High Frequency Trading Development Kit

HFT market makers play an important role in those transactions. Specifically, they make it cheaper to buy and sell stocks by (1) tightening the bid-ask spread and (2) providing more quantity at each price, so that the average cost of executing an order is less. Not only that, when markets become tighter, they actually enable transactions to occur that would not have happened before. In other words, previously where buyers and sellers would NOT have traded because the transaction costs of crossing the bid-ask spread were too high, those two parties can now trade. Specifically, without HFT, there would be far fewer than 1 billion shares traded by utilitarian traders on a daily basis.

To address the other point of providing liquidity "when the markets need it most", let's take a step back. When you say that "market makers should step in to provide liquidity [for society's benefit]", you're implying that there's some externality to lack of liquidity in financial markets (if so, this is yet another reason that we need HFT on a daily basis). Suppose that this is the case: there is some negative externality to society when markets are illiquid, as is oft to happen when things go crazy in the world. During those times, volatility is insanely high because the risk of being in any position is also insanely high. Remember, market makers get compensated (on average) for holding risk that you don't want. If risk is higher, naturally, the compensation should be also. This is manifested in higher costs of execution: spreads widen and the available quantity at each level decreases.

If you want to force HFT market makers, which are private corporations, to step in to provide more liquidity, then you are forcing these companies to pay for that externality. In effect, they would take on huge risk for far diminished expected returns. That doesn't make any particular sense to me. However, if society as a whole has this view that some private corporations need to pay for public externalities, then that should be a matter of regulation. But if that's the case, why pick on HFT in particular? Why not force McDonalds and Whole Foods to give food to hungry people during famines? Surely, there is an externality to the food industry NOT stepping in during periods of extended hunger, "just when people need it the most."

[1] http://georgewashington2.blogspot.com/2010/10/yes-70-of-us-e...

In a zero sum game where knowledge is power, you know exactly who is buying and who is selling - before John Q. Public knows.

Since when was it the prerogative of every market participant to get quotes at the exact same time? There is a huge cost to colocation--it doesn't come free. The fact that trading has as high barrier to entry is a moot point. Starting a biotech company takes hundreds of millions of dollars in capital. Is it unfair to John Q. Public that Amgen and Novartis have competitive advantages in that field? Of course. Is it unethical? Absolutely not. When the steam engine was invented, was it unfair for guys who drove horse buggies? Of course. The new technology replaced him because it was able to do what he did, but more efficiently. This is no different. Day traders (I'm assuming that's what you're referring to when yous ay John Q. Public) are horse and buggy drivers. It isn't the fault of high frequency traders that they are that way. If John Q. Public wants to stay competitive, he has to change what he's doing.

If, instead, you're talking about your pension fund buying 1 million shares of Microsoft, then you have to realize that HFT is actually decreasing the cost of their doing that. Tighter spreads and more liquidity lower transaction costs for everybody.

Peruse this Forbes article, if you will - http://blogs.forbes.com/afontevecchia/2011/02/15/bernanke-pu....

I find it ridiculous that the article you cite makes no mention of HFT! In fact, I'm pretty sure that those profits are from their prop trading desks that don't do HFT. I can tell you that with certainty, because I know the ballpark of how much HFT firms make, and it's nowhere near that number. Please don't cite facts that are irrelevant to your point and then carry on as if they prove your case. I perused the article, did you even read it?

Having the advantage of being able to front run the markets is not limited to just market making, however. Limits are one of the ubiquitous features of stock markets - the ability to say, I will buy or sell X shares of this stick up until it hits price Y. This can be exploited easily by HFT/front running - you have 30 ms [2] to probe out where the limit is with small IOC transactions. In this way, you are able to meet orders at prices that are different than the currently trading price - effectively bypassing all competition.

Flash orders, if they're even used by anybody anymore, must account for some negligible fraction of market volume.

3. I have used HFT and front running as synonyms because they seem to be inescapably tied together. Why the need to have picosecond advantages if you aren't trying to beat another bottom feeder to the prey?

Market makers need high speed mostly to avoid getting picked off by other aggressive HFT firms. The prey isn't day traders, it's other HFT firms. Day traders don't operate on the same timescales as HFT. Just the fact that a day trader is using a mouse to enter and exit positions already precludes that possibility. If day traders are placing limit orders into the market and are upset that they can't cancel fast enough, they need to understand that their edge isn't in cancelling quickly, but purportedly something else (predicting longer term price movement?).

I'm all for a civil debate, but please checks your facts. Most of the sources you cite are irrelevant to this discussion :(

I think that's definitely part of it. The issue is that people don't know how much high frequency traders actually make per contract. The amount is pretty small (on average). Typically, each trade takes on "bite-sized" risk and expects "bite-sized" returns. Do that thousands of times a day, and your bite-sized returns grow to something reasonable, but not ridiculous. Certainly, it's not on the order of how much other forms of proprietary trading make.

I think the other issue is that people don't understand that all traders, HFT or not, take on risk when they enter a trade. A lot of people use terms like "skimming off the top" or "making money for nothing". This indicates to me that they don't realize why market makers should even make money (on average). It's simply risk transfer, and that has a price (on average).

You're right though, identifying bona fide trends are pretty difficult. If it were easy, everyone would be doing it and arbing those trends away.