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High-Frequency Trading - The Dog Days are here
July 30, 2013 10:47 AM   Subscribe

How the Robots lost - The Fall of High-Frequency Trading. For the past few years High-Frequency Trading was where the money was but now it looks like the worm is turning. The scale of HFT is stunning - see, for instance, what happens in a half second of trading in Johnson & Johnson.. While profits are evaporating, serious concerns remain about systemic risk.
posted by storybored (50 comments total) 31 users marked this as a favorite

 
It's good to hear that these parasites are having a hard time. Microarbitrage serves no purpose other than to skim money out of the economy.
posted by NoxAeternum at 10:52 AM on July 30, 2013 [13 favorites]


Why its almost like capitalism has killed the capitalists.
posted by JPD at 10:55 AM on July 30, 2013 [8 favorites]


So... We SHOULDN'T burn the sky?
posted by Artw at 11:06 AM on July 30, 2013 [4 favorites]


Ha- I once somehow found myself writing an article for a finance blog about HFT, despite the fact that I have zero knowledge of finance. What struck me was the fact that infinitesimal errors can very easily be magnified ten thousand fold, losing a company millions because of a literal typo- and somehow, this is irreversible. Once the money is gone, it's GONE, possibly within minutes.

The proposed solutions I found for the article were all technological- design software to more accurately clear high frequency transactions, etc. No one was proposing "hey, let's stop doing this dumb thing."
posted by showbiz_liz at 11:06 AM on July 30, 2013 [2 favorites]


No one was proposing "hey, let's stop doing this dumb moneymaking thing."
And no one will.
posted by oneswellfoop at 11:09 AM on July 30, 2013 [1 favorite]


Hm. The article says that as a result of widespread use of HFT,

Volatility, a measure of the extent to which a share’s price jumps around, is about half what it was a few years ago. By seeking out price disparities across assets and exchanges, speed traders ensure that when things do get out of whack, they’re quickly brought back into harmony. As a result, they tamp down volatility, suffocating their two most common strategies: market making and statistical arbitrage.

These are all good things, aren't they? I mean, isn't the whole point of a stock exchange to let the market efficiently find the "actual" value of a given stock?

It doesn't sound like "the fall of HFT" so much as it sounds like "HFT has made arbitrage less profitable, because it works as intended."
posted by ook at 11:11 AM on July 30, 2013 [22 favorites]


Why its almost like capitalism has killed the capitalists.

So You'd Like a Society that Places Value on Everything: A 100-Point Checklist

Step 1: Are you sure you're as valuable as you think you are?
Steps 2 - 99: Are you really sure?
posted by jason_steakums at 11:12 AM on July 30, 2013 [17 favorites]


It's good to hear that these parasites are having a hard time. Microarbitrage serves no purpose other than to skim money out of the economy.

The big loser from HFT was not "the economy," i.e., nonfinancial sectors, but traditional market makers.

Which is not to say there might not be instability risks from HFT--there might be--but the need for every financial story to be "Wall Street rips off Main Street" is unfortunate and often misleading. Quite often its "part of Wall Street beats another part."
posted by dsfan at 11:18 AM on July 30, 2013 [12 favorites]


It's interesting that this follows a predictable cycle:

1. An idea gets developed that makes money in a highly marginal way, repeated very quickly.
2. As this idea gets repeated, the returns diminish.
3. Firms try continually more desperate ways to make money in this marginal fashion.
4. Eventually people can't continue because the cost is higher than the marginal profits.

Lesson: markets waste a shit ton of money chasing marginal profits.
posted by graymouser at 11:22 AM on July 30, 2013 [8 favorites]


These are all good things, aren't they? I mean, isn't the whole point of a stock exchange to let the market efficiently find the "actual" value of a given stock?

"The argument" (and I put that in quotes because I don't support it) is that while HFT has driven down spreads and vol normally, that during times of stress they leave the market and there is no one left to provide liquidity such that bid/asks blow out and vol goes to much higher levels than you would have seen with traditional market makers who would have stuck around to make a market.
posted by JPD at 11:28 AM on July 30, 2013 [4 favorites]


I mean to dsfan's point - the guys who have been put out of business by HFT where actually extracting even more value from regular investors. They just did it while wearing an ugly sportcoat and an earpiece.
posted by JPD at 11:30 AM on July 30, 2013 [2 favorites]


HFT killed off retail too (the trading us little-guys do), which is more lost revenue for the banks.
posted by MillMan at 11:43 AM on July 30, 2013


It was the summer of 1989... the world’s first high-frequency trading firm, Automated Trading Desk

a Princeton-trained physicist who’s worked at the Securities and Exchange Commission since 2009...His primary task is to give the SEC its first view into what high-frequency traders are actually doing.


I can spot 20 things wrong with this picture.
posted by justsomebodythatyouusedtoknow at 11:45 AM on July 30, 2013 [4 favorites]


previously
posted by garlic at 11:58 AM on July 30, 2013 [1 favorite]


I'd agree with dsfan that traditional market makers sucked worse that high-frequency traders. Should we care if scaredy cat algorithms make the occasional market panics worse?

In the long run, we benefit by removing the trader types from finance all together, initially replacing them with developers and mathematicians, eventually with standardized open source automated trading platforms. Imagine if there was simply no way to make all that much money in day trading, like selling Linux servers now.

How do you kill a parasitic activity or industry like management, real estate, finance, etc.? You might make it so extremely efficient that no real people remain to defend it politically so that work to turn the political tides against it is opposed only by obvious bad guys. You might need to erode the monopoly that enables their parasitic power too, ala foreign markets, bitcoin, etc.
posted by jeffburdges at 12:01 PM on July 30, 2013 [6 favorites]


I mean to dsfan's point - the guys who have been put out of business by HFT where actually extracting even more value from regular investors. They just did it while wearing an ugly sportcoat and an earpiece.

It's funny because the usual spin on HFT is "Uncontrollable computers will destroy the economy while their clueless masters rake in easy cash", but another spin on it is, "Math and programming nerds overlooked by hoity-toity high financiers find a way to break into Wall Street and show that they can make money based on their brains and not who they know."
posted by Copronymus at 12:05 PM on July 30, 2013 [3 favorites]


what happens in a half second of trading in Johnson & Johnson
DEFEND CITIES
posted by thelonius at 12:06 PM on July 30, 2013 [6 favorites]


What's 'worse' for a market panic? If on 5/5 the prices were basically the same as they were on 5/7, then did the HFT guys make the flash crash on 5/6 worse because it happened quickly, or better because it recovered quickly?
posted by garlic at 12:07 PM on July 30, 2013


Is there systemic risk that applies to *non*-high-frequency-traders?

If a large amount of the market is controlled by HFT algorithms with stop-loss code paths like "this stock is going up, so I'd better buy some quick" or "this stock is going down, so I'd better sell some quick", then sure that's unstable and going to add volatility, but this volatility takes the form of "handing free money to non-HFT investors on the upswing, then handing them free stocks on the downswing".

This only becomes a risk to other investors if combined with "heads I win, tails you lose" decisions canceling the trades wherein the bots lose money. Martingale betting sounds like a fantastic idea if I can have a do-over whenever I eventually lose.
posted by roystgnr at 12:10 PM on July 30, 2013 [2 favorites]


This only becomes a risk to other investors if combined with "heads I win, tails you lose" decisions canceling the trades wherein the bots lose money.

I'm opposed to canceling trades just because the market has moved dramatically, but I'm not sure if it's the HFT firms who tend to support it--my sense, and I might very well be wrong on this point, is that it's more ordinary traders who enter in market orders (i.e. orders to be filled at any price) which transact far from the value of the underlying security in periods of market turmoil. Canceling trades would then dissuade HFT firms from remaining in the market, since they can't be confident that providing liquidity will actually make them money. The solution there I favor most is simply banning market orders, because I don't think many, if any, traders actually want their trade to go through at any price.
posted by dsfan at 12:22 PM on July 30, 2013 [1 favorite]


It's good to hear that these parasites are having a hard time. Microarbitrage serves no purpose other than to skim money out of the economy.

This skimming money out of the economy is called profit (in the classical, Adam Smith sense, not the accounting sense), and is one of the defining features of capitalism. I agree that it's parasitic (that's why I'm a socialist), though that's perhaps not what you meant. I also agree that, regardless of one's opinion on profit in general, profits arising from HFT was particularly egregious; and it's nice to see Smith's argument that, in a perfectly competitive market, profits will tend to zero working in this instance.
posted by eviemath at 12:53 PM on July 30, 2013 [4 favorites]


OK, so Ritholz's embedded video made me think of Galcon. Now I want to make a game with an HFT theme, using this general visualization...
posted by symbioid at 1:01 PM on July 30, 2013


The big loser from HFT was not "the economy," i.e., nonfinancial sectors, but traditional market makers.
Kevin McPartland of the Tabb Group, which compiles information on the financial industry, projected that companies would spend $2.2 billion in 2010 on trading infrastructure—the high-speed servers that process trades and the fiber-optic cables that link them in a globe-spanning network. And that was before projects were launched to connect New York and London by a new transatlantic cable and London and Tokyo by way of the Arctic Ocean, all just to cut a few hundredths of a second off the time it takes to receive data or send an order. -Wired, 2012
Thousands of very smart people are engaged in billions of dollars of infrastructure spending, entirely devoted to wringing out the fifth decimal place on a hundred dollar stock price, faster than a human can even perceive, much less comprehend. How is this massive dubious allocation of both money and intellect not a loss for the economy as a whole? I really like the proposal for a 0.03% tax; a tiny fraction for people who are using the market as an actual way to allocate capital and invest, but a potentially lethal dose for the masters of the fifth decimal place.
posted by Homeboy Trouble at 1:02 PM on July 30, 2013 [9 favorites]


How is the amount the US spends on defense not a loss for the economy as a whole? How is the amount that is spent on marketing beer not a loss for the economy as a whole?
posted by garlic at 1:19 PM on July 30, 2013 [2 favorites]


The second question is easiest: The marketing doesn't magically appear. The money is paid into the pockets of hundreds or thousands of people whose jobs range from janitorial services at the marketing companies to artists to (ugh) marketing professionals, to cameramen for the commercials to actors who act in the commercials, to the CEO of the company.

The first question is more complicated. A lot of what is spent on defense is a loss for the economy as a whole, but not all of it.
posted by Justinian at 1:23 PM on July 30, 2013


How is this massive dubious allocation of both money and intellect not a loss for the economy as a whole?

...the exact same way literally any other allocation of money and intellect contributes to the economy? It creates jobs, it creates a profit, that profit is taxed, that tax money gets spent on things, those profits and the salaries of the people involved gets spent on things.

Perhaps I'm misunderstanding the point of your question, but AFAICT allocation of money and intellect is what an economy is. Whether those allocations serve some tangible purpose isn't relevant.
posted by ook at 1:26 PM on July 30, 2013


So... We SHOULDN'T burn the sky?

Burn the land, boil the sea, you can't take the sky from me.

I'm sorry, I had to.
posted by Canageek at 1:29 PM on July 30, 2013 [5 favorites]


From the Wired Link, re:underground NY-to-London HFT cables:
In what some might consider a case of karmic justice, sharks threaten the financial industry by biting its cables, attracted by the electromagnetic fields generated by the wires that power the amplifiers at intervals along their length.
Heh, that's an entertaining way to frame that. Though I reckon that said sharks are hardly 'threatening the financial industry', I appreciate that clever, exaggerated turn-of-the-phrase.
posted by Theophrastus Johnson at 1:33 PM on July 30, 2013 [2 favorites]


There is definitely a "[horrible miss-allocation] of both money and intellect" here, Homeboy Trouble, but we'd hardly be using them any better otherwise. There is no world shortage of "very smart people" anyways, well they'd just end up building website otherwise. Or worse engaging in activities society considers really unimportant like teaching. In the long run, we've entire sectors of the economy that should be all but eliminated, like finance, but our only politically plausible way to do that right now is to automate them.
posted by jeffburdges at 1:39 PM on July 30, 2013


Take that!
posted by Mister_A at 2:00 PM on July 30, 2013


So, I left an HFT shop a few months ago, anticipating that the field will simply not be profitable enough, and one critique being bandied here is correct: it was attracting more talent than could be justified.

But the rest of the scapegoating is amazzing me. These are the one group of people in finance who are NOT wallowing in corruption. (You're not going to trade on a "hot tip" in a stock when your computer is trading in 500 of them nonstop, at sub-second frequencies.)

And they did in fact benefit other investors. You low frequency traders (read: investors) want to buy stocks to hold on to for a few months/years/weeks. That's very nice. But when you make that decision, you want it done right there and then. Guess who you're trading with: someone trading at a higher frequency than you.

In the old days, when you invested, you effectively paid 12.5 cents a share to the specialist (or a little less to one of his colleagues) when you bought in, and again when you sold out. The specialist, meanwhile, spent most of the day trading in such a way that he could be replaced with a keyboard and a drinky bird, a la Homer Simpson.

Now, with HFT you pay about 1 cent per share. That's why these people are not parasites. That's also why they're not making that much money.
posted by ocschwar at 2:45 PM on July 30, 2013 [13 favorites]


You low frequency traders (read: investors) want to buy stocks to hold on to for a few months/years/weeks. That's very nice. But when you make that decision, you want it done right there and then.

It does not follow.
posted by benzenedream at 2:52 PM on July 30, 2013


You want to be able to sell the trade when you want to, and not have to wait for someone else to want to buy it from you. i.e. If you had an investment you wanted to get rid of, 10, 15yrs ago you would need to wait for someone to buy it or need to sell at cheaper price than you really wanted too just to get some cash on hand. Clearing houses provide a smilar service, but usually only for specific trades. HFT can be applied to any product (and can be tweaked to exploit each product's quirks)


At it's best HFT works like a match program between buyers and sellers at a much higher speed and a better discount from the old middleman of a dude yelling into a phone.

Obviously there are pros and cons to both methods.


Most here would argue there are just cons all around.
posted by larthegreat at 2:58 PM on July 30, 2013 [2 favorites]


And they did in fact benefit other investors. You low frequency traders (read: investors) want to buy stocks to hold on to for a few months/years/weeks. That's very nice. But when you make that decision, you want it done right there and then. Guess who you're trading with: someone trading at a higher frequency than you.

Yes, clearing houses are necessary, and yes, HFT is doing their work, cheaper.

Sure, the first stock I bought was around 1990, by mail. That was really inconvenient. And then, in the late 90s, you had to call a broker up and talk to him and all that. That was inconvenient, as well.

But what does "there and then" even mean? I just pinged servers in Toronto, New York and Frankfurt, and they take 160ms, 180ms and 260ms respectively. If my computer can't even communicate with a market in less than 180ms, then I can make no use of trades at a higher frequency than that. And more to the point, even if I have a spreadsheet doing the rebalancing calculations for me, even a small portfolio of, say, 5 different investments takes a minute or two to do, just entering prices, then entering orders. And that's without actually thinking about my investing. If the market traded only once every minute, that would be totally fine from my perspective. What greater actual benefit, rather than one group of traders profiting versus another, would be attained if shares traded more frequently than once per minute? Or even once per second?
posted by Homeboy Trouble at 4:50 PM on July 30, 2013 [1 favorite]


What greater actual benefit, rather than one group of traders profiting versus another, would be attained if shares traded more frequently than once per minute? Or even once per second?

Might not matter to you, since as you pointed out, you don't have access to the infrastructure to make a difference. But any decent-sized pension/mutual fund does. And it does matter, in that case.
posted by graphnerd at 4:57 PM on July 30, 2013


I'm nervous about major players possessing different trading frequencies myself because that creates an opportunity for monopolization. I'd support say a 300ms speed limit if HFT outfits were all acquiring one another or Goldman-Sacks and Morgan-Stanley were monopolizing the land around the exchanges or whatever.
posted by jeffburdges at 5:48 PM on July 30, 2013 [1 favorite]


When the market opened on Aug. 1, a new piece of trading software that Knight had just installed went haywire and started aggressively buying shares in 140 NYSE-listed stocks. Over about 45 minutes that morning, Knight accidentally bought and sold $7 billion worth of shares—about $2.6 million a second. Each time it bought, Knight’s algorithm would raise the price it was offering into the market. Other firms were happy to sell to it at those prices.

I used to play Java Settlers of Catan, which was pretty good for its day, but the AI players, represented by boxy cartoon robot faces and names like Robby and Gort. They were reasonably OK players, but sometimes you could follow up a reasonable trade that they turned down, like two sheep for one brick, with a far more ridiculous one like one sheep for a brick, a wood, and a stone, and they'd snap it up.

Anyway, good to see those guys ended up with good jobs.
posted by ignignokt at 6:01 PM on July 30, 2013


Yes, clearing houses are necessary, and yes, HFT is doing their work, cheaper.

Sure, the first stock I bought was around 1990, by mail. That was really inconvenient. And then, in the late 90s, you had to call a broker up and talk to him and all that. That was inconvenient, as well.


More than just inconvenient. The longer it takes you to send an order out, the further the price will drift by the time you get your order filled. If you want confidence that the price you just saw scroll by for Turnip Twaddlers Inc. is a price you can get for your shares if you sell, you need to be able to reach a buyer right away. That takes more than a clearing house. That takes an actual buyer. And that buyer is going to be an HFT shop, more likely than not.
posted by ocschwar at 6:08 PM on July 30, 2013


Once the money is gone, it's GONE, possibly within minutes.

If the money can be destroyed, it wasn't money. With the stock market, it's only money before you put it in and after you take it out. Once it's in the market, it's just hopes and dreams denominated in dollars.
posted by gjc at 6:24 PM on July 30, 2013 [3 favorites]


In the old days, when you invested, you effectively paid 12.5 cents a share to the specialist (or a little less to one of his colleagues) when you bought in, and again when you sold out. Now, with HFT you pay about 1 cent per share.

That has nothing to do with HFT. It is due to the change from the fractional to decimal system by the exchanges in 2001, before HFT really had much of an impact. HFT has had only a tiny incremental effect on spreads compared to the benefits of decimalization.
posted by JackFlash at 11:13 PM on July 30, 2013 [3 favorites]


The new frontier is with algorithmic long-term trading (ie. a single transaction every 3 years or more). HFT replaced market makers. Algo long term trading will replace Warren Buffett and the entire industry of managing clients money. Hand your money over to a computer, lock the door turn out the lights and come back in 3 years to collect the profit. That's the vision anyway and some firms are already doing it. You just have to be a super math whiz able to tease out correlations in massive amounts of Big Data. I just read a great book called Dark Pools: High-Speed Traders, A.I. Bandits, and the Threat to the Global Financial System, highly recommended. Really the people driving this are the "plumbers", the network engineers and software developers creating the exchanges. All part of the larger story of how computers (and robots) are replacing humans in many industries.
posted by stbalbach at 8:58 AM on July 31, 2013 [1 favorite]


That has nothing to do with HFT. It is due to the change from the fractional to decimal system by the exchanges in 2001, before HFT really had much of an impact.

Actually according to the book I just linked to above, the transition from fractional to decimal was due in large part to the new computer-only exchanges like Island ECN gaining in popularity, they were the ones who really pushed for the decimal system (Josh Levine of Island in particular). Without the existence of computer-run exchanges it's likely the market makers would have had the power to retain the golden goose of fractional trading. By 2000, everyone could see where things where headed with market makers and they had little influence to keep the fractional system (though they tried).
posted by stbalbach at 9:05 AM on July 31, 2013 [1 favorite]


There are plenty of long-term algorithmic traders. Lots of them. Just like people their results are dispersed around the market return with the mean being less than the market return.
posted by JPD at 10:40 AM on July 31, 2013 [1 favorite]


They make money the old fashioned way, they skim it.

It seems to me that this is like a temporal version of an old computer crime called "Salami." You're shaving off a thin slice of each transaction, so thin it is unnoticeable to the transactors. In a traditional Salami scheme, you're stealing mils, hundredths of a cent, that appear as round off errors in high precision calculations. But it seems to me, HFT is just shaving off a slice of profits from increasing trading friction, so they can make microprofits (if any) that get buried in the cost of larger transactions by other traders.
posted by charlie don't surf at 11:01 AM on July 31, 2013 [1 favorite]


all of wall street is a "Salami Scheme" In reality HFT is a new Salami Scheme that replaced an old Salami Scheme that took bigger slices.
posted by JPD at 11:34 AM on July 31, 2013 [3 favorites]


True, JPD. I think the complaint here is that the HFT scammers have skimmed too much from the little people, and all the big traders saw the money there, so now they are trying to skim off the same people. So there is no profit there any more, now they have to try to skim off the big traders, who are harder to scam.
posted by charlie don't surf at 1:53 PM on July 31, 2013


no - that's not really how it works. they are essentially providing liquidity, anyone who needs liquidity gives them a slice - they don't differentiate between big or small. What's actually happening is that there are so many of them trying to offer liquidity, and all of them are about as good at it as everybody else, that they are essentially competing against one another, forcing them to take smaller and smaller slices, while competition requires them to invest more and more of their money into staying as fast as everyone else.

Actually given I hope small investors trade less than big shops they should in theory be paying a smaller vig to the HFT guys.
posted by JPD at 4:28 PM on July 31, 2013 [1 favorite]


I mean what's important to note about this is that the biggest complainers are market participants who have been disintermediated - trading shops who use to live off of spreads.
posted by JPD at 4:29 PM on July 31, 2013 [1 favorite]


. I think the complaint here is that the HFT scammers have skimmed too much from the little people, and all the big traders saw the money there, so now they are trying to skim off the same people.

1. If HFT is a scam, then I too am one of the scammers.

2. What money HFT makes from retail investors, is far less than what the big traders used to make.
posted by ocschwar at 7:44 PM on July 31, 2013 [1 favorite]


I don't know about you guys, but when I buy or sell stock, I have to go through a broker. That guy charges me 10 bucks to make a trade (which is way lower than it was 30 years ago due to competition he faces). Then I know that guy doesn't actually make the trade, he passes off the flow to some big fish like Knight (now KCG) who he pays some access fee too, and Knight matches my order with something else they have, or if they don't have the liquidity in their dark pool (because maybe I'm trading South African toiletry companies or something) , then across the relevent open market exchange. But in that whole transaction, if Knight makes a trade with some other HFT giving one or both of them 2-3 cents, that's not a significant portion of my price, because I had to pay my guy $10 bucks.

HFTs are mostly only taking your money if you used to make your money as a in-person market maker getting 13 cents + a trade. Even if you're a big time investment bank, HFT traders market-making help reduce your costs, not increase them.
posted by garlic at 7:19 AM on August 1, 2013 [4 favorites]


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