Nicely written piece; to give some taste of the article contents:
"Height, then, played an important part in facilitating that speed. A trader’s physical height became an advantage, which is part of the reason some traders were former basketball or football players – “taller traders were easier to see”. In the 1990s, some traders wore high heels in the pits to trade faster, and inevitably experienced injuries due to lack of balance. This prompted the Chicago Mercantile Exchange (CME) to impose a ruling making the maximum size of platform heels two inches in November 2000."
I think in the next 5 years we'll be down to a handful of true Ultra low latency, high frequency traders and they'll probably be the ones you know, TradeBot, Getco, Citadel, etc.
I think I'm very fortunate not to have to compete in that space, it allows us to concentrate more on the algorithms than the execution.
It's very hard to get started in it anymore. I work for a decent sized firm and we can get laughed out of meetings when we ask about some of the more desirable fiber routes. I can't imagine what it would take to get any microwave spectrum space:)
The incumbents have the spectrum and fibre locked down and the bigger players like Citadel pay the retail brokers for their retail flow so they can trade against the "dumb" money before anyone else. I've heard that most Canadian banks sell their flow to a big US fund that has a chance to trade against it before it reaches the market.
If the CN tower was available for renting out microwave signals I'm sure someone would have rented out the entire spectrum and held it for themselves. Its in a very good location for Inter-listed arbitrage between Toronto and Chicago and Toronto and New York:)
This is a good article about the cutthroat business of being in the HFT space and the one I think the post was talking about.
> "There are rumors in the industry that people have bought tower space or have bought frequencies that they don’t use,” Cumberland said. “We call it ‘frequency squatting’ or ‘tower squatting."
> "Traders need multiple towers because signals run the risk of breaking up beyond 100 kilometers (62 miles). Controlling a single tower wouldn’t benefit a trader unless the goal was to force rivals to go around it by using a slower, less direct route, or hoarding the frequencies that companies rely on to transmit financial data, said Colt’s Cumberland."
Meta note, if anyone wants to talk trading algos or technology feel free to reach out, email in my profile.
Why is that distateful? My impression is selling flow is the only way for retail brokers to keep competitive prices while complying with SEC rules. Instead of executing orders themselves according to the rules, they sell the order then price it to the customer as if it had been executed by the rules. I've never worked in equities so correct me if I'm wrong.
My concern is that the investor doesn't understand what is happening. Someone goes out to hit a bid, but actually a prop group has paid to see their intention before it goes to the market, and can choose to participate or not.
But I'm a futures guy, so my understanding of payment for flow is minimal.
You are being overly pessimistic about access to these microwave paths. In some cases in the U.S. you can purchase wireless market data directly from the exchanges†. I am less familiar with the Canadian markets so I can't speak to what is available there.
Agreed -- however, it's worthwhile to note that in my experience, you get what you pay for in terms of wireless connectivity. There are superior products to the Nasdaq offering.
How profitable are the large HFT firms? My understanding is that as more competitors entered the space profitability has gone down significantly. I remember hearing one HFT guy explain how in the early 2000s, before HFT became big the bid-ask spread could very large but it is now virtually non-existent due to so much HFT activity.
The race to zero (or more accurately c) on the networking front is seeing significant action, largely because it's the "lowest hanging fruit." Network latency is six to eight orders of magnitude higher than processing latency in most case. By Amdahl's Law, it's a very good system to optimize. This is especially true for places like Korea, and for the US where there's significant geographic distance between futures and equities.
Microwave is an "early adopter" technology that will soon be replaced with superior ones. The first microwave network was slated to cost 15M/yr at the time of its launch in 2012. However, competition dropped that number to around 2M by launch time, and within six months it was < 250K. Mind you, everyone was locked into a 1-2yr contract at the higher price points. For the U.S. Tradeworx (aka Thesys) is one of the fastest "publicly" available networks so they're commanding a premium at $250K, but microwave is now available for less than 80K a mere two years after launch. Same story for Spread - seven figures and a two year commitment at the time of launch, down to 15-60K.
On days with snow, rain, or wind kicking up pollen/dust, packets are dropped at comical rates. Dropping a packet is more expensive latency wise than sending it over Spread, and if the weather is bad enough, you're not getting anything through at all, which leads to dual Spread/microwave deployments. Spread knows this which is why the introduction of microwave didn't dramatically drop the price of Spread.
Bandwidth wise you used to get about 1.5Mbps over a shared link. That number is better now, but not substantially. Even with no loss there's barely enough bandwidth to carry L1 price updates on a single active market data symbol, so market data on the whole is a no go. From what I can tell most people have gone the route of transmitting many types of data over both fiber and microwave while leaving the responsibility of deduping to the receiver.
There's not much coverage on it but we'll see some interesting things on the fiber front soon. Photonic-crystal fiber is getting cheaper and we'll continue to see interesting advances on the hollow-core photonic-bandgap front in general [1]. These technologies can theoretically get very close to the speed of light (.997c) with extremely high bandwidth and low attenuation (repeaters in either fiber or microwave networks add significant latency) at which point the race to zero will stair step down again.
what protects a HFT microwave line from a targeted (perhaps even legal) attack of drones that get between line of site? or is the wave length larger than this?
There are easier ways to annoy HFT: "Every day for up to ten minutes near the London Stock Exchange, someone blocks signals from the global positioning system (GPS) network of satellites ... timestamps on trades made in financial institutions can be affected. "
http://www.economist.com/news/international/21582288-satelli...
Yea that article is a bit off & largely a marketing piece.
For a start, if you disrupt (rather than MITM attack) the GPS signal, the internal time distributor host (prob sending PTP & NTP) will fall back to their internal oscillator. Usually these are Rubidium or caesium. They will have a hold over of enough days to sort out the issue.
Secondly, Chronos Technology are trying to sell a service where you don't need to rely on GPS but they will come to your DC with a highly portable time source recently GPS synced and discipline your caesium or rubidium oscillator every n days. They are trying to be the modern day Ruth Belville*.
It is useful as an idea in cases where we don't have an easy way to set up GPS in the DC and you can live with a relative clock domain.
Throwing off the exchange generated timestamps doesn't mess with any HFTs. The exchanges themselves don't synchronize against one another so the timestamps are basically useless to begin with.
I think it is outlandish to suggest, but in theory you could time a GPS attack long enough and timestamping requirements tight enough to make the drift a problem.
I can't think of a single real use case for that level of timestamping accuracy nor a reason you would want to mess with it. But you could.
But it isn't just about the accuracy it is about the immediate degrees of drift that can occur. With GPS time disciplining removed a crap OCXO (and there are plenty) will wander off back and forth in mad errant degrees. With this used to discipline dozens of other hosts results are not always pleasant.
I have not heard of anyone intentionally interfering with microwave links, but generally speaking these RF lines are not reliable and you get gaps from time to time due to weather and whatnot. There are a couple of ways to deal with this. In the market data case, the data only flows in one direction and usually consists of sequenced messages, so you just send the data down both the microwave and a fiber path simultaneously. You can do simple line arbitration (throw away duplicates) at the receiving end.
i guess this depends if the HFT lines are owned by them. i'm not versed on the legalities of this field but as an example my neighbor put their wifi network on the same channel as me, legally interfering with my network.
If you are referring to microwaves, they are not "owned" in the same sense that for example a landline might.
Wifi has a different sort of license. In fact, it is unlicensed, and further, some of the wifi bands are secondary services to Amateur Radio, and if the wifi interferes with Amateur Radio work, it must be relocated or silenced.
Further, Wifi has built-in protocols to make channel sharing a very effective reality.
I wonder how low we could get friction for one of these things. An evacuated tunnel and magnetic suspension are probably decent, but I'm curious how much additional power would be required to get the train all the way up the uphill portion.
I was. HFT is an interesting and rich problem on its own, but its complexity and difficulty pale in comparison to cancer research.
And I don't get this "our brightest minds wasted on HFT/adclicks/etc" argument. Research positions at universities and labs are extremely competitive. There are hordes of brilliant people beating down the door to work on the problems that matter. The bottleneck is funding. A smart person who chooses to work in a higher-paying field and contributes enough financially may well have a larger impact on overall scientific progress than doing research in person.
I've never thought of that. But it sure feels liek there are a ridiculous number of positions in HFT/adclicks/etc compared to research in hospitals. Certainly, there is less respect attached to earning money than 'making a difference' in medical research, yes?
I am in fact not accusing CmonDev of hypocrisy. My point is that he very likely has good reasons for not working on a cure for cancer, such as knowing absolutely nothing about that very complicated subject. The same is true of the people who work in HFT.
Frankly, "Why aren't you curing cancer instead?" ought to be a recognized logical fallacy.
An important part of the Rothschild family fortune was apparently made in a similar way around Napoleon's Waterloo defeat, using an optical precursor of the telegraph networks. http://www.lowtechmagazine.com/2007/12/email-in-the-18.html
Along the lines of your question, the guys at escapecom also wrote a white paper [1] that covers the high level technical details, and talk through the Chicago to Jersey problem from the OP. They do also sell such gear, so there may be some bias and salesmanship in there as well, but it was a good read.
I don't see how HFT does any good for anyone. It adds no real value, and serves no purpose except to shift money from someone else's pockets, not by clever investment and market knowledge but pure technical advantage.
It's a lot like BitCoin, it turns some expensive resource (be it CPU/GPU power or optimized data links) into money, but it doesn't help with earning/generating the money in the first place, so it just extracts it from someone else.
It's a scam and should be banned worldwide. I don't know anything about trading, but I guess by making very small changes (make people hold stock for a few seconds?) you could render the whole HFT industry useless without any negative effects to the real economy.
HFT is basically just computerised market making. Market making increases liquidity and reduces spread, which is fantastic for small investors.
HFT is the reason I can personally put in an order and have it executed within 10 seconds without the price moving much. I've traded on markets with little to no liquidity, it sucks. You wait half a day for your order to fill only to have the price significantly move against you...
>> "HFT is basically just computerised market making."
Except that they are not real-deal market makers, haven't signed those contracts with the exchange, etc. Which means when times are tough, HFT's and their liquidity will vanish very quickly. And that's exactly when we need them.
if you make people hold stock for a few seconds, you will increase bid/ask spreads and that extra cost will be imposed on the real economy. The cutthroat technical competition in HFT space serves the real economy by having HFT firms spend lots of money on technology, fast computers, etc.
Perhaps spreads will increase -- but that 'extra cost' seems pretty trivial: Stock trading worked just fine when those spreads were larger. The average citizen isn't reaping the benefits of lower spreads, perhaps financial firms are, perhaps corporations are?
I'd say the larger disservice of HFT is funneling resources away from anything with real concrete meaning into this strange invented money-shuffling game in the financial world. A big drain on the potential of society's best and brightest is that many are drawn to chase money in silicon valley or in the financial world. And both options often serve to create a sort of technological bubble in which the idea of increasing 'real human value' can be lost.
Stock trading did not work just fine when those spreads were larger. Investors wound up paying substantial amounts of money to human specialists. In the same sense as most investors with basic sophistication would avoid mutual funds with management fees today, the large-spread stock markets of the 20th century basically imposed a similar fee structure on everyone just to be in the market at all. Not only that, but those fees were the product of overt collusion, as the "odd eighths" scandal illustrates.
No, no, no. Large spreads are terrible for normal investors.
It is nice to have a commercially viable use for compelling technology that is separate from the military-industrial complex though. Even well funded development stage pharmaceutical companies can have a hard time investing in speculative ideas on the hardware/software front.
Lower spreads on the underlying transactions of mutual funds leads to lower fees in the funds that make up the 401(k) plans used by the average citizen.
The invention of the atomic bomb has stopped superpowers armed to the teeth with conventional weapons from fighting each other in massive land wars every 10-20 years.
Yes, and putting everyone in jail serves the real economy by creating jobs building jails. And if we researched ways to torture people, the economy for grails and iron maidens will double maybe triple overnight!
...Just because HFT serves the economic interests of two narrow groups (traders and computer vendors) doesn't it mean it benefits the larger economy, nor does it justify it morally to the remainder of the population whose economic futures are tied up in it.
HFT doesn't move markets; it simply takes advantage of the lag between information becoming available and the market's response. By doing this, HFT makes the market respond to information faster.
This is how arbitrage works. If there is an inefficiency in the market (e.g. the speed with which the market reacts to information), someone can take advantage of it. By taking advantage of it, the inefficiency disappears. Eventually, the arbitrage becomes commoditized and the "value" of the arbitrage situation is a few points above the cost of the solution.
You can't apply morality to financial markets. All investments carry risk, and its up to each individual investor to choose securities in line with their personal risk tolerance. If the investor doesn't understand the risks involved in a security, they shouldn't be making investment decisions, full stop. If you're like the majority of US retail investors, you're buying a stock and holding it for a long time. HFT doesn't really affect you in that case, because they play both short and long positions alternated many times throughout the day, yet averaged over a period of time it's a zero sum game.
A good analogy to think of are Riemann sums vs. integrals in calculus. The actual movement of the market is the curve, but you don't know the formula of the curve and you need to measure the area under it. So you approximate the curve by sampling a number of points (the current price of the stock at any given moment) and calculating the distance from the axis. HFT effectively allows you to sample more points, getting a more accurate result by removing "arbitrage" (or space between the sampled points and the actual curve).
Actually it's a fact that they're doing that since they're playing the spread and by definition that means offering liquidity. The debatable point of course is whether it counts since they might yank all liquidity in response to unexpected movements and thus weren't offering usable liquidity.
Liquidity is that which isn't there when you need it by definition. Unexpected movement always reduces liquidity. The only interesting question is is the spread tighter when I want to trade in the presence of HFT or in its absence. Then you look at all the times that non-liquidity providers may want to buy and sell and determine that.
As far as I know it's almost always a tighter spread in the presence of HFT. So when you buy you buy cheaper and when you sell you sell for more money. The profit from market making shifts from know nothing sons of friends of the brokerage's CEO to those who can compete at something real. Everyone except those whose Daddies can get them high paying jobs wins. Financial market function more efficiently making it easer for smart people to get funding to do promising ventures. Incumbents, eh, annoying when the gravy train loses steam, really annoying.
While I agree with some of your points, I don't see how they relate to the conversation you stepped into.
> The only interesting question is is the spread tighter when I want to trade in the presence of HFT or in its absence.
There's never only one interesting question, so that's not correct. If you're seeing liquidity that disappears the second you try and touch it, it's an arguable point that's it's not real liquidity.
If you genuinely can't hit a price being shown, ever; I'd call that market a fraud. A spread you literally can't ever trade is not a spread it's a lie. I've never seen any evidence of it. And it should be really easy to spot. Spread width n millis before execution. Spread at execution. IF the latter is consistently wider it's not a market it's a con, take your business elsewhere. Of course with two players vying to be at the front of the queue showing the tightest possible price, well spying on your ioc order and backing off just means you make no money. Competition is good like that. Only one market maker in a market? Yeah that's always been a problem and likely a worse one when it's some rich, fat bastard who knows it, knows you and can rip your face off. And they do. Michael Lewis made a career out of documenting it. In the Big Short, in Liars Poker etc. etc. But it doesn't seem to happen when there's HFT does it because if you quote a market like that you make no trades and someone else gets the pennies on offer.
The actual spread that you can actually trade when you want to trade is the only thing that is interesting when discussing liquidity. No really. If that spread that you actually can trade is wider it's more expensive, if it's tighter it's less expensive to transact in the market. The rest is a load of BS. And smelly BS. That spread that you can actually trade has been shown to be consistently tighter in the presence of HFT. Evidence showing otherwise is something, we all will be very interested in.
> If you genuinely can't hit a price being shown, ever; I'd call that market a fraud.
Which is exactly what many are complaining about; welcome to the conversation.
> Spread width n millis before execution. Spread at execution. IF the latter is consistently wider it's not a market it's a con, take your business elsewhere.
Again, that's the complaint they have, see, you do understand the debate.
I'm not the one making the claim nor am I against HFT, I'm simply highlighting the fact that there are those making the claim and they do have valid arguments and they do claim to have evidence so go see their evidence.
Yeah see this is just plain silly and emphatically does not show vanishing quoted volume when you hit an order. It shows prices being adjusted when things happen on other markets.
The test is can I put a single order in to hit a price being shown on onesinglemarket and consistently miss when nothing else is going on. Because that really is fraud. This just plain isn't. This is taking info from another market and updating your price as fast as possible so you don't get arb'd as a market maker.
Why is the test one single market? Because if you're transacting a very large, (ie market moving) qty for something on multiple markets you'd expect that information to move the other markets where that instrument is being quoted. So now it's just that market makers are set up to deal with info from the other markets really fast. Maybe their link from one exchange to the next is faster than your link to the second exchange. That's clearly what is happening here. This is incredibly competitive nature of quoting really, really tight. You can't do it otherwise, you have to be wider. This is also falls under the normal definitions of efficient market hypothesis.
Note these guys who are complaining still get better prices for their market moving qty than they would get in the absence of HFT. That is with no HFT they could successfully transact all their volume at a much worse quoted price on all those markets and their investors are worse off. Effectively the worst price they get as the market moves with their big trade as they execute at multiple prices would be the best price anyone would ever show in the absence of HFT.
But hey if you're sucking as a funds manager while charging a fee that is a wealth tax in excess of 1% per annum of total wealth you've got to blame something, right? Short sellers are a popular one too despite being the basically only counter-mechanism we have for bubble inflated asset prices. And if you're a broker, some nerds cut your lunch, make them stop with their superior skills, dammit.
The width of the spread you actually get is the only thing that matters, but there is a mountain of BS fearmongering to divert your attention. That's where this convo started.
I think we've all fully expressed ourselves now. All the best.
OK, I guessed I don't have any knowledge to propose a solution here. :)
I still doubt that HFT serves the real economy in any noticable positive way. Does the HFT firm's spending on technology really outweight their effect on the traded stock? And is it aceptable that they earn money purely by gaming the system?
What "effect on trading stock"? The benefits of automated trading are not abstract: you can go ask Google for spreads from the 1980s to 2010 and see the impact.
Actually yes, it's a gut feeling and I think it's justified.
I can totally understand the general idea of stock trading and how it helps both those who have good ideas and need money and those who have the money and invest it according to their taste.
But it's very hard for me to believe that something like HFT where firms go to unbelievable lengths to implement purely technological trading advantages benefit the real economy.
The fact that financial industry as a whole just recently in the 2008/2009 crash and it's aftermath were able to extract obscene amounts of money from our governments (i.e. us) to keep the world's finance system from collapsing makes the suspection that most financial products purely based on a material advantage (be it monetary or technological) are akin to a scam very reasonable.
"I can totally understand the general idea of stock trading and how it helps both those who have good ideas and need money and those who have the money and invest it according to their taste."
This is a cognitive bias that is very prevalent (for obvious reasons) on HN. The markets are not primarily vehicles for moving money from investors to enterprises. Another important, and probably dominant, purpose of the markets is to accurately price and allow the buying and selling of risk. This is neither a new or unexpected phenomenon.
"But it's very hard for me to believe that something like HFT where firms go to unbelievable lengths to implement purely technological trading advantages benefit the real economy."
This is because of your cognitive bias and your ignorance (I mean this in the non-perjorative sense that you haven't investigated this). HFT firms, like any other trading participant, smooth demand curves generated either in time (buying from a participant now and selling later), venue (buying in one place and selling in another), or other ways. This allows other participants, who are not interested in being traders to hedge their risk more efficiently and thus more cheaply.
"The fact that financial industry as a whole just recently in the 2008/2009 crash and it's aftermath were able to extract obscene amounts of money from our governments (i.e. us) to keep the world's finance system from collapsing makes the suspection that most financial products purely based on a material advantage (be it monetary or technological) are akin to a scam very reasonable."
And now we see why gut feelings are dangerous in this discussion. You rightly feel deeply troubled by the big bailouts that cost all of us to the advantage of a very powerful few, and you correlate that with HFT. When in fact, HFT did not receive any bailouts and for the most part small independent shops without the size or power to engineer them. The 2008/2009 crash was based on non-HFT traded instruments where single deals could dwarf the entirety of the HFT industry.
What's particularly galling about this is that the anti-HFT narrative benefits the Goldmans and JPMs of the world. The largest technologically aggressive sell-side firms are smaller than the personal wealth of hedge fund principals.
Banks and hedge funds are both examples of buy-side firms. Confusing things further: the big investment banks all run operations that are morally equivalent to hedge funds.
The fact that financial industry as a whole just recently in the 2008/2009 crash and it's aftermath were able to extract obscene amounts of money from our governments (i.e. us) to keep the world's finance system from collapsing makes the suspection that most financial products purely based on a material advantage (be it monetary or technological) are akin to a scam very reasonable.
I think you're dangerously conflating HFT with the financial industry as a whole. For example, iIn 2012, the whole of HFT firms earned $1.25 billions in profits. In the same year, Goldman Sachs alone earned $7.5 billions.
HFT firms drive down the price of trading stocks by lowering the bid/ask spread, increasing competition amongst exchanges (especially in regards to fees), and spreading technology throughout the trading industry.
There is an argument to be made that they also provide needed liquidity but it is a contentious one.
I'm not sure that they actually reduce the cost of anything. I just finished reading "Flash Boys" by Michael Lewis and; as I understand it, this is how HFT works:
1. You the buyer, tell N exchanges that want to buy at a maximum price $X.
2. HFT "watches" the exchange that my bid reaches first (by milliseconds)
3. HFT traders then place themselves between you and the N-1 exchanges and offer to sell you the stock at the maximum bid price. They do this by finding the stock on those other exchanges at less than your max bid price and owning it for a fraction of a second before they sell it to you at a higher price.
This is the single biggest problem with the Michael Lewis book is that it implies that this is happening without ever walking through it.
What is actually happening is that:
1. HFT is quoting both buy and sell prices on every exchange.
2. A big buyer sends orders to all of the exchanges trying to buy (or sell) all of the available inventory at a given price.
3. On 1 exchange the big buyers order gets there earlier than on other exchanges, triggering a transaction with the HFT.
4. The HFT uses that transaction as a price signal to change their prices on all the other exchanges and if they are faster than the big buyer, the big buyer cannot take advantage of the lower price.
There is no middleman buying from 1 place and selling to another and driving up the price. What this sort of price signaling does is allow the HFT to quote smaller spreads in the more common case, when 1 participant is not trying to wipe out all of the liquidity in the market at a given price point.
I'm ignorant and only working from first principles, while you seem knowledgeable about actual practice. In your explanation, the fastest HFT knows before anyone else that the someone is buying large quantities of a stock at Exchange A at a price higher than the ask at Exchange B. From this, they know to raise their asking price at B, since they (and no one else) know that there is a buyer willing to pay a higher price.
This makes sense, and they would make some money doing this. But why wouldn't they also buy up all the stock at B that is priced less than transaction price they observed at A? If they do, they (hopefully) get to quickly resell it for a slightly higher price. If they don't, much of the order from the big buyer they are counting on will be filled with lower priced stock from their slower competitors, and they will make less money.
There is no middleman buying from 1 place and selling to another and driving up the price.
If they have the knowledge and they ability, why wouldn't they? I'd think it would be in their financial interest to do so. Or is your point that they are indeed doing what would normally be called "frontrunning", but that the knowledge comes from one exchange while the transactions all take place at another?
Let me first clarify, there very well may be certain HFT that try to do this, but it isn't a large class, because the sophistication and speed required would mean that you could market make more profitably in most instances.
The short answer to your question, is that other HFT prevent them from doing this. It is very rare for a single HFT entity to represent the entire order level at a price. Therefore just because they can react to their own transactions (the only ones that aren't on a public feed) faster doesn't mean they can react to everyone else. Further, just because demand on one exchange implies demand on others, it doesn't require it. So in the case where you read the demand wrong, and you are just changing your price you lose priority at the old price point and therefore there is an opportunity cost, but if you are actually making a transaction you lose both priority and the bid/ask spread which is a real cash cost.
Finally, we need to be very careful about the term frontrunning. It is a specific thing. Acting on the same information available to a counterparty faster than them is never frontrunning. The only time it is frontrunning is if you have a fiduciary duty to be acting on a parties behalf and you don't live up to that duty by trading ahead of orders they placed with you.
In chollida's top comment:
bigger players like Citadel pay the retail brokers for their retail flow so they can trade against the "dumb" money before anyone else. I've heard that most Canadian banks sell their flow to a big US fund that has a chance to trade against it before it reaches the market.
This sounds a lot like frontrunning, but with the behaviour split between two parties. The bank sells the information but doesn't make the trade. The HFT makes the trade, but has no fiduciary duty. It would seem that if the HFT is benefitting, and if this any any way causes the banks client to pay more, it the bank is in breach of fiduciary duty.
I'd want to be a little broader about 'frontrunning' so that it includes any case where you gain knowledge about an upcoming trade before it happens, and manage to change the market in your favor so that you profit and the original buyer pays more than they otherwise would.
If this isn't frontrunning, is there a different term for that more general case?
I am not an expert on equities law or order flow trading, but I believe that the fiduciary duty extends to the order flow purchaser (or at least the broker maintains the liability).
I know for a fact that order flow purchasers are required to conform to the NBBO prices, so in theory they can't adversely impact the price of the security.
The problem with your broader definition of front running is that it undermines basic market mechanics. If a participant expresses a desire before entering the market that desire needs to be taken into account for accurate pricing. This is true of buying cars, houses, and cheeseburgers. Why shouldn't it be true of equities?
The problem with your broader definition of front running is that it undermines basic market mechanics. If a participant expresses a desire before entering the market that desire needs to be taken into account for accurate pricing. This is true of buying cars, houses, and cheeseburgers. Why shouldn't it be true of equities?
I think it makes a large difference how that desire is expressed. If you go to a price comparison website, and click on the link that takes you to the seller's website for the item that is priced $100 less than all others, you've expressed some desire to purchase the item. If the comparison website were to sell their real time click flow to the seller, who then raised their price in the milliseconds before servicing your web page request, you'd probably feel duped. Even if there was no breach of fiduciary duty, it would probably be classified as false advertising.
Still, that's not quite parallel. I think a closer example might be domain names. You go to a site to search for whether a $10 domain name is available. It is, but you aren't ready to buy. The search site sells the search information to an HFT who buys the domain for $10 (or better, just reserves it for a month without paying anyone), and then offers to sell it to you for $100. Have they have increased market liquidity in much the same manner as the HFT for a similar degree of public benefit?
What more positive parallel story do see for cars, houses, and cheeseburgers?
"The search site sells the search information to an HFT who buys the domain for $10 (or better, just reserves it for a month without paying anyone), and then offers to sell it to you for $100. Have they have increased market liquidity in much the same manner as the HFT for a similar degree of public benefit?"
In general, I don't like speaking in analogies about HFT as it is a highly technical area that depends on details. That said, this is a particularly bad analogy because unlike equity shares, domain names are not in any way fungible. pets.com is worth way more than akjalfdj89898afdsfyyy834u384734.sexy and there is only 1 pets.com, so if a market participant makes pets.com harder to acquire they are certainly not providing liquidity.
If you really want a stretched analogy, lets assume that McDonalds has contracted with a purchasing company, to secure enough beef to support their SUPER SAD SEPT SALE of cheeseburgers where they will need an extra amount of beef. If that purchasing agent then tells his brother to go out and buy all the beef he can, and they then collude to defraud McDonalds that is probably out of bounds. Conversely, if the purchasing agent finds that the average price of beef on the market is $1 a lb, but he himself has bought some for $.90 a lb, most people would view him selling it to his client for the market rate as fair. If the purchasing agents brother has some $.93 a lb beef and pays the purchasing agent $.02 a lb to sell to McDonals for $.98 we also usually don't have a problem. Further, if the purchasing agent stocks up on Coke because he assumes the sale will drive up the price of sugar water for his other clients, that also doesn't seem out of bounds to most people. Finally, in our super stretched analogy, no one would expect a savvy farmer who notices the purchasing agent buying up all the beef around to not raise his prices.
Having read 'Flash Boys' by Michael Lewis, this post seems like the logical followup after someone discovered the first microwave tower at the end of the book.
Didn't know that the same scam is running in Europe...
There is a real problem when discussing this topic that many terms are bantered about without rigorously defining them. Most electronic trading (trading done via computers and computer networks instead of in person) exists on at least 4 spectrums.
1) How algorithmic is it? How much of the trading decision is made by a computer and how much human intervention is there.
2) How often does it trade? Some electronic trading systems can trade thousands and thousands of times a day, while others only trade a few times a quarter.
3) How long does it hold a position and/or leave a quote on the market? Some trading systems are designed to never hold positions and others hold positions constantly.
4) What latency requirements does the trade have from the time the exchange publishes data until the time an order needs to be in the market.
There are electronic trading systems that exist with variables at every end of these spectrums.
It introduces asymmetry of information. Some forms of such asymmetry are obviously unethical and illegal - the good old insider trading. Some are legal and ethical(#) - just having better research on public information is ok.
Buying extra {milli, micro}seconds to get ahead of the competition is just too new to have a general consensus on its ethical status.
(#) In the mainstream. Obviously you can find contrarians to any position.
A) these microwave towers are mainly on routes to/from commodities exchanges that have equities derivatives and the equities exchanges where the underlying equities are traded, or between 2 different commodities exchanges. Insider trading, you will find, is much less regulated in commodities trading as there is all manner of information asymmetry built into the market, in fact one of the purposes of the market is to discover a valid price in the face of this information asymmetry.
B) Buying extra time via technology is as old as trading. If you read the article, or taken an architectural tour of the CBOT building in Chicago you will have noticed that one of its main design requirements was to house telecommunications gear.
I was specifically replying to the idea that we haven't had time to judge the ethics of communication technology in trading, when it is in fact a basic market force.
I'm not an ethicist so I'm hesitant to speak on the ethics of market forces, but I will say:
A) How do you prevent some actors from getting information before others? Do all actors have to wait for the slowest participant? Why should we prevent it?
B) In general, faster dissemination of information leads to a more efficient market, we should encourage this, not discourage it.
The scam is what you use the microwave communication for. If you have access to fast lines or even faster radio comms means, that you can rig the market more efficiently.
The book has been discussed here at length[1]. I never worked in finance but it doesn't seem to hold up very well under scrutiny from experts. Comments by 'kasey_junk and 'yummyfajitas were particularly informative. The latter even wrote a couple of blog posts, including "A Fervent Defense of Front-running HFTs"[2].
Being faster is rigging the market? How does that work?
Also, it isn't called front running, at least not legally. It can't be, HFT don't have any customers. Maybe Michael Lewis has a different definition of front running but for the rest of us: words have a meaning.
HFT might not have direct customers per se, but if an order matches, they have a counterpart on each trade they make. If you have an unfair advantage for that trade, what would you call that system? Rigged? That's what the big players in the HFT field are doing by using the various tools available (near-location, co-location, fast networks, fast custom hardware and lately microwave networks).
On the term, you're right - front running might not have been the correct therm.
Every trade that happens in every market in the world can be viewed from a game theory perspective as adversarial. In the absence of other outside factors each trade in isolation is a zero sum game, that is 1 counter party will make money on the trade while another loses (at least in the form of opportunity cost). In this adversarial encounter it is expected and encouraged for all counter parties to strive for unfair advantages. Some do this by using vast swaths of overworked and underpaid ivy league grads to do market research for them. Some do this by using massive amounts of leverage others do it by being fast, some use illegally obtained proprietary information and still others do it via mobbed up boiler rooms. Some of that unfair advantage we have deemed illegal and others we have deemed legal. The point is, the existence of an advantage in a trade is a necessary condition for the market to operate correctly, not evidence of it being rigged.
You will notice that the "big" players in HFT are much smaller than the people they are taking advantage of, the giant hedge funds. The HFT competitors have access to the same technology, technologists, exchange access and microwave networks. Further, they have better access to capital and legislative power, not to mention access to best selling authors.
> Rigged? That's what the big players in the HFT field are doing by using the various tools available (near-location, co-location, fast networks, fast custom hardware and lately microwave networks).
I can't personally afford to have a Bloomberg feed in my living room to trade off of. Why is this any different?
But it does if I have to buy it at higher price just because Avis knew a that I and a few fellows where to buy the car 2 min in advance because he saw us asking about that car, bought the available stock of car we were interested in to the car dealer, propose them at a slight premium to the the car dealer who then finally sell it to me and my fellow 1 minute later at another premium because, you know, it has to make its own margin. The whole thing happening just under my nose.
That's how I (unobjectively I concede) feel about HFT.
Ok, now let's take that thought experiment and make it closer to the real world:
Imagine that Avis is buying cars in bulk and getting better deals as a result, and then imagine that the knock-on effect of them doing that is that you get better deals on cars because of how they change the way the car market works.
Car dealerships are, for obvious reasons, really fucking upset about this. And they are noisy and well-funded. Normal people start getting angry at the giant rental car companies and the unfair advantage they get, unaware of the fact that without those companies, they'd be getting screwed even worse by the dealerships.
That's what HFT does to normal investors. You don't have to take my word for it; the Chief Investment Officer at Vanguard, among many other people, has said exactly this.
If you create an ad on television stating that you are buying tons of a particular model and make of car, and then demand for that car goes up, why is this seen as a negative in a functioning economy? A functioning economy responds to demand.
Now what is the difference between sending an exchange an order for more shares than they have available and a television ad broadcasting your buying intent? In this day and age: not much.
What isn't happening: small traders, like you and I, are not sending small trades to markets and having them be "intercepted" by HFTs. HFT's wouldn't pay attention to the "guy buying one car" type of trader, and there isn't enough of a difference in the signal (your trade) and the current market price to be arbitrageable.
This would just be price correction, if a given car is becoming popular then it makes sense for it to cost more. Likewise if a given car is becoming less popular Avis would be willing to shift their excess stock at a discount.
Once again, this time with feeling: HFT firms don't prey on pension funds, mutual funds, or value investors. They improve things for those kinds of investors. HFT firms prey on other sell-side firms.
HFT has been around in Europe and is as well established as the US, so I assume the alleged scam relates directly to buying and operating Microwave networks. Seriously, please do provide more information, I am keen to learn more.
disclaimer: I've not read 'Flash Boys' yet, so apologies if it's all explained in that book
If you are interested in the topic of HFT, 'Flash Boys' might literally be the worst introduction to the industry you could read. It is rife with bias and technical incorrectness. Worse than that it is disjointed and plain poorly written (and a fair chunk of it appeared in Vanity Fair which is available online).
I have my own problems with 'Dark Pools' by Patterson, it does have some technical inaccuracy, but on the whole it paints a picture that is closer to reality and is still readable.
If what you are looking for is "narrative" non-fiction, Flash Boys and Dark Pools sort of own the corner. Of the two, Dark Pools is much better. In general, it is hard to tell a good narrative around HFT because it is so technical.
Trading & Exchanges by Harris is dated but will give you an introduction into market microstructure, keep in mind it was written before RegNMS.
Reading TCP/IP Illustrated won't teach you how to configure BGP prefix filtering regexes on a Cisco router, but the background sure is helpful. Harris is similarly helpful (and in a bunch of weird ways, similarly constructed and written) for understanding financial technology. I do software security consulting for large financial technology companies, and if you ever want to get one of their developers head's nodding, mention an example from Harris.
It's weird that more nerds on HN haven't read it. It's a great book, and it's great in a very nerdy, systems-y way.
Read the book and you'll learn why it's a scam. Only because something is well established, doesn't mean it's morally legal. Your pension funds (and so is mine) are getting screwed big time by HFT.
No they aren't. One of the largest and hands-down most respected mutual fund companies in the world, Vanguard, the company that inspired the "Bogleheads" movement, publicly stated last year that HFT had helped them, by driving down spreads.
The fact is that credible pension funds don't make their money by competing with sell-side firms. When your only job is sporadically making large block trades, you're happy to see spreads competed down as far as they can go. You don't care which market makers are winning the race to provide the cheapest possible liquidity.
Claims that buy-and-hold funds are victimized by HFT are hard to square with what Vanguard said, and with the logic of how automated trading works.
Your pension fund might be aggressively speculating in daytrading. Mine is not. You might want to look into that for reasons beyond other market participants. You can lose your shirt if you're a short term speculator very quickly, regardless of presence or absence of HFTs.
Long term investment might be a better strategy than wild speculation for a goal like that.
I believe in Flash Boys the issue is not HFT itself but that the way the market provides access favors certain parties. I could be wrong though, I've only seen the (somewhat related)documentary on the subject some time ago.
"IEX's main innovation is a 38-mile coil of optical fiber placed in front of its trading engine, which adds a round-trip delay of 700 microseconds and is believed to limit traders' ability to respond on the dark pool ahead of IEX's own pricing algorithms."
IEX is not an exchange. It is a dark pool with technology, rules and special order types specifically in place to give large hedge funds advantages over "average" investors.
They still allow collocation, venue arbitrage, and non-human timescale trading. Any electronic trade you could do on any other dark pool you can do on IEX.
The main difference between IEX and other dark pools is that they are owned by hedge funds and they either duped or bribed a famous author to write about them.
[edit] The comment below correctly points out my insinuation about bribery and Michael Lewis is unfair and snarky. I will point out that Michael Lewis wrote a glowing book about Jim Clark a decade ago, who happens to be an investor in IEX, so there is at least the potential for intentional bias.
IEX is currently not an exchange. What they offer is a dark pool connected in series with a Smart Order Router. That's what all the big brokers (e.g., JPMorgan, Morgan Stanley, Goldman, Deutsche Bank, etc.) have been offering to their customers for years and their dark pools usually offer a lot more liquidity. The big brokers have become better and better and smart order router technology to protect their customers as much as possible from HFTs. IEX is at least 5 years late to the party.
Perhaps they are planning on becoming an exchange one day, but I am not sure how they can do that while slowing down order executions. It seems to me that that would be a serious violation of Regulation NMS.
"Height, then, played an important part in facilitating that speed. A trader’s physical height became an advantage, which is part of the reason some traders were former basketball or football players – “taller traders were easier to see”. In the 1990s, some traders wore high heels in the pits to trade faster, and inevitably experienced injuries due to lack of balance. This prompted the Chicago Mercantile Exchange (CME) to impose a ruling making the maximum size of platform heels two inches in November 2000."