Budish et al. start with the statement that "The high-frequency trading arms race is a symptom of flawed market design" and present a mechanism that mostly addresses a specific feature of the current market structure. In 2021, most folks on all sides of the table (liquidity providers, executing brokers, financial institutions) agree that the arms race is individually and collectively value-destroying. They don't claim that it's the "best mechanism" for capital markets. And every mechanism is a set of tradeoffs, so no one should ever really make that claim. At OneChronos (YC S16) [1], we view the arms race as something that's very much worth solving for, but a tiny piece of a much bigger opportunity to make markets function better for all players.
The high-frequency trading arms race: frequent batch auctions (2015)
71–80 of 94 posts
Re: The high-frequency trading arms race: frequent batch auctions (2015)
#72Earlier quoted context omitted.
The way I see it, HFT firms provide liquidity to the market, which is good. They do so in an automatic fasion which makes it cheaper than the past system of human traders. But they also do a speed competition which is mostly wasteful. There may be some benefit for the overall market of faster communications but it is pretty low. All systems have waste, some more and some less. This is unavoidable. So the discussion m…
How do HFTs add valuable liquidity to the market? Does the 500ns faster transaction time for a block of AMZN matter to literally anyone? Other than the two sides of the trade who lost some money to the HFT who MITM'd them.
HFTs add liquidity to the market by market making: having quotes in the book.
Re: The high-frequency trading arms race: frequent batch auctions (2015)
#73HFT seems like it should be illegal. The 'idea' of the markets is that its fair access to all, at least in theory. I understand there is always assymetry, but things like insider knowledge has been made illegal to try keep the fairness (or at least attempt). HFT does what no ordinary person can, its an unfair advantage. So should it not be banned? I recall there was a company setting up a market with a minimum latency, ensured by all trades going through a spool of miles of fibre optic cable in their office. The idea was to prevent HFT at source, which was cool, but a shame wider markets just let HFT slide, and the fairness assymetry widen.
Re: The high-frequency trading arms race: frequent batch auctions (2015)
#74Earlier quoted context omitted.
How do HFTs add valuable liquidity to the market? Does the 500ns faster transaction time for a block of AMZN matter to literally anyone? Other than the two sides of the trade who lost some money to the HFT who MITM'd them.
Faster transaction times result in tighter spreads, as HFT firms compete each other on the price-time priority queue. HFT firms compete against each other on time, and while yes, that's a zero sum game, the end-result to the broader market is useful. An analogy might be something like Uber and Lyft competing with each other for clients and drivers. From the perspective of everyone else, it doesn't matter much if they…
But the spread in many-to-most stocks is limited by the sub-penny rule (SEC rules, as of 2005, say you can't have a spread < $0.01) rather than by the supply of market makers in that stock. Extra competition in those markets is negative-sum.
Re: The high-frequency trading arms race: frequent batch auctions (2015)
#75HFT seems like it should be illegal. The 'idea' of the markets is that its fair access to all, at least in theory. I understand there is always assymetry, but things like insider knowledge has been made illegal to try keep the fairness (or at least attempt). HFT does what no ordinary person can, its an unfair advantage. So should it not be banned? I recall there was a company setting up a market with a minimum latenc…
The exchange you are referring to is IEX [1]. Michael Lewis (author of The Big Short) wrote Flash Boys about the intricacies of low latency trading and this exchange [2]. One of the primary "unfair" aspect of HFT is Front Running and has been illegal even before electronic trading (the name comes from traders racing ahead of big buyers in the trading pit). It was a big problem during the advent of electronic trading but has since been tamed. Exchanges arbitraging off their clients order books is another matter. Trading fast in reaction to real time (public) events is a market efficiency. Not accessible to the masses, but neither was traveling to wall street to place a trade.
Re: The high-frequency trading arms race: frequent batch auctions (2015)
#76Earlier quoted context omitted.
Swap to an auction batch model and they don’t provide liquidity, they simply don’t have significant stakes relative to the number of daily transactions. Essentially their an outgrowth of all trades needing to be instantaneous which lets them reuse the same capital thousands of times per day. Add to that the fact HFT are profitable and they must therefore provide negative economic value. Either the seller or the buyer…
The idea is that HFTs provide value by tightening spreads. The slower a market maker is, the more risk they take on when they quote, because they are more likely to be caught by market moves - less likely to cancel their quote when the market starts moving, less likely to be able to hedge if they get filled at the start of a move. To make up for that risk, they have to earn more per trade. The only way to do that is…
But lots of stocks have their spread limited by the subpenny rule, in which case additional HFT in that market is completely socially useless.
Re: The high-frequency trading arms race: frequent batch auctions (2015)
#77Earlier quoted context omitted.
I'm merely an observer, but it feels, intuitively, that HFT was great when things were fairly predictable -- or more like the major indices and individual names moved a most 2% on any given day -- and now, in the post-covid era, starting with the DPZ spike, and you could argue the TSLA original call buying spree, everything is in shambles. A lot of HFTs I know of suffered serious losses... Could you explain, indirect…
It's kind of an open secret, but retail traders hopping onto meme stocks like DPZ and TSLA is, counterintuitively to an outsider, actually very profitable for HFTs and market makers. A good example might be - imagine you are a car dealership, so serving as a rough approximation of a market maker. What kind of entities do you want to trade against? Other car dealerships (informed counterparties), or your average subur…
I'll just chime in and say I believe you are misinformed and wrong on this issue. I can say definitively that my firm which engages in HFT and all the other quant/HFT firms I know of have decided to stay clear of the meme stocks, ie. GME, BB, AMC, and a few others and I am not aware of any open secret that HFT firms are sneakily taking advantage of this situation.
Your statement that HFT firms think that retail traders have no clue what they're doing is a complete misrepresentation of the intention behind PFOF. It's not at all that we think retail traders are idiots, it's that retail orders are usually not coordinated and sustained activities the same way that institutional orders are. If an institution is buying and I sell into it, it is quite likely that the institution will continue buying more and more over a long period of time which increases the duration of my exposure to that institution's order flow. Furthermore it's unlikely that institutional order flow on the continuous market will balance out with other institutional order flow, since in situations where such an opportunity exists, brokers for said institutions will arrange for a block trade or use auctions instead of the continuous market. So trading against an institution means assuming exposure for an extended period of time.
With retail orders, usually a trader buys with a few orders in a way that's typically uncoordinated with other orders and that's it. I don't need to be worried that if I sell to a retail trader that a whole bunch of further traders will follow behind them in the same direction, increasing my exposure.
This is not to say that institutions know what they're doing and retail traders don't, or vice-versa. An institution may have no idea what they're doing and pissing their money away and I still won't want to trade against it simply because as an HFT firm my goal is to lock in a spread as quickly as possible as opposed to speculate on the long term prospects of a company. If anything, to the extent that there is an open secret in this industry, it's that institutions don't perform much better or have much of an advantage over anyone else. That said even if they did it wouldn't matter one way or another, what I care about is that the order flow that I am trading against can balance out over a short period of time so that I can lock in the spread.
It is precisely because retail traders are behaving in a coordinated manner on meme stocks that my firm and all the other ones I know about are not participating in them. Retail flow on meme stocks is often coordinated, at least implicitly so as an HFT firm you may risk holding a significant position for a long time, which is not ideal.
That said the market is very big and the meme stocks constitute but a tiny fraction of a fraction of the activity. It's not a particularly big deal one way or another.
Re: The high-frequency trading arms race: frequent batch auctions (2015)
#78Earlier quoted context omitted.
The way I see it, HFT firms provide liquidity to the market, which is good. They do so in an automatic fasion which makes it cheaper than the past system of human traders. But they also do a speed competition which is mostly wasteful. There may be some benefit for the overall market of faster communications but it is pretty low. All systems have waste, some more and some less. This is unavoidable. So the discussion m…
How do HFTs add valuable liquidity to the market? Does the 500ns faster transaction time for a block of AMZN matter to literally anyone? Other than the two sides of the trade who lost some money to the HFT who MITM'd them.
The main reason they compete on speed is because it's illegal to compete on price. Abolish the sub-penny rule and it'd go back to being boring market plumbing.
Re: The high-frequency trading arms race: frequent batch auctions (2015)
#79Earlier quoted context omitted.
Faster transaction times result in tighter spreads, as HFT firms compete each other on the price-time priority queue. HFT firms compete against each other on time, and while yes, that's a zero sum game, the end-result to the broader market is useful. An analogy might be something like Uber and Lyft competing with each other for clients and drivers. From the perspective of everyone else, it doesn't matter much if they…
But the spread in many-to-most stocks is limited by the sub-penny rule (SEC rules, as of 2005, say you can't have a spread < $0.01) rather than by the supply of market makers in that stock. Extra competition in those markets is negative-sum.
The SEC rule is that one may not quote a spread less than 0.01, but that does not mean one can not trade with a spread less than 0.01. There are several workarounds available that are well known, the simplest is in the form of mid-point pegged orders that allow spreads down to half a penny. On top of that U.S. exchanges offer a variety of different fee combinations, including negative fees which can be used to decrease the fee even further. All HFT firms take advantage of these fees, furthermore there are liquidity enhancing programs offered by the major exchanges as well as by ETFs. These can all be used to reduce the spread of a stock below the 1 cent limit.
Re: The high-frequency trading arms race: frequent batch auctions (2015)
#80Earlier quoted context omitted.
How do HFTs add valuable liquidity to the market? Does the 500ns faster transaction time for a block of AMZN matter to literally anyone? Other than the two sides of the trade who lost some money to the HFT who MITM'd them.
The main reason they compete on speed is because it's illegal to compete on price. Abolish the sub-penny rule and it'd go back to being boring market plumbing.
This isn't really a good take: many markets do not trade one tick wide in the first place and people are still competing on speed. Delta neutral trading is a zero sum game and no matter what rules you put in place it will still be incredibly cut-throat.
Moreover at this point speed is a commodity, if you're willing to shell out cash, you can get access to top tier infra right out of the gate. The real game is not how fast you are (though obviously that's important too), but how smart you can be while maintaining good tick-to-trade latency.
Trading has never been a vanilla/boring business and it likely never will be either.