• 24 May 2012 at 12:37 PM

Reducing High Frequency Trading By Regulating It Less

Market microstructure is a thing that I don’t really understand and that seems daunting to me so I’ll pass this along as tentatively as possible, but: I thought this piece was really good.* Again, not my area, so if you disagree just get furious at me in the comments, but I thought it might be fun to talk about it as a parable of financial regulation.

The background here is that there is a thing called high-frequency trading in which (i) people, and by “people” I mean “computers,” (ii) trade, and by “trade” I really mean more like “post bids and offers” – they trade, too, but the activity that they’re optimizing is posting bids and offers, (iii) frequently, and by “frequently” I mean “in tiny fractions of a second.” There are various worries about this thing, of which the two biggest are:
(1) computers are scary and
(2) the amount of resources devoted to this activity is staggering and probably out of proportion to its social benefit.

Worry (1) is hard to address** but maybe you’ll be a bit soothed to learn that humans can be scary too? No, I mean, fat fingering is a problem and seems to be a bigger problem with virtual fingers but let’s just bracket that and talk about worry (2).

Worry (2) can be phrased in two different ways. There’s the disinterested snooty way to phrase it, appropriate for those, like me, who aren’t exactly trading stocks a thousand times a day. This runs something like “wow, a lot of people are buying a lot of computers and building a lot of fiber optic cables*** and hiring all of the engineers in the world basically so one guy can trade stocks a nanosecond faster than the other guy with computers and cables and engineers, wouldn’t it be nice if those engineers were like engineering cancer treatments or whatever?”

The other, partisan and alarmist way of phrasing it, is “these rent-seekers are seeking my rents!,” which is appropriate if you trade lots of stocks, maybe? I don’t really get this; I suspect on balance HFTs offer improved liquidity to real-money market participants, but sometimes hose them in particularly hurtful and confusing ways, with those hosings perhaps especially concentrated at the worst possible times.

Anyway though former HFT guy Chris Stucchio tells the story in the first way, as a story of rent-seeking, and he isolates the rent that is being sought in the SEC rule prohibiting stocks from trading in increments of less than a penny:

The subpenny rule essentially acts as a price floor on liquidity – it is illegal to sell liquidity at a price lower than $0.01. … As with a classical minimum wage, two parties are harmed – the purchaser (who must pay extra) and the lower priced seller (who is pushed out of the market).

Similarly, at prices higher than $0.01, it makes price movements lumpy – on a bid ask spread of $0.05, it is illegal for someone to enter the market at price $0.049 or $0.045. Thus, at any price point, speculators are forced to compete on latency rather than on price. Price competition is only possible if one market maker is willing to offer a price at least $0.01 better than another, which is often not the case.

When price competition is impossible, market makers must compete for business via other methods – in this case latency.

His proposal is then to eliminate the subpenny rule, and lists some advantages and disadvantages****:

The first benefit is that the bid ask spread is likely to narrow (probably by about half a penny), thus making it cheaper and easier for speculators to ply their trade … [which] benefits price discovery (and presumably society in general). Realistically, this is probably not a major benefit.

A more significant benefit would be diverting labor from the latency arms race to more productive purposes. When I worked in HFT, my coworkers were extremely smart people, capable of doing many valuable things. I don’t believe the best use of such people’s labor is in reducing latency to make one HFT trade faster than another. While I don’t generally like to second guess a free market, I believe in this specific case the market mechanics line up in such a way as to make the most socially optimal option not individually optimal.

Coincidentally, he is not the only person thinking about slowing down the HFT arms race – yesterday David Merkel had another suggestion:

I have my own solution to high frequency trading: revamp all markets such that there is one auction per second in the trading day. Auctions happen at the top of each second: 9:30:00.000000… 9:30:01.000000… … 16:00:00.000000. Additionally, orders still standing at the start of any second may not be cancelled for the next second.

Auctions once per second. Click, click, click, click … 23,401 auctions per day offers more than enough flexibility to buyers and sellers. No truly economic commerce would be hindered by such an arrangement.

So if you like the idea of tamping down HFT, you could either eliminate the $0.01 minimum increment, or add a 0:01 minimum increment. How do you evaluate those proposals? Here is a Tyler Cowen post from three years ago that is skeptical about regulating HFT out of existence. It is short and all of it is good but let’s focus on this:

The more I read these debates, the more nervous I get about the idea of a financial products safety commission. Essentially on innovation we’re seeing a flipping of the burden of proof and I don’t think it is possible to easily fine-tune that flipping in a way to capture good innovations and rule out bad ones.

Right? How do you know the socially optimal amount of liquidity? How do you know if an auction once per second is the right number of auctions? It strikes me as a question not particularly capable of a priori answers though, I mean, that is a lot of auctions.

Similarly, how do you know that the right price for liquidity is $0.01 or an integral multiple thereof? Again, that doesn’t seem susceptible to a priori answers but you can sort of wave at interesting empirical answers by noticing that there are fewer stock splits and higher share prices these days, and by taking this chart from this Alphaville post as some evidence that there is a natural price for liquidity and it is not an integral number of pennies:

But that’s not the point. The point is, the subpenny rule reduces price competition and adds a relatively arbitrary regulation for traders to game: because you can’t be outbid by another bidder within the same penny increment, you get free money by just getting there first. One way to compensate for that waste might be to add another arbitrary regulation: if people are inefficiently competing to get that $0.01 at 9:45:00.5, because they’re forbidden from trading for $0.009, why not forbid them from trading at 9:45:00.5 and make everyone bid fairly at 9:45:00?

It’s not obvious that that’s a bad solution. But, compared to getting rid of the subpenny rule, it’s an inelegant solution – compensating for the ill effects of one arbitrary-number-based regulation by adding another arbitrary-number-based regulation – if you could achieve the same goals by just getting rid of both of them. (Again, there are probably ill effects of getting rid of both of them that I don’t know about, so commenter fury much appreciated.)

There are definitely lots of ways to go too far***** (and incentives for doing so) in claiming that the cause of all financial problems is financial regulation. But sometimes it’s a useful place to look. There’s lots of research suggesting that our financial system is not that great at reducing the cost of financial intermediation; part of the reason for that may be that the people involved in our financial system are really really good at focusing on regulatory regimes and finding ways to profit off of them.

Sometimes we celebrate that here: the intellectual daring, rigor and artistry deployed to game complex regulations is, when viewed in a certain light, breathtaking. And – this is just a subjective impression here – I suspect that the regulators rarely bring the same artistry and dedication to the game. Which is why, when there’s a possibility of achieving regulatory goals without playing, it’s probably worth considering.

High Frequency Trading – What’s broken and how to fix it [Chris Stucchio]
Should Stocks Trade in Increments of $.0001? [MR]
Stock splits and the volume-price correlations [FTAV]
Fewer Stock Splits, Record Share Prices [BW]

* It was in Write-Offs the other day but I was re-reminded of it by this good Marginal Revolution post this morning.

** If it worries you a lot, have I got a book recommendation for you! I did not love Robert Harris’s The Fear Index but if I were to give you a plot summary – which I won’t because it would contain spoilers – you would laugh really really hard because THE HEDGE FUND COMPUTERS ARE COMING TO GET YOU.

*** But!

**** An interesting possible disadvantage that he raises:

The other criticism is that it might be more difficult for traders to evaluate the markets. Instead of merely looking at the number of shares available at $10.00, a trader might need to add up the number of shares available at $10.0000, $10.0003, $10.0015 and $10.0029. In my view this will merely require minor modifications to behavior and the tools available – for example, trading programs might merely display a price of “no worse than $10.0029” which aggregates the prices between $10.0000 and $10.0029, and traders will need to look at cumulative price views rather than ladder views.

As someone who sometimes reads about stocks living in continuous time, this suggestion pleases me, though I suspect the technological fix is pricier than he lets on.

***** Start at like 3:15; it’s pretty silly.

73 comments (hidden for your protection)
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Comments (73)

  1. Posted by Im_a_Dude | May 24, 2012 at 12:39 PM

    finally a picture of Matt's office.

  2. Posted by Guest | May 24, 2012 at 12:42 PM

    How many trades can be executed by a HFT platform in the amount of time it takes to read this post with all source material included?

  3. Posted by Guest | May 24, 2012 at 12:44 PM

    "Again, not my area, so if you disagree just get furious at me in the comments…"

    Should have said "Again, not my area, so if you disagree just get furious at me in the comments, where I will offer no defense"

  4. Posted by NakedShort | May 24, 2012 at 12:49 PM

    furiously getting furious at Matt in the comments

  5. Posted by Also furious | May 24, 2012 at 12:56 PM

    Second

    - Guy who really wanted to make 'Furious' comment in post but didn't get there in time

  6. Posted by Deleveraging | May 24, 2012 at 12:57 PM

    I forced myself to read this post as punishment for having 3 slices of Pizza at lunch. As always, love the footnotes.

    Downloaded the book onto my Kindle.

  7. Posted by Guest | May 24, 2012 at 1:02 PM

    If you connect all those dots, and then color it in a little, that appears to be a cornucopia spraying semen everywhere.

    -Its not magic, its science.

  8. Posted by ILoveLamp | May 24, 2012 at 1:14 PM

    But what happens when they get rid of the penny altogether because it costs more in copper than it's worth? What happens to your little theory then, huh? Huh? Yeah, I thought so, bitch.

  9. Posted by getmeadrink | May 24, 2012 at 1:16 PM

    Its only the main exchanges that have this rule right? last week I bought a bunch a market and got fills at 17.7583, 17.7587, 17.7586, 17.759,17.7585. WTF. its worth doing a market order just to make CGT forms simpler.

  10. Posted by BigTrade | May 24, 2012 at 1:18 PM

    The big problem with HFT isn't price increments, it's the lifetime of a bid/ask, where trades go through on bids/asks that haven't gotten to all exchanges, therefore rendering the NBBO useless.That's how HFT make money, by seeing the market a fraction of a second before everybody. I guess a solution may be to have auctions at the top of each second and each bid/ask has a lifetime of at least half a second…

  11. Posted by Female HFT | May 24, 2012 at 1:21 PM

    I fully enjoy it when you are in my space.

  12. Posted by PermaGuestII | May 24, 2012 at 1:25 PM

    ^this

  13. Posted by evo4242 | May 24, 2012 at 1:25 PM

    Reducing the tick size would certainly impact the strategy used by market makers, but ultimately they would adapt and still use technology/speed to gain an edge. Right now, they use technology to find ways to get to the front of the queue (ahead of retail traders) for passive orders, and to be faster than retail when sending aggressive (liquidity-taking) orders. Changing tick size would only impact the former edge, as there would be no queue to sit in front of. But what would happen is that algos would be fighting to become best bid/offer by changing price by $0.0001 or whatever was the minimum increment. They would be sending and cancelling order in milliseconds virtually continuously. So a manual retail trader would almost never get his limit order filled until the stock blew through his price — which is pretty much the same situation as now. Additionally, the exchanges would probably have great difficulty mananging all the increased order sending/cancelling.

    I agree that such a change would benefit people sending market orders in highly liquid low-priced stocks (say, SIRI), but it would actually hurt limit orders, as algos would always be able to jump in front of them without substantially improving the price.

    I suppose the theory is that competition among algos would make HFT generally less attractive, and most of the players would pull out. That could happen, esp. if volumes in general plummeted. But overall, introducing a system that rewards real-time data processing (the ability to read and react to constantly flickering price changes of hundredths of a penny) will likely increase HFT's advantage vs. retail (esp. limit order users), not reduce it.

  14. Posted by Avid Iconoclast | May 24, 2012 at 1:30 PM

    Great stuff, Matt! Why couldn't they get rid of the penny rule AND institute auctions? Wouldn't that get rid of the "fighting over nanoseconds" issue while also helping liquidity?

    I think I might actually prefer reading a Matt post to a Bess post these days. In a good way!

  15. Posted by Maple Syrup Broker | May 24, 2012 at 1:30 PM

    Hasn't been a problem for us yet eh, ya hoser.

  16. Posted by Bess | May 24, 2012 at 1:30 PM

    no commenting allowed matt

  17. Posted by Guest | May 24, 2012 at 1:32 PM

    The only thing that Exhibit 9 shows is the sub-penny rule in action! 1bps on $100 is 1 cent. 2bps on $50 is 1 cent. 4bps on $25 is 1cent. This chart shows that the most-liquid names are hitting hard up against the sub-penny rule wall and probably want to go much lower.

  18. Posted by JPM | May 24, 2012 at 1:42 PM

    Matt hedging posts in deference to commentators? Pressure (and Bess's whip) is getting to him…

  19. Posted by guest | May 24, 2012 at 1:42 PM

    Apples/oranges but glad you got that off your chest?

  20. Posted by Admiral Mike Taylor | May 24, 2012 at 1:47 PM

    Matt,

    Fleet Week is here again. Looking forward to seeing you down by the docks in that pretty little dress. Should we meet at our usual place? xoxo

  21. Posted by Guest | May 24, 2012 at 1:49 PM

    Odd, I have a much different reaction to Bess's whip

  22. Posted by Guest | May 24, 2012 at 1:53 PM

    Do you think Matt gets himself jacked up by saying "I'm going to Mattack some graphs today!"? Because I want to live in a world where that happens.

  23. Posted by Duncan | May 24, 2012 at 2:06 PM

    when "they" get rid of the penny? Who's this "they"?

    Last time I looked, this was some kind of participatory near-democracy.
    Except that it's really run by the 1%.
    Which is mostly us, the readers of dealbreaker, no?

    We had trading in 12 1/2 cent increments long after the hapenny was gone.
    Trading in 6 1/4 increments and wait a sec there never even was a quarter penny, was there?

  24. Posted by Avid Iconoclast | May 24, 2012 at 2:06 PM

    Yeah! My therapist was totally right!

  25. Posted by guest | May 24, 2012 at 2:09 PM

    you can get filled at prices out to fractions of a penny but you can't provide liquidity at a spread less then a penny

    -disappointed i didn't have something snarky to say

  26. Posted by The Dealer | May 24, 2012 at 2:11 PM

    Yeah, let me see here….first the mantra was was we need to move from 16ths to 100ths to increase liquidity. Now we have less visibly displayed liquidity at each price points and off exchange executions that take place at sub-pennies. Whatever benefit to the investor was generated by the decreased spread has been lost in the costs to attain lowest latency and increased spreads in less liquid stocks.

    Listen, in your top 100 or so stocks with low spreads and tremendous volume, speed and small spreads have been beneficial. However, when you try to buy trade in a low volume issue your paying a spread that is greater than you did with an old school market maker, even if he did scalp you for a few cents.

    You can thank your regulators for regulating away the participants that stabilized markets. Today you have a bunch of algorithms that only play when they want to and will drain liquidity as soon as CNBC broadcasts a protestor throwing a molotov cocktail in Athens or Lisbon.

  27. Posted by guest | May 24, 2012 at 2:13 PM

    Matt, your summary of the article is, as usual, significantly more comprehensive (and more masturbatory) than the entire body of works of the original author, who at one point actually had something valuable to say. I award you no points, and may God have mercy on your soul.

  28. Posted by Duncan | May 24, 2012 at 2:21 PM

    Articles on market microstructure should ideally be written by people with some idea of the structure of the market.
    At least, you could find someone who knows something about the U.S. markets to reference. Is that too much to ask?

    There are so many things tarded about Stuccio's essay I hardly know where to start, but let's start with the argument that HFT's are socially wasteful.
    No, let's start with him completely ignoring the effect of maker/taker pricing on the market.
    No, let's start with penny stocks actually being priced in subpennies.
    No, let's start with 30% of trading in NMS securities occuring off-market at subpenny prices and with no quoting.
    No, let's start with consideration of the latency in the SIP, and the limitations of co-location when there are multiple market centers.

    Give me a chance to stop hyperventilating and I'll start with one of those.
    HFT's aren't a problem; they have substantially lowered the transaction costs of your 401k manager, even if you don't trade yourself.

  29. Posted by Snow White's Hymen | May 24, 2012 at 2:21 PM

    Spurious "furious" comments are curious.

  30. Posted by VonSloneker | May 24, 2012 at 2:26 PM

    I will declare total victory

    - HF Manager long 20 million nickles

  31. Posted by 401k manager | May 24, 2012 at 2:30 PM

    Your 401k manager tries to find information about an asset's value and to buy the asset if it is undervalued. The 401k manager trades in size and has to break up his total trade into small fills. After a few fills, the HFT gets the idea, drives up the price, and reduces the alpha remaining for the 401k manager. This causes the 401k manager to make less money for you, the average investor, while allowing HFTs to free-ride off the information gathering resources of the 401k manager. In the end, the average investors make less money and 401k managers have reduced incentives to collect information, reducing in both less efficient markets and poorer citizens.

  32. Posted by HighFrequencyHater | May 24, 2012 at 2:42 PM

    About the only time you see the market a faction of a second before everybody is when you're making market and get filled… and everyone will see that print on the tape as soon as it hits the market data.

    Ask ICAP how their minimum quote life implementation is working out for them..

  33. Posted by NowOnePerson | May 24, 2012 at 3:00 PM

    I forget – remind me how you were front-run before HFT?

  34. Posted by UBS Fiat Quant | May 24, 2012 at 3:04 PM

    Wow! What's that worth these days?

  35. Posted by 401k manager | May 24, 2012 at 3:09 PM

    Your 401k manager does some research on a stock and figures out its fundamental value is $35. The current trading price is $30. A passive investor needs to sell some of that stock for liquidity reasons, and has a limit order to sell at $30. After the 401k manager executes a few buys, the HFT figures out what is going on, takes all the remaining inventory from the seller at $30, and drives the price up to $35. As a result, the HFT captures about a $5 spread, the passive investor is no better or worse off than before, while the 401k manager has no remaining alpha and 401k investors are left with no alpha. The HFT free rides off the 401k manager's efforts to determine fundamental value. In equilibrium, 401k investors have less reason to try to identify fundamental value, and so less information becomes incorporated into markets, i.e. markets become less efficient. Investors need to be able to capture rents from information gathering for information gathering to continue to occur. HFTs free ride off the information gathering process and reduce alpha available to average investors.

  36. Posted by Guest | May 24, 2012 at 3:11 PM

    wrong

  37. Posted by 401k manager | May 24, 2012 at 3:11 PM

    Note that without the HFT's presence, the 401k manager would be able to capture $5 spread, the passive investor / seller would be no worse off than before, and information gathering would be rewarded.

  38. Posted by Duke of URL | May 24, 2012 at 3:14 PM

    disinterested = unbiased, impartial
    uninterested = not interested

    Learn proper English you jerk

  39. Posted by Duncan | May 24, 2012 at 3:16 PM

    We're talking about Matt's 401k manager, not mine.
    Mine, at least, has competent traders who don't tip his hand. Usually.
    I would think Matt's 401k manager probably does too.

    Buyside traders love to whine about HFT's because they're in an adversarial relationship and, let's face it, the HFT guys are smarter than the buyside.

    Before there were HFT's we used to say all the same things about Goldman Sachs, right? That doesn't mean they really were a giant vampire squid on the financial system.

    Oh, wait…

  40. Posted by PermaGuestII | May 24, 2012 at 3:20 PM

    Wasn't the fraction-to-decimal thing also supposed to "make investing simpler for the average investor," too?

    -guy who thinks that if you can't figure out that 1/4 = 0.25 you have no business investing in anything

  41. Posted by Finkle is Einhorn | May 24, 2012 at 3:24 PM

    90% of comments come from Matt today or something?

  42. Posted by Guest | May 24, 2012 at 3:46 PM

    on what fucking planet?

  43. Posted by 401k manager | May 24, 2012 at 4:08 PM

    For instance, it's much more rewarding for information gatherers to trade in emerging market stocks, OTC-traded instruments, and small cap/low-price stocks, as HFTs won't front run or can't front run you in these instruments.

  44. Posted by Guest | May 24, 2012 at 4:10 PM

    your examples are nonsense, and you clearly don't trade in bulk, nor do you have any experience trading for a large institution. it was cute try though.

  45. Posted by I semen, too | May 24, 2012 at 4:15 PM

    Best comment of day

    - Guy who sometimes confuses best / favorite

  46. Posted by jerk nut | May 24, 2012 at 4:36 PM

    1. try midpoint peg orders u fuckstick
    2. the real arms race is the es-spy basis trade, $MM to go from NJ to CHY in under 8ms
    3. the HFT firms are gonna fuck themselves anyway, as they have spent $10+MM to get the "fastest" shit, only to find out that volumes in equities and all CME produtcs is down 20%. oops

  47. Posted by obvious | May 24, 2012 at 5:07 PM

    Brain surgery is a thing that I don’t really understand and that seems daunting to me but I will anyway write a long piece about the subtle intricacies of it.

    First off, brains are pretty big and also I guess they say that most people never use more than 10% of their brains so there is a large margin of error for you when you do a surgery. Now another thing I know is that the brain is in this skull thing so you'll need like a saw or something or at least a drill. If you use a drill, make sure that you are drilling over part of the unused 90% in case the bit goes in too far.

    <more rambling musings and heuristics that have nothing whatsoever to do with the reality of the highly complex subject of the post>

    So really I think that the laws about brain surgery need to be relaxed and it is amazing what you can do with a sharp scalpel and some carefully applied novocaine.

  48. Posted by Guest | May 24, 2012 at 5:16 PM

    I'll take 401k manager's side on this one.

    Where, exactly, do HFT traders make all their money? It doesn't fall out of the sky, and goodness only knows that they aren't actually putting capital to work in anything productive.

    The more you evaluate HFT trading, the more it comes down to one simple strategy: getting in front of big trades, particularly those executed by algos, and scalping money off the big trade. I'm not convinced that there is anything more to it.

    Should it be legal? I'm not for a lot of regulation, but I have to ask what the utility to society is of allowing mid-microsecond trades. It seems that the problem is that it is enormously inefficient to trade large volumes because market trading is heavily fragmented across order sizes and execution times. Yes, the dark pools are one potential solution to that problem – but there are reasonable suspicions that the HFTs are pinging the dark pools and using that information to their advantage.

    I don't particularly like the one-second rule, but I'm not sure that there is a better way of solving the market fragmentation problem which makes it incredibly inefficient to trade in anything other than 100-share lots.

  49. Posted by Guest | May 24, 2012 at 5:20 PM

    Note that some economists have proposed increasing the tick – not to one second, but to one day. I think it is a serious question as to what the utility to society is of allowing intra-day trading. Given that most investors check their investments, and the news, daily, the people who are primarily served by intraday trading are – not surprisingly – traders. But that comes at everyone else's expense. It could be done without regulation, simply by setting up an exchange where stock trades only once a day, by auction. A radical solution, to be sure, but interesting to consider.

  50. Posted by RiceRocket | May 24, 2012 at 5:23 PM

    you're clearly not in the biz bro bc hf market makers pay extra to interact with retail orders — that is to trade against them not to race them.

  51. Posted by Guest | May 24, 2012 at 5:55 PM

    What you say about the source of high frequency traders' profits is patently false. High frequency traders replaced floor traders and traditional market makers and brought bids and asks closer together in the process – thus a small portion of the massive amount of money that floor traders/market makers used to pocket now goes to the high frequency guys and the rest of the money they used to make stays in the pockets of the market participants on either side of the trade. When we went to the decimal rule, the old school market making crowd threw a fit, and cried about the penny tick taking away their source of income. They were right, the computer trading platforms that were coming on line back then that were able to trade efficiently at $0.01 were eating their lunch – but they made far less money in aggregate doing it (relative to volume). So while you think high-frequency traders make a lot of money (and at the individual level, some of them surely do), what you're neglecting to consider is how much MORE money was being extracted from the equity markets by old school traders relative to trading volume.

  52. Posted by Guest | May 24, 2012 at 5:59 PM

    that is the dumbest fucking thing i've ever heard.

  53. Posted by 401k manager | May 24, 2012 at 6:10 PM

    i agree. another alternative is an ultra short term capital gains tax, e.g. a 99% tax on all transactions where the holding period was less than 1 week.

  54. Posted by evo4242 | May 24, 2012 at 6:21 PM

    No shit… You're talking about paying for order flow. What exactly does that have to do with tick sizes of electronic exchanges? If an individual trader and a quant firm have the same exact (correct) view of where a stock price is moving in the next second, the quant firm will beat the indiv. trader to the punch. That is my point — specifically, that the ability to be faster (a significant source of edge) is not impacted by smaller tick sizes.

  55. Posted by Pedantic Guy | May 24, 2012 at 6:52 PM

    And how exactly does the HFT know that the fundamental value is $35 (I'll ignore the absurdity of an HFT attempting to drive up the price by $5 here)? I mean, the PM's value could be $50, $30, or anything between — anything greater than $30 really. But let me work with your dumb ass.

    Let's say, as you assumed, the PM's value is $35. So he drives up the price to $35 and the PM (or his trader is driving up the price), continues buying right alongside with him, helping the price move along; but at $35, the PM has all the stock he or she wants, and stops buying. The HFT is now stuck with a bunch of stock. The fundamental guy thought that long term potential was high, so ignored the market. The market still thinks the stock is worth $30, and doesn't understand the run up, so the liquidity on the bid side is weak. Not to mention, the HFT probably aggressively bought the stock using market orders since he wanted to act before the market moved, and so payed the BA spread (trust me, offering liquidity in a rapidly trending market will get you nowhere unless you're betting against the trend). So having paid for a bunch of stock only the fundamental guy thought was worth more (on a long term basis) than $30 (what the market thinks it's worth), and paying the bid ask spread plus taker fees to acquire these shares, the HFT now has to load unload these stocks into an unwilling market, and make a profit, and more than that make a profit significant enough to cover the BA spread plus commission fees, and all this in a matter of seconds or, if the HFT is feeling adventurous, minutes.

    Oh, wait, whats that you say, it gets better. Some other HFT, seeing the price movement was, statistically speaking, an aberrational move, started selling you small amounts of stock once you and 401k manager sucked up all the liquidity at increasingly higher prices, because he knew the shit wouldn't last; but he was selling into the market and was using limit orders and only so he skipped paying the BA spread and actually got a rebate. So know he's offering liquidity to buy as the price drops, but only at a price where he'll make money (rebate, no BA spread) and you won't (you have stock you want to sell into a know rapidly falling market, so you must take liquidity, whereas he is buying in a falling market, so he can).

    Can you please explain to me exactly how this works. As far as I can tell, you thesis seems to be:

    1. Make a dumb ass trade
    2. Get on the wrong side of the market
    2. ????
    3. Profit

    Oh, and one more thing. Yes, HFT's sometimes play games with each other to move the price. We are talking about one or two pennies here, at most. Yes they sometimes detect a large order coming in and try to profit. Again, one or two pennies at most. If you want to go back to the days where you paid a 12.5 cents BA spread to trade, but got the exact price you entered fine. Me, I'll take loosing perhaps 1 or 2 cents to an HFT, and paying a 1 cent Bid Ask spread.

    –Guy who hopes this 401K manager is nowhere near his retirement funds

  56. Posted by guest | May 24, 2012 at 7:32 PM
  57. Posted by guest | May 24, 2012 at 7:35 PM

    that's similarly moronic. a week is not nearly 'ultra short term'. you might as well just prohibit something if you are going to tax it to oblivion (see: Obama)

  58. Posted by Pedantic Guy | May 24, 2012 at 7:42 PM

    Yes, yes. We see where you're going here and I like it. It's great to see some of the people in finance aren't all jerks and are actually on our side. So, while we're talking, we have this other proposal that I really think you could get behind We think any 401K manager who doesn't make at least 5% p.a. for his clients should be taxed for 100% of his or her bonus, and 99% of his/or her income, so as not to reward people making money off of losing the retirement savings of sweet old grandmothers everywhere. We're almost done, and the bill as mentioned is fine, but we're having a little trouble deciding on the best way to add in a clawback provision. As it stands the bill strikes us as a little week.

    Your's truly,
    OWS

  59. Posted by 401k manager | May 24, 2012 at 8:21 PM

    the tax is only on the gain, not the total transaction value. by taxing only the gain, you allow people to sell for liquidity reasons if they need to.

  60. Posted by 401k manager | May 24, 2012 at 8:24 PM

    only a naive investor would measure t-costs by comparing execution price relative to the prevailing bid.

    Let's say you need to buy 50,000 shares.
    the first 1,000 shares you buy at $30, the prevailing bid.

    then the bid magically moves up to $40, the ask to $40.10, and the remaining 49,000 shares you buy at $40.

    You always transacted at exactly the bid, and your broker tells you that you earned the half-spread. Is the broker being honest, or did you just lose $490,000?

    An institutional investor only cares about price relative to decision price, not the local bid-ask.

  61. Posted by Guest | May 24, 2012 at 8:37 PM

    Good point. But God help us if you ever meet Matt in real life

  62. Posted by Guest | May 24, 2012 at 9:28 PM

    Market makers just offered the 401k managers all the stock they wanted, out of the goodness of their hearts.

  63. Posted by Guest | May 24, 2012 at 10:33 PM

    Its like a nerd slap fight up in here.

  64. Posted by Bubbagump | May 24, 2012 at 10:42 PM

    Captive order flow and regulatory arbitrage through fractured marketplace and invisible orders. If you want quotes from the HFT firms saying this you can just search them up. They make their money because they can fade and trade ahead better than you can. Other ones make cash due to large amounts of captive flow. Stop yapping HFT about crap noone here seems to know about. Profits are way down over last 2 years, theres a long list of firms already under, some of them are now selling their algos to buyside. HFT is getting screwed because the guys who aren't quite fast enough or rich enough to buy location or flow are selling execution services to smart investors. HFT and payment for flow as well as dark pools have killed the traditional market maker. Canada at least is looking at the value of requiring price improvement on this, but until we dump and no one is there to catch the knife, no one is going to care.

  65. Posted by buboe | May 25, 2012 at 12:21 AM

    So your argument is that it's alright to rob, as long as you take less than the last robber?
    Thanks.

  66. Posted by evo4242 | May 25, 2012 at 2:39 AM

    What the F are you saying? That smaller HFT are suffering, and larger one ares a prospering? Not exeactly news.

  67. Posted by HFguy | May 25, 2012 at 6:37 AM

    "Market microstructure is a thing that I don’t really understand"

    I shrudder to think about the size of epitome if you did understand
    L. Tolstoy

  68. Posted by Guest | May 25, 2012 at 9:28 AM

    Well, that's more or less the response I expected on a website that is a home for people who, you know, make their money trading the markets.

    But as for "dumbest thing ever", I need to point out that there already are markets that price once daily by auction, or even less frequently – generally fixed income markets where rates (hence prices) are set periodically by auction. It's not exactly an OWS-style revolution that's being proposed here, just extending a model that is already in use in one part of the market to another.

  69. Posted by Guest | May 25, 2012 at 12:05 PM

    increase the tick to one day… that's genius! If it's a penny now going to a day is perfect!

    wait, what the fuck am I talking about?

  70. Posted by Guest | June 1, 2012 at 3:00 PM

    No, my argument is that ATMs cost bank customers less than tellers do, and somehow you disagree with me. Your argument is "but those $2 fees, man".

  71. Posted by @sternthinker | August 5, 2012 at 9:58 AM

    IMO: If one-cent increments and/or timed auctions are needed to fix the problems arising from HFT, so be it. The incentives to cheat, sometimes at TBTF levels, will drive brilliant people with vast resources to exceed the capacity of any non-fascist regulator to effectively oversee. Structural modifications are required. Surely we can agree that markets are made "imperfect" by many mechanisms — in this case, the value(?!) lost to "friction" ought to be viewed — perhaps with regret –as necessary measures. Market perfection is a straw man. Why demand of financial markets when we accept sometimes-draconian mkt imperfections in other commodities? Philip Stern

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