A High Frequency Trader's Apology, Pt 2

Usually the low latency stuff is kept pretty secret. However, I got good at writing performing code, and as a result styloot.com is pretty fast.

The article clearly states that they "have no opinion or information on whether Apple is a valuable company."

This is an exaggeration. Some HFT's incorporate speculative mechanisms into their strategy, supposedly a few people buy the twitter firehose and market news and feed that into their strategy. But in general, HFT's run purely technical strategies.

So what do they have information about? The price history of the stock? The current contents of the book? And on what basis do they make decisions?

All this sort of stuff. For example, if the book has 20 buy orders at $10.00, and only one sell order at $10.03, that's an indication the price might be going up shortly. But really, it's not all that vital to predict things.

The HFT is passively waiting with orders at $10.00 and $10.03 for someone else to fill them - they make money when they sell to someone at $10.03, then close their position by buying at $10.00. The trick is to avoid adverse selection - if the market is likely to move up, don't get caught with a sell order.

(a) The secondary market (stock markets, etc.) informs the prices in the primary market (stock issues, etc.). For example, when Facebook's IPO happens, its shares will be priced in part based on the stock prices of companies in related industries and in the broader market. Securities prices reflect not only the "intrinsic" value of the underlying enterprise/cashflow/whatever, but also complex second-order factors described by economic concepts like risk premia, liquidity, etc., that are predominately relational in nature.

(b) The primary market cannot exist without the secondary market because no one will buy into your IPO if they don't think they'll be able to turn around and sell the shares at some point. This is obviously the case for securities that generate no income (stocks that don't pay dividends, etc.), but it is also true of other securities for a slew reasons. This is the core of the the complex and amorphous notion of liquidity.

(c) By publicizing the value of the underlying assets, prices in the secondary market inform the wider world about the performance of the managers of those assets. Investors who believe those managers are doing a poor job can put up their money, throw the bums out, and bring in someone who will do the job properly.

All of these things support the efficient allocation of capital and ultimately shape the behavior of all economic actors. Capitalism requires that this mechanism works fairly well.

One of the biggest justifications for HFT that I see is that it increases liquidity. However, did major markets ever really have a huge problem with lack of liquidity, 20 or 30 years ago before HFT?

I can't help but wonder if this level of liquidity is only really useful to HFT, if it is something that HFT is both the primary provider and beneficiary of, and if they're sort of using their existence to justify their existence, so to speak.

Chris uses mom and pop trader examples to explain the concepts here, but the fact is that Algo trading now accounts for much of the volume on major exchanges, and HFT is probably a decent portion of that.

I'd love to see Chris or any other HFT trader's take on that. He sort of does near the end, but would be interesting to see a more in depth discussion:

>Although the latency competition provides little to no value to the end consumers, all HFTs must play the game. If they don’t, a faster HFT will beat them to market and their order flow will be reduced.

This is a very real social cost of HFT - many very smart people spend a lot of time and effort reducing the latency of trading systems. I’m no fool, but when I worked as an HFT I often felt like one. The field contains a lot of very smart people, and the world would probably be better off if the stock market had a little more latency and those smart people were building products for the world. For example, after leaving HFT I built a useful consumer product.

But with current market mechanics, the global optimum where trading is marginally slower and smart people build useful products is impossible to reach. The latency arms race has us stuck in a suboptimal Nash Equilibrium which is similar in character to signalling competitions (e.g., the education bubble).

Liquidity has gone down with the advent of HFT: http://opusminimax.wordpress.com/2012/04/20/ardent-support-f...

But math isn't. Everyone is entitled to their own opinion; mine just happened to result from the mathematical proofs I was forced to study and write for the postulations of that "bullshit field." I would also submit that your argument ignores the law of leaky abstractions (http://www.joelonsoftware.com/articles/LeakyAbstractions.htm...) ... All non-trivial abstractions, to some degree, are leaky. Finally, economics doesn't assume people "[act] at all times to consume as much as possible without regard to relationships." It assumes that individual actors make decisions that maximize their utility. Utility can result from completely selfless acts -- it's whatever makes you happy. "Selfishness" does not rule out actions that benefit others or society at large. This argument exemplifies the misunderstanding of "basic economic principles" referenced in my original comment.