't put our money at risk while the other side takes a risk free $21 Billion out of our pockets annually.

Let the forking computers trade each other into oblivion, then we'll come back to investing in the US Equity markets. Until then, HFT shops can kiss our ass.

Kid Dynamite said...

i understand your sentiments, J Willis, and no one is forcing you to trade - if you don't like it, you don't have to. good for you.

i think a key point is that HFT is not controlled by a tight group of Italians, rich people, Wall Street blue-bloods, or any other group. It's a democratic thing - anyone with the skills can do it. that is a VERY important point. Perhaps it's a philosophical difference between you and I, but i would never fault anyone for having a business model that they execute well.