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Another Defense Of HFT, Promptly Refuted By New York Fed
An article today in Time magazine with the unassuming title "The Truth About High Frequency Trading" is the latest in the spin campaign defending High Frequency Trading. The story is well known- liquidity, and innocent market makers who only care about their spread without positional exposure or underlying bias.
Marketmaking explains why high-frequency trading accounts for over half of all U.S. stock volume: Every transaction begins with a trader offering to buy or sell. These days, more often than not, that trader is a high-frequency marketmaker.
Yes, high-frequency marketmakers profit from the bid-ask spread, and yes, other traders will benefit from being able to get in and out of the market more easily, but what about those who are not actively trading? Most of us aren't concerned with having a tight bid-ask spread at every moment, since we are longer-term investors interested in holding a portfolio — not continually trading.
While some assumptions in the article are naively assumed to be facts, the key flaw is that market makers simply provide liquidity with no regard for the underlying direction of the stock they make a market in. And, as author Ari Officer explains, these very market makers are almost exclusively computers who have taken over ultra fast liquidity provisioning.
Ironically, Exhibit A refuting Ari's argument comes not from a place like Zero Hedge, but from a much more "objective" and traditional venue: the New York Fed itself:
Exhibit A
A staff report paper released a week prior to the Time article titled "Are market makers uninformed and passive? Signing trades in the absence of quotes" comes to a conclusion which debunks Mr. Officer's Utopic conclusions about naive and uninterested market makers. And we quote:
When we look at the cross-section of market makers and relate the extent to which their initiated trades are inventory increasing to their profits from trading, we find a significant and positive relation. Our results provide evidence against the market maker being just an uninformed liquidity supplier. On the contrary, he seems to actively speculate on private information signals.
Not only that but the following:
We therefore conclude that for locals and duals on announcements days there indeed is a positive and significant relation between inventory increasing trades and profits from trading, with the strongest relation for the dual traders. These results are consistent with the market makers building up a position after the announcement, and earning a profit from this. The market makers that have the highest percentage of inventory increasing trades earn the highest profits. This relation is strongest for dual traders, the group of market makers with the additional information set of observing what orders customers bring to the market.
The New York Fed apologizes for bursting Time's (and other people's) bubble, but the obvious (and naive) observation that market makers are unconflicted, disciplined managers of inventory positions is singly refuted. In fact, reading between the lines, market makers are active participants in hoarding techniques pushing stocks in either direction upon observations of client traffic flow, exacerbating bid/ask discrepancies due to a lack of supply or demand in either direction.
The NY Fed's conclusion taken one step further as it applies to HFT algorithms, which advocates will claim provide just these "market making" services yet on a much larger scale, explains why so many independent observers disclose their distrust of market making activities by algorithms that, courtesy of Flash and other order flow exposing tricks, are all too well aware of which "private information signals" to analyze when making instantaneous decisions on which way to "speculate."
And when these "market makers" are in control of 70% of stock volume on any given day, to claim that stocks trade on anything even remotely connected to fundamentals, is pure lunacy. Although as the market is now an SEC-sponsored casino, why should anyone care? After all the market is only up, day after day after day. Any puke (which incidentally brings out all the volume) becomes a case of everyone rushing for the exits until some "market maker" decides to reverse the flow, and return "stability" as other participants step to the sidelines. And just like any Ponzi, as long as the overall direction is up, everyone is happy, whistleblowers like Markopolos be damned.
Full New York Fed paper presented below:
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I'm a bit naive on the subject but with the technology of today, isn't it possible to do away with human market makers who are driven by human nature, aka greed, and instead computerize the entire system and just make money off spreads like the original intent of MMs? Of course whoever owns the computers would have to be regulated to not be profit driven but alas when the regulators are in bed with the regulated you get a broken system. Now where have I seen that before?
Teh fed must die.
Speaking about magazine covers, how 'bout the rigor mortis Escher Business Week Stairstep mirror cover showing 'Why the Market Will Keep Going Up' and 'Why the Market is Going Nowhere.'
Best since the 1982 'Death of Equities' BW Cover.
Guess this new one leaves Market Going Down as the contrary choice...
JubileeProsperity.com
you're saying human market makers have no bias either?
you should continue to go after flash trading which amazingly is still technically legal, naked short selling, and getting cds listed on an exchange with some reasonable margin requirements. those are all worthy causes which seem to have died as the market rebounded in the era of 2 week attention spans.
Of course human market makers had bias! And they used to get kickbacks (todays rebates)...FLASH trading should allowed. It wasn't forced. It was optional. One could opt to flash their order or not. If you want to flash your order be advised that others(who pay a next to nothing fee for quotes) will see your hand. But at the same time, Flash orders cause locked markets. A locked market is the most efficient market!
Here is where it is going:
De-fragmented BATS model exchange
All in the Open
All public price discovery
No internal matching, black pools, etc...
Perhaps costs 20 cents per 100 units....all exchangers
If there is or is not a spread.....that's up to the marketplace....not politicians....
There should be 0 taxes on any security class in the
name of efficient capital...
The technology is here today...it's called "BATS"....
All info. can be wiki based....
This should be implemented world wide....
Also the SS issue is resolved by electronic tag....
It would not be possible to SS more than the actuals....
First come...First served....same cost to all....
May the best management win....
The technology was not available yesterday....but it is today....
That is quite hilarious.
I guess the New York Fed doesn't want it's 400 newly hired "Traders" to be taken advantage of
http://www.cnbc.com/id/32369139
"'m a bit naive on the subject but with the technology of today, isn't it possible to do away with human market makers who are driven by human nature, aka greed, and instead computerize the entire system and just make money off spreads like the original intent of MMs?"
Good question! Why can't the "markets be made" by open source, government controlled (SEC?) computer software programs?
Now that would create a level playing field for all participants, and a nice profit for uncle Sam...
the answers are right before our eyes,
yet we are all too blind to see.
Yes, exactly, the problem isn't the "old school" market maker on the floor of the NYSE; the problem is the market maker/trader that gets the orders before everyone else and trades on the information for their own prop account. To call this "market making" is total bullshit.
The idea that we need market makers due to the liquidity they provide by virtue makes the market maker biased. How does one become a market maker and not be biased? Why would any company become a market maker if there was no profit in it? Why do we need a market maker? Shouldn't the liquidity or lack-thereof define the market? Seems to me that having anyone outside the exchange be the market maker is asking for conflict of interest since no one is going to absorb the cost of operating as the market maker without being paid to do it and the fact that they're in business for profit means they're conflicted.
The only purpose for liquidity is to provide a means to trade, not necessarily to invest. If all securities bought and sold were made strictly for the purposes of investing (owning part of the security), liquidity wouldn't be an issue. But then brokers wouldn't get paid much, exchanges wouldn't get paid much, regulators wouldn't get paid much, and right on down the line. Investors who invest in a bad investment get burned, as they should, and it puts risk management back into investor's heads.
MM's (and their hi-tech progeny) are so 20th century...they just refuse to die unless they take us all down with them.
the future is open-source.
the future is now.
build it and we will come & build it with you.
leave the old boys in the dust to rot and compost.
As far as I can tell the "old school" market maker *is* the market maker/trader. Not only do they make short term profits off the bid/ask on a daily basis but also reap huge profits in intermediate and long terms plays via their segregated and omnibus accounts. The actor-turned-investment-counselor Richard Ney exposed the NYSE specialist scam back in the early 1970s and very little seems to have changed since then.
Of course, doing away with DMMs and replacing them with computers would be a cinch, but with the gargantuan risk-free profits the DMMs/Specialists are raking in, they have and will continue to move Heaven and Earth to prevent this from ever happening.
As far as I can tell the "old school" market maker *is* the market maker/trader. Not only do they make short term profits off the bid/ask on a daily basis but also reap huge profits in intermediate and long terms plays via their segregated and omnibus accounts. The actor-turned-investment-counselor Richard Ney exposed the NYSE specialist scam back in the early 1970s and very little seems to have changed since then.
Of course, doing away with DMMs and replacing them with computers would be a cinch, but with the gargantuan risk-free profits the DMMs/Specialists are raking in, they have and will continue to move Heaven and Earth to prevent this from ever happening.
Have you considered sending the conflicting data that the NY fed puts out to time. It's been cear for a while the market makers are not just market making.
It's nearly impossible to get someone to see if they are paid not to see.
Time Magazine....= SHAME !!!
p.s. Next time, try publishing your articles under anonymous writers, maybe those articles will have less bias and more objectivity. (fat chance)
even if the writers were anonymous, they'd still be corporate drone slaves to their monthly mortgage nut while the value of their assets hovers on cliff's edge.
@84090
what are you talking about? the "old school" mkt maker is long gone. most of the old specialist firms no longer exist.
the changes over the last few years have been extreme. the specialist/floor brokers used to screw you to some degree, but at least it was predictable (fair enough--they were providing liquidity at least). nowadays the robots will take you for *every* cent they can squeeze out of you (ie. you better be fighting back with an even better buy/sell algo).
Looks like Time pulled the article.
The more participants that are in a market, the more liquidity is available. Simply look at the "spread" in high volume stocks and compare it with low volume stocks. The spreads are usually one penny for stocks like GE etc, and 10 to 50 cents for low volume issues like preferred stock.
Your attempt to demonize market making activity is nieve. Sorry. Higher volume tightens the spead....and makes the market more efficient. This is as obvious as the fact that you have 5 fingers on each hand. Have you talked to anyone trying to sell a house right now? They would jump for joy if they could sell their real estate within seconds like we can stock. Short term traders make this possible.
The only part I agree with is that the people who can see orders from clients seem to do this more. Isn't that an indication that firms like Goldman and Morgan are front running, and that smaller prop shops are just good?
The only part I agree with is that the people who can see orders from clients seem to do this more. Isn't that an indication that firms like Goldman and Morgan are front running, and that smaller prop shops are just good?
On that note, anyone know where I can find a COMPLETE list of DMMs AND the stocks they make a market in? Just been looking around the web and I can't seem to find one....
I once wanted to buy a Stihl weedeater. So I went to Stihl.com and saw I could buy one and have it shipped UPS Ground for $299.99 straight to my doorstep, $324.99 for next business day.
Thus, I went down to Earl and Edith's Hardware Store and low and behold they had one on the shelf for $249.99 that they bought from their regional distributor for $200.00 that was bought from Stihl for $175.00.
I then decided to go to Home Depot where I found the same weedeater for $199.99.
Where did I buy my weedeater? And what personal relationship does HD have with Stihl? Only to keep prices low enough for everyone to make money and the customers to be happy.
Now speed up the game, and ask an investor when he wants to buy 1000sh of XYZ for his portfolio if he would like to buy:
100sh @ 22.78
200sh @ 22.80
400sh @ 22.81
300sh @ 22.84
--or--
1000sh @ 22.75 while his counterparty is willing to buy 1000sh from another investor selling his stock @ 22.74
instead of... Get my point?
Reg NMS, moron
If you are going to demonize market-makers in the NYSE model who have special rights and obligations, fine. But look at the CME or other pure order book markets where everyone has the same information. Examples such as that make it clear, without the noise of worrying about certain participant's having inside information, that you MUST have short term traders pursuing market-making strategies to maintain good liquidity.
A market structure that somehow has a market-maker in the middle that is not motivated by profit will never work, it would lose business to a real order book market. It is patently ridiculous to hang the main point of this post on the evil self-interested market maker. The use of "quotes" for conspiratorial emphasis is laughable, like most of the trading-related posts and comments on this site.
If you guys, including the zero hedge editors, do not like trading, you should stay away from it. But if you don't understand it, please don't complain about it.
And I have to say, after having been banned from posting here before, and having basically all my posts modded out, that the idea of an underground secret website based on "fight club" that filters comments? It is beyond ridiculous you look like fools.
correction - you are wise to pose my mean comment and I applaud your underground financial news blog, it is exactly like fight club should have been.
when the apocalypse comes, or when one of your slavishly devoted "registered users" shoots a magazine reporter on the sidewalk outside his apartment, you will be vindicated. the "main stream media" and other corporate sheep will all know who holds the REAL power in this country!
we can all go back to our farms and leave this 20th century madness behind!
GREAT POST!