As a side note, if you are an outsider who is at all interested in finance and are a well-educated person, Matt Levine (the writer of this article) is one of the finest sources of information. His articles are accessible, thorough and well thought out.
Can you expand on this more? I'm looking to learn about finance, but it all seems so... overly complicated. It's hard to digest information when the simple stuff is hidden behind tons of terminology. I will definitely look more into Matt Levine. Any other recommendations for how to learn more about finance in general?
This is usually true; but in this case he's parroting a data "analysis" that excluded 99+% of IEX's orders. Essentially, in < 1% of types of trades, IEX underperforms, in the rest it outperforms.
However, the IEX opponents decided to pretend that this minuscule fraction of trades was important, and Matt Levine was either careless in believing this; or he purposefully wrote a dishonest and misleading article.
I won't state which it is, but he's a smart guy... it's hard to believe that he'd make such an egregious error by accident.
Huh? He explains this all in the article very clearly. He addresses the issue Citadel brings up but then demonstrates how unimportant it is to retail investors.
Of course not. The pre-existing, traditional exchanges are about the little guy. A retail investor can now buy or sell a stock with unprecedentedly low execution slippage.
The current HFT-driven market penalizes haphazard execution of much larger orders.
The largest and most reputable of which funds publicly support HFT driven trading/execution/market-making. I guess it depends on how much you trust Vanguard. I trust them a lot.
As the number of trading venues increases, discrepancies in prices across those venues will naturally result. The price discrepancies across multiple markets create an opportunity for nimble traders to make a small arbitrage profit by scouring the markets for these discrepancies and eliminating them. As the number of trading venues expands, the number of such arbitrage opportunities increases. So, it is not surprising that we have seen a tremendous increase in trading volume over the past decade, and that the activity is increasingly dominated by "high frequency traders." While Vanguard does not engage in this type of trading, we recognize that such trading has a positive impact on the markets at large, including longer term investors. Such arbitrage trading enables investors to get a fair price across market centers. Vanguard believes that the market structure changes facilitated by the Commission's various regulatory initiatives and the "knitting" together of the marketplace by "high frequency trading," have led to a significant decline in transaction costs for long-term investors over the past ten years through increased liquidity and tighter bid-ask spreads.
and
Various groups have attempted to quantify the reduction in transaction costs over the last ten to fifteen years. The Commission will continue to receive this data throughout the comment period. While the data universally demonstrate a significant reduction in transaction costs over the last ten to fifteen years, the precise percentages vary (estimates have ranged from a reduction of 35% to more than 60%). Vanguard estimates are in this range, and we conservatively estimate that transaction costs have declined 50 bps, or 100 bps round trip. This reduction in transaction costs provides a substantial benefit to investors in the form of higher net returns.
One of the reasons that there are currently so many stock exchanges in the US is that while you aren't allowed to quote at subpenny levels, if you have several exchanges with different levels of make/take fees, you effectively have the ability quote (or remove liquidity) at subpenny price levels net of fees and rebates. In that scenario the proliferation of exchanges is less about competition and more about finding clever ways of negotiating the regulatory environment.
I found it odd given what we saw in the US exchanges was the opposite of that before fragmentation, but the argument is that the network effects of large exchanges reduces the overall costs.
On exactly what front are exchanges competing? Order types? Fees? Volume? Differences in any of these are very often opaque to the customer.
From what I've seen, exchanges are basically functionally equivalent, since they provide a utility-like service. And, as Vanguard points out, more trading venues means higher market frictions and costs.
TBH I'm still trying to forming a strong opinion on the issue, as indicated by "probably" in my initial comment. And I think it's a topic worth discussing.
It doesn't matter if it's opaque to the customer or if every exchange is selling an identical product; there's reason for multiple exchanges to exist to avoid monopoly. Multiple players want to play in the market, that means multiple exchanges. Saying there should only be one exchange is picking a winner and giving them the entire market.
Interestingly IEX's application has attracted 388 comment letters, with 99% supportive and Citadel's one of the handful against: http://www.nanex.net/aqck2/4709.html
For contrast, the BATS application received 3 comments only.
A bit disingenuous - the handful against include major exchanges like NYSE and BATS as well as major trading firms like Citadel.
You could argue that these are direct competitors of IEX and therefore have a vested interest in preventing the new exchange - or you could argue they are best suited to see the holes in the application.
Keep in mind that previous exchange applications have went through without this level of discussion. You could argue that this is because the other exchanges are "scared" of IEX. Or... consider the possibility that IEX's application has some faults. For example, much of the focus has been on IEX's smart order router not following the same rules as all the other exchange participants. The argument is too nuanced to summarize here... but you should never decide an argument based on number of responses!
That must be related to the publicity of "Flash Boys" and the fact that some entities are rallying the public to send comment letters.
BATS when it became an exchange was nothing but a vanilla competitor marketed as a Better Automated Trading System. It didn't have anything like a speed bump.
Title is a little misleading. The article is seeking to refute a letter from Citadel opposing the establishment of IEX ('Flash Boys' exchange) on the grounds that it is not as efficient for the smaller retail investor. Article explains how 1) many of the retirement funds and institutional investors do actually represent the little guy 2) why exchanges that encourage HFT are costing all of us with retirement funds lots of extra dollars.
I for one would like to see traders compete something other than speed and hope to see the IEX up and approved as an exchange sooner rather than later.
I think that an exchange that places less of a premium on speed like the IEX is an way to evaluate claims that HFT is hurting markets. Let the market evaluate by providing different options to investors. If HFT is providing benefits in terms of cost or liquidity then IEX will fail as it is not providing those benefits. I'm all for providing options to investors and letting them vote with their dollars about which exchange they like best. If HFT is truly providing value then they should welcome some competition to show how much value they are adding.
Except the buyers and sellers (mutual funds, etc) aren't the brokers, and brokers ultimately decide where to send the orders. I don't believe there is any regulation that forces a broker to use an exchange the customer specifies; rather, that they must buy or sell on the exchange that provides the best price.
Is there any transparency or accountability for this? Eg, does the broker have to give the client a report of trades and the exchanges they were sent to?
This might be true on a micro level when it comes to order execution, but on a macro level the costs have yet to be determined. HFT in its current form has not really been through a market downturn, and the way in which the algorithms interact with each could turn out to be very detrimental to markets (and by extension retirement funds) as a whole.
What is "HFT in its current form"? If you're going to project some harm from automated electronic trading, I think you need to be specific about both the form of trading you're concerned about and the harms it might visit on the market.
By "in its current form" I mean whatever growth & developments have been implemented in the industry since 2009, and to a lesser extent since 2011.
I'm not an insider or an expert, and I'm sure there are many nuanced arguments for and against individual use cases. I'm really just trying to point out that there it is not clear what the systemic risks are, or how algorithms will behave in a market that is drastically different than the what we've seen in the last 4 years. It is impossible to test a system like this as a whole. My personal lack of knowledge about the inside baseball does not change this fact. And dismissing the macro view because of nuanced micro arguments comes off as flippant, elitist, irresponsible, and incorrect in my opinion.
I guess I'm suggesting that you haven't actually made a macro argument, because you're not defining your terms. Could you please do that, and then we can see if the concerns you're bringing up are credible? They might be!
My argument is that it is theoretically possible that in a declining market environment, the combined effect of HFT and other algorithmic traders (I apologize for conflating and using crude terms, but my vocabulary is admittedly imprecise and incomplete) could accelerate a market selloff and overwhelm the normal mechanisms that have evolved over time.
For example, one worry I have is that algorithms may crowd out non-silicon short sellers. As much as short sellers are demonized as "evil speculators" in times of market stress, sometimes in a down market they are in fact the only buyers available and actually slow down declines when they cover. I don't have solid evidence that short sellers are crowded out by HFT... but I am trying to provide an example of a scenario where the "macro" effects could transcend the nuanced "micro" arguments about cost, efficiency, liquidity, etc. There are numerous other plausible scenarios that fit this bill as well, and it is the uncertainty around them that I am trying to point out.
Of course, none of these things have to do with IEX or a time delay... maybe things like order stuffing or spoofing are related but even those things are not what I'm talking about. Especially considering the dialog that has taken place since Flash Boys was released, I feel that both industry and regulators risk getting caught up in a cost/benefit analysis of the small issues while ignoring potential systemic problems.
As an investor I don't really have a huge dog in this fight... I'm not expecting any pension, and I don't own any managed funds. I generally use fundamental analysis to do long term investing in broad sectors using ETFs and a smattering of individual stocks. I manage my own money and so I will have no one to blame but myself if things go wrong. And frankly, if I lose $0.0002 on a trade by being frontrun in a dark pool it doesn't change my life, so for me to argue for or against IEX is somewhat irrelevant. However as a taxpayer I am concerned that public pension systems could very quickly find themselves vastly underfunded in a short period of time, and as a human being I worry about people who have worked their whole lives and just want to retire in peace.
I think that my concerns are not entirely disconnected from what the general public feels/understands about "modern markets", so while in most cases I probably have no basis to refute your specific arguments, I suppose I take exception to people with "macro" views such as mine being dismissed as unsophisticated proles. Even if that is not what you were trying to do... Matt Levine definitely comes off like that in his article.
Traders have always competed on speed and "will always" compete on speed, you can't stop this, it's not possible, nor is it bad. So why exactly are you against competing on speed?
> why exchanges that encourage HFT are costing all of us with retirement funds lots of extra dollars.
Why do you believe this, HFT lowers the spread making entering the market cheaper for those guys.
Both the article and the original "flash boys" book make a compelling case about how HFT can in some cases be used to virtually front run orders. I personally don't understand the system enough to prove or disprove those claims.
I do think that an exchange that places less of a premium on speed like the IEX is a reasonable way to let the market itself evaluate the benefits of HFT. If the exchanges with HFT do provide a better value in terms of liquidity or price then the IEX will suffer as it provides an inferior product. If IEX flourishes then it is providing some value to investors. Let investors vote with their dollars
Personally, I think that IEX becoming an exchange is a done deal and have absolutely no problem with that. What causes me concern (and many of the opposition letters point to this as well) is that we don't want IEX becoming an exchange to be seen as some sort of referendum on HFT and specifically how HFT impacts individual investors.
The biggest reason for that is that I believe that individual investors are dramatically better off in a world of cheap wholesale market makers than they could ever be being dumped in the shark tank of hedge funds that is IEX. I have no problem with institutional investors who want to take advantage of IEX if they think that is best, they are professionals and that is their job to figure that out (though I wouldn't want to be invested with an institutional investor who wanted to trade on IEX because I would be suspicious of their competence). What I find really scummy is the marketing ploys of IEX to try to frame this as in someway good for individual investors.
[edit] Obligatory, please if you've read Flash Boys read "Flash Boys: Not So Fast". No one who understands/has worked in electronic trading that I've met believes that Flash Boys is anything but misrepresentative and bad.
Neither the article nor Flash Boys makes that case.
The article doesn't make that case because Levine is semi-famous for repeatedly calling Flash Boys into question, particularly with regards to the book's claim that HFT allows "front-running".
Flash Boys doesn't make that case because it's an incoherent mish-mash of different arguments that don't add up to a definition of "virtual front running", let alone an argument that it's happening.
> and the original "flash boys" book make a compelling case
Except it didn't, it merely showed that the author has no understand of what HFT is. Flash boys is full of hyperbolic bullshit that may sell books but shows no real understanding of how the market works. He misuses the term front running (which is illegally using knowledge of your clients positions to trade ahead of them) and applies it to being a faster speculator, which is in no way front running. The guy quite simply doesn't know what he's talking about.
Anyone think we will get something that is happening in AdTech? There are several ad exchanges and there is 'header bidding' technology which let's you hit all the exchanges at once for the bets price. Anyone know if this is already occurring in stock exchanges?
Yes, of course. Exploiting price differences between exchanges is arbitrage. It's very easy to take advantage of (if nobody else is doing so) so is done early on in any market.
Sounds like you are describing the NBBO (National Best Bid and Offer) which literally requires everyone to execute at the best price (or better) to buy or sell in the market.
If you send an order to an exchange (say NYSE) and they don't have the Best Bid then they will route your order to the other exchanges (NASDAQ/BATS/etc). Is this what you are getting at?
I've started reading through the 388 comment letters to IEX's application, and this one in particular is basically a free lecture on the relevant issues by a professor at the University of Chicago -
The author is a critic of continuous limit-order book markets for what seems to be a different reason: as the interval at which things trade constricts, correlations can break down between things that should be priced 1:1.
His best example is ES and SPY, two different ways to trade the S&P500.
There's a straightforward high-frequency arbitrage strategy to deploy against that problem: if ES or SPY is "mispriced", trade in offsetting amounts, in the expectation that the correlation will be restored (as it must eventually be). In Budish's view, this trading is a needless cost that doesn't improve price discovery.
I'll just say, that's not IEX's argument against HFT.
