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Pipeline Executives Confirm Abusive HFT Practices, Including Potential "Front Running"
An article in yesterday's Advanced Trading magazine, written by Pipeline executives Fred Federspiel and Alfred Berkeley, which was supposed to extol the virtues of HFT (or of the Pipeline product offering specifically, we were a little confused on that issue), ended up doing anything but, and in fact confirmed many of the concerns voiced with regard to high frequency trading in the blogosphere and in other venues.
While the positive spin on HFT presented in the article is no surprise - basically a recap of what all other proponents chime in with, it provides liquidity, it must be good, etc. (and later on, we will dissect this argument more closely), it is the negatives that AT presented, that were very surprising.
First, the focus is on what the authors call "rebate harvesting algorithms" or rebate seekers as they are more popularly known:
Some high frequency strategies "the so-called rebate harvesting algorithms" do much more than simply harvest rebates. Many rely on very short-term alpha predictions to create profitable trading opportunities, and the best of them wring every timing advantage possible from the markets. When the alpha is strong enough, they will cross the spread to take advantage of short term fluctuations. Operators of these strategies will co-locate at the exchanges or ECNs in an attempt to be the first to act on any signal to enter, or pull back from the market. The extreme measures they deploy to time their orders results in adverse selection losses for the institutional orders on the other side: the institutions trade more slowly when they should have traded quickly, and they trade too quickly when they should have held back.
The key issue here is that so called liquidity providers are in fact doing much more than just the altruistic act of collecting a third of a cent on any limit order, especially when matched with a client's own market order. This is especially true when, in the case of Goldman Sachs for example, they provide their clients almost exclusively with a market order option following VWAP for large block trades. All the while, Goldman as principal will eagerly wait on the other side of the trade, not only collecting rebates for every single trade initiated by its own clients via REDI and other market order routers, but will potentially exacerbate the "adverse selection losses for institutional order on the other side", i.e., its very own clients. Indeed, the architecture of the market is one which reinforces in a positive feedback loop adverse selection for those who are unable to unwilling to mask their participation under the guise of liquidity providers. It is in this light that the NYSE's SLP program has to be much more carefully evaluated, as even Pipeline admits there are many agendas driving "liquidity providers", of which providing (transient) liquidity being the least of.
Continuing with AT's observations:
Other high frequency trading approaches "a class of stat-arb strategies sometimes called information arbitrage" look over longer timeframes in an attempt to detect asymmetries in trading interests, and then profit by trading before institutions have a chance to finish their orders. These intra-day timing tactics have been called "front running" or "penny jumping"; they directly generate market impact losses for institutions.
And there you have it - HFT's direct and mandated involvement in what is explicitly front-running of various trading interests, as a function of information traffic speed and asymmetries. And this is not merely Flash orders - this is the whole market landscape: the underlying premise of today's HFT participants is to promote riskless (or as close to as possible) trading for those who are embedded within the market topology and have been given the green light by exchanges to "front run" or "penny jump" - call it however you want. Maybe it is time the SEC provided its own semantic definition of this phenomenon.
Another purported benefit of HFT:
Interestingly enough, the evidence shows that institutional trading costs, taken in total, have remained remarkably constant during the transition to high frequency trading. The implicit components of transaction cost " adverse selection losses, and direct market impact losses " have indeed been driven up, but the commission component has decreased in measure.
Ironically, Zero Hedge analyzed the explicit costs associated with HFT - namely implementation shortfall (slippage) and commission costs, and Pipeline's claim unfortunately seems to be far and away from the facts on this one. As we highlighted in our post "The Cost of High Frequency Trading", while commission costs have indeed decline, over the past 18 months IS costs have increased by almost 50%! The actual data, courtesy of ITG, below:
Claiming a 50% increase in HFT related costs is "remarkably constant" is a little skewed. Of course, if Pipeline can provide us with supplementary data that refutes ITG's facts, we would be happy to present it.
And the conclusion of the article: how should traders proceed in this market (assuming they do not wish to subscribe to Pipeline's product):
Exceptional traders can harvest that high frequency liquidity, while limiting adverse selection losses through sophisticated control of trade timing, and limit their impact losses through obfuscation of trading interests. An ongoing focus on state-of-the-art techniques for limiting adverse selection losses and direct market impact losses will put institutional traders, and the millions of individual savers they represent, back in the driver's seat.
Zero Hedge agrees that institutional traders, ("and the millions of individual savers", although based on Bernanke's adverse treatment of the last category from a macro economic perspective with his consistent push to devalue the dollar, it is likely that in no time America will have negative savings rates once again) will only benefit from the ongoing evaluation of all the various interrelated issues that comprise HFT, that have gone unanalyzed for far too long.
And in conclusion, returning to the topic of HFT providing liquidity, Reuters' Matt Goldstein had some prophetic words in this context: "I’m not impressed with the securities industry’s main defense of computer-driven high-frequency trading, which essentially is that all this lightning-fast trading provides liquidity and better prices for investors."
Matt has the right idea:
It’s a hard argument to swallow when you consider that many high-frequency trading programs are simply engaged in trading the same stock thousands of times a day in less than penny increments. Now maybe all those rapid-fire automated trades are getting better prices for some investors. But when a broker excessively buys and sells securities to generate higher commissions, it’s called churning, and that can result in an investor lawsuit or a regulatory sanction.
Indeed, when fast-fingered day traders were doing much the same thing as today’s high-frequency traders — albeit without the benefit of a sophisticated algorithmic program to guide them — Wall Street’s biggest firms were quick to dismiss them as either amateurs or rogues who were causing unnecessary volatility in the price of tech stocks.
And Matt's conclusion is the one that all proponents of HFT realize is the right one, yet are unwilling to put in front and center, as it goes to the very heart of the landed interests in the debate over high frequency trading:
If the main purpose of all that extra liquidity is to simply make fat profits for high-frequency traders at Goldman Sachs, UBS, GETCO, Citadel Investment Group and Interactive Brokers, that’s liquidity the markets can do without.
Zero Hedge will continue working with the proper channels to continue exposing the hypocritical charade that is HFT, and unmasking each and every unsubstantiatable defense of the vampyric technology that these days accounts for 70% of stock volume, whose sole purpose of generating 60-80% reutrns with a 5 Sharpe ratio for a very select few.
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What the fuck happened to this vaunted FDIC report that was supposed to come out yesterday and kill the markets and start the next downwave?
I WANT MY MOTHERFUCKING CHAOS AND DESTRUCTION, please.
I am Chumbawamba.
I thinks " The armagedon is coming soon" Stop the game, fair play.
I thinks " The Armageddon is coming soon"
Stop the game, fair play please !!!!!!!
Yeah, where the hell IS that FDIC report?
Muthafuggin' chaos and destruction is purported to occur during the 2009 Labor Day Bank Holiday Massacre. Something better happen quick, I'm sick of waiting
Reading a critique of the impact of HFT from Pipeline is basically their sales pitch.
Pipeline's sole business is to help buy side firms move large positions in the face of more sophisticated market participants with whom they compete.
So, Pipeline is in the business of selling their services to mutual funds and pension funds, so that they can move block trades and get reasonable exectution.
Much of the material coming out of Pipeline is quite interesting (i.e. the paper posted here a few weeks back about adverse selection and dark pools), but like everyone else - the papers that they put out are intended to highlight the value that they can bring to other market participants (i.e. stupid mutual funds who were simply unable to make a 4 character order route change to avoid using venues where their orders would be flashed!).
Pipeline is in an interesting spot. They want to have a fragmented market place with lots of odd but useful things (dark pools, flash orders, HF Traders), as well as a large group of funds who simply do not understand the trading environment, and therefore need Pipeline's help to not have terribly execution.
It is within that context that all of their work must be read.... or if you are not a ridiculously clueless manager of a large fund, safely ignored.
The only thing worse than swallowing my short positions currently, is the smug look of people who are long the market, and especially financials. Many a co-worker they are.
I think the fdic report will be released on August 27.
See http://www.vodium.com/MediapodLibrary/index.asp?library=pn100472_fdic_qu...
Tyler, it is convenient how your implementation shortfall data ends in Q4 2008, a quarter in which the extreme volatility would be expected to drive up IS. How about giving us data for the last two quarters? I'll bet anyone $1,000 that IS for the last two quarters is back in line with previous data.
Stop showing us half of the issue TD!
Tyler, your measurement of IS increasing by 50% is not quite fair. Of course IS is higher given the market swings of the last 18 months. Saying its fully a result of HFT is not fair. Further, lets all remember that short term non-algo prop traders, or short term algos not using flash or dark pool orders have equal right to the market. Fundamental analysts use certain bits of info to act on, and technical/orderflow guys use others. One is not more fair. A fundamental guy uses sales numbers (supply and demand) to make a decision, a short term trader uses supply and demand of a stock. A fundamental guy may have analysts/researchers sitting in malls to take notes - - should they be punished for having quicker information compared to fast short term traders? sounds unfair that they have the money to have employees sitting in target for the back to school sales while mom and pop cant do that...and therefore they should be banned.
Flash orders and dark pools are bad and not equal...agreed. But stop blaming short term guys whose living is every bit as legit as any fund mangager on the street reading balance sheets and looking for info edges
If you dont like lobbyists in Washington, then you should not like the fact that firms have investor relations departments or allow big funds more access to information than the little guy. The big slow trading fund has more access to speed in the form of information than 10x all this hft crap. Focus on the dinners giant fund managers like Pimco have with companies to gain information before the street gets it. Dont tell me they dont get any extra info from these meetings over too much wine than is available to the street. Is that unfair speed to info? And is that better than high speed trading on short term alpha signals based on supply and demand (if gained via equal access?).
Your headline for this post is completely misleading to serve your bias. He says, "These intra-day timing tactics have been called "front running"... "have been called". People, including ZH have inaccurately called HFT/Flash Orders front running. Maybe everyone should learn a little about front running before calling a flash order front running. If a market participant trading as principle, makes a trade because they think there is a larger buyer out there it is not front running. This is not illegal. This is the market. We all buy because we think others will buy. You are only front running if you trade in front of (as principle) your OWN client order.
An institution has numerous information advantages over other market participants- access to management, access to analysis, access to cheaper capital and execution costs, I can go on and on. Yet you are focusing on orders and HFT? Come on.
Its not called churning... This is just wrong. Churning is over trading to earn a commission. Trading to earn a profit is never churning.
IS costs rise in a volatile market- enough said.
I can't tell if this post is naive or dishonest when it claims the Pipeline article is extolling the virtues of HFT. Anyone paying attention knows that Pipeline has been badmouthing HFT for a long time and for good reason: they're selling a dark pool which they maintain is safe from the HFT evil-doers.
HFT is not front-running. A front-running example is if you give a large order to your broker and ask them to work it over several hours yet the price moves against you because they moved their own block ahead of you or they've tipped a friend. It abuses their fiduciary relationship and it's illegal. On the other hand, if you suddenly see the bid is a 50,000 share block and you quickly buy some stock figuring the price will rise, that's not frontrunning whether you do it by hand or thru an algorithm.
Similarly, churning is when your broker overtrades your account to move commission money from your pocket to his. If you are an HFT trader and your commissions are high that is your choice and harms nobody. It is not churning.
Your slippage analysis shows 42 months of declining slippage followed by 18 months of rising. The last 18 months is obviously due to the worst market meltdown in 80 years. And if the analysis went back to 2000 it would be even more clear the last 18 months was a temporary blip on a long-term downtrend in costs.
And yet ironically HFT has gone from 30% to 70% of market volume over the past two years. Notice a pattern there?
Tyler, I love ya, but this last comment and this article totally cherry picks the data as one of the last comments state. Further, the numbers on what % of volume is algo traded, hft, basket trading...etc, are ballpark guesses and lump multiple styles of trading into one basket. An example would be large buy hold and pray guys putting in vwap orders to ITG, who then splice them up into 10 zillion child orders. Thats algo trading, and each of those child orders has hft logic in them to try and beat vwap or IS, but I would not really call that hft relative to what you are talking about.
Further, this last comment is way too simplified. Its like me saying since Obama took office, the market is way up, therefore Obama is responsible for the rally. Dont dumb down this site....its been too good.
What is your argument? That IS costs are declining? Obviously not based on historical data. Explanations can be provided: volatility has i) increased or ii) HFT has become a dominant market strategy. One can also say i) and ii) are linked. But at this point a definitive conclusion can not be derived. The one independent variable that has been observed is that slippage costs have increased. And anyone claiming the opposite is wrong. Simple.
Slippage costs have increased? Over what period of time? For who? Just because ITG's slippage costs to clients has increased doesnt mean CSFB slippage costs to its clients have increased. ITG's data doesnt represent the whole market- it only represents the slippage to their clients who use ITG execution.
In addition, slippage when defined as the avg fill price of the parent order to the arrival price of the fill isnt always bad. Slippage has to be put into context. Have you ever analyzed trade data in your life?
Slippage has also decreased as volatility has decreased. Simple? Making unsupported comments is simple.
Your perspectives are appreciated. In the meantime, here are some more perspectives from Pipeline on the matter:
http://www.tradersmagazine.com/news/pipeline-blocks-high-frequency-trading-al-berkeley-104059-1.html?ET=tradersmagazine:e353:9120a:&st=email
Tyler, I would argue giant institutions are the enemy of the common mom and pop investor. It is widely known that as size increases that performance is likely to decrease. That is why small day traders can make 100% plus returns and giant mutual funds cant do that unless the market has similar returns.
Super big funds bleed clients with advertising/marketing/bloated salaries all in an attempt to beat the market by a couple basis points, and as a whole after fees miss that mark by a large margin. Mom and pops should be more concerned with them sucking 1%+ from their money than short term players. If the fund was smart, they would be more lean, cap investors and money under management, and stop paying analysts with 1 year experience 100k+.
So, sure, if you think that short term players make giant funds look silly when it comes to execution youre right. But, that to me says they are not set up for success for the investor rather than someone is a bad guy for taking advantage of their carelessness and stupidity. I think finra/sec should be going after funds, which have the same track record of beating the s&p after all fees and taxes as the 2x levered etfs do of outperforming their benchmark over time.
Looking at HFT as long/short strategy in microsecond time frames; given enough time, there will be enough players to take the other side......arb will more or less disappear and market orders will fill well.
As long as monopoly/oligopoly outcome is prevented! Your fears are well grounded in this regard.
Those entering market orders in this environment better be looking in the mirror.
40muleteam borax
Referencing a paper by Pipeline about the dangers to buy side instituions from HF Traders is about as insightful as a paper from GS about the value of HF Trading.
Each and every paper Pipeline puts out is a marketing piece for their service.
I know you have this hatred of all things relating to computers making trades faster than you can blink... but you do not make your case by referencing a puff piece by guys who's entire business is predicated on finding ludite institutions who are losing money to more sophisticated traders and solving their execution problems.
What is Pipeline going to say - there is not HF problem and your execution does not suck so stop giving us business?
The article closes with this gem:
> Berkeley: I would do exactly what Pipeline is doing. The great unsolved problem is optimizing a system for the traditional mutual fund, investment manager and pension fund. The traditional buyside is the neglected part of the market. I would want to build a system that solves the problem for the buyside moving large blocks in and out of the market. Almost everyone else is addicted to the volume that comes from high-frequency trading.
Pipeline is doing exactly what they should be doing. Writing pieces to scare buy side investors into using their services.... and for all I know, they are doing a great job with the execution. But, to reference Pipeline "research" in support of any argument against the merits of HFT is quite unreasonable. They are simply not an unbiased source.
Why should we trust those (30%, 70%) stats?
Even Matthew Goldstein@Reuters says he's uncomfortable with the Tabb group numbers:
> COLUMN-High frequency fuzzy math:
> ...
> But when pressed on how it arrived at this figure, Tabb representatives won't say.
>
> My colleague Felix Salmon, on his Reuters blog, says the Tabb figure 'is not obviously
> unreasonable,' but he would like to know more about how the firm got the figure
> (http://r.reuters.com/byz59c ). So would I, and until Tabb comes forward with more
> information, I'm not sure how reliable a statistic it is to keep quoting.
My experience is that slippage costs have decreased dramatically since 2000 but that the rate of decline has gotten slower as we've gotten closer to zero. Slippages I see are lower than 1 year ago. Not sure what ITG has been doing wrong the last several quarters but their most recent Q1 number is a lot better.
For a peek back at what life was like not so long ago here's an article from 2003 that shows how bad things were then before competition, in part from HFT, reduced the specialist's "take":
http://www.pbs.org/wsw/news/fortunearticle_20031026_04.html
Here are excerpts from the 2003 Fortune article. These are the type of practices (as well as high spreads) that HFT has helped to drive out of the market. Also, these historical costs were many pennies per share while today's costs have been reduced to fractions of a penny per share.
"SEC chairman William Donaldson and congressional lawmakers are "assessing" whether the NYSE's rules allow human market makers to impose many billions of dollars a year in extra costs on investors -- first, by grabbing markups for themselves at customers' expense; second, by forcing them to pay excessive commissions to the floor brokers who work for Wall Street firms; and ultimately by skewing the stock prices that investors pay."
"Even the NYSE admits that the specialists have at times abused their position as middlemen to fleece customers. The Big Board -- pushed hard by the SEC -- is in the midst of an investigation that has so far unearthed evidence that specialists sometimes sold investors stock from their own inventories at inflated prices when the clients could have bought it cheaper directly from another seller."
"specialist firms posted pretax margins of 37 percent to 61 percent last year, vs 9.7 percent for the big Wall Street firms."
"The buyer can't bid against the specialist because it takes him too long to cancel his initial order and enter a more competitive one. He's trapped, in other words. After several seconds have passed, the best offer for XYZ shares could have risen to $10.16."
"And that has to do with yet another advantage the specialist holds. Only he sees all the orders in his "book" on a real-time basis. "The specialist has all the information on the way the stock is going to move, and we don't," says Fidelity's DeSano. If the orders point to a rush of interest for XYZ, it's in the specialist's advantage to price-improve the seller. But that prevents the would-be buyer from securing his order before the price moves up."
"The second cost is potentially larger and more shadowy. Buyers and sellers sacrifice their anonymity by divulging their orders to the Wall Street middlemen. Most securities firms zealously try to protect that information. But Wall Street is famously a sieve -- information leaks out from everywhere. And those whispers can dramatically move the price of the shares that the fund is in the process of accumulating. "When we're bulking up on a new stock," says American Century's Wheeler, "and we give the buy ticket to a bulge-bracket firm, they can trade ahead of us on a proprietary basis after they execute the first order. We might as well write them a check."
"Eliminating the trade-through rule would be an enormous blow to firms like Merrill Lynch and Goldman Sachs. Commissions aren't quite as lucrative for Wall Street houses as they used to be, but those fees pay the bills when the really profitable businesses -- floating IPOs and secondary offerings -- are in a slump, as they have been for the past couple of years. And the specialists, who own many of the seats on the exchange, don't want any substantive change at all. So it's no surprise that the official NYSE position is to leave unwell enough alone."
Read the whole thing here:
http://www.pbs.org/wsw/news/fortunearticle_20031026_04.html
HFT has gone from 30% to 70%? Says who? Are you talking about program trading? If so, you should really review what constitutes program trading.
Please provide us with the source of this statement. (And the jokers at Themis Trading claiming HFT =70% is not a source.)
From what I understand the 70% number includes all types of quant trading, not just HFT. Its an extremely misleading number but the fear mongers love to throw it around.
> his consistent push to devalue the dollar, it is likely that in no time
> America will have negative savings rates once again
Econ 101 fail
If Bernanke was devaluing the dollar it would make exports go up and imports go down.
The trade deficit would go down.
We'd make more money on exports and we'd spend more money on imports.
Savings would go up.
Reality 101 fail
We don't make shit here anymore, doofus.
I am Chumbawamba.
Name fail
Your name is the band that made tubthumping.
Pessimism fail
Actually we are still the world's largest manufacturer. 50% larger than China at last count.
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aNW6grgakpM4
http://www.manufacturing.net/Article-Is-Anything-Made-In-The-USA-Anymore...
i wonder if this continuing pattern is a result of the HFT algos
ITG's Q109 Trading Cost Review has been available since the end of July. HFT costs aside, stop cherry-picking data to fit your editorial bias if you care about your credibility.
http://www.itg.com/news-research-events/itg-research-trends/ITGGlobalTra...
Big surprise... costs appear to be coming back down (along with volatility). But that wouldn't have supported the point of the article so obviously could not have been included in the analysis. I think they've made it pretty clear over the past few months that their credibility is not of much importance given the blatant misinformation that is propagated.
are the HFT algos causing 4 stocks to reflect 37% of the trading on the NYSE yesterday. see Denninger at http://seekingalpha.com/article/158286-analyzing-strange-volume-on-the-n...
I gotta be honest, I am tired of this. This is how I think Wall St works: If you can make money trading for yourself, why wouldnt you? Those who cant, go learn from someone who can, or from someone who cant but whose marketing is so strong they get clients to buy. Last year, mutual funds everywhere collected their fees even though they blew up their clients portfolios. Now, I am supposed to feel bad that those idiots are being picked off by the short term guys who actually risk their own money and actually only get paid if they make money rather than parasites who take fees from the masses regardless if they lose 50% in a year?
The mutual funds are the evil ones here. I say they go to a fully performance based fee system, and put them on the same playing field as the HFT and we will see who crumbles under the pressure of "fair"
I know that when I trade TNA or DIA and the few times I hit mkt sell I get filled 4-5 cents lower (2500 shares). They constantly ass rape you.
I am tearing up over here for you. It's just not fair that your order has slippage when you market sell. I recommend a strongly worded letter to the evil market participants who dont want to sell to you at the price you want.
The market reacts to every single order. Get used to it. Or maybe if you see this happening you should learn to break up your order and minimize market impact.
Oh and thank you for your 5 cps- I was on the other side of your silly trade.
Why play a game that is rigged by nearly every crossroads holder? Better to pull your liquidity from the markets and let the crosswalk guards flag themselves.
without action there is no progress
HFT/Colocation from Marketplace/NPR:
http://marketplace.publicradio.org/display/web/2009/08/26/pm-colocation/
They should cut a check to ZH...
Flash orders and dark pools are bad and not equal...agreed. But stop blaming short term guys whose living is every bit as legit as any fund mangager on the street reading balance sheets and looking for info edgesgood articles; good articles 4 slow news day ..http://www..
hat tip: finance news & finance opinions
Either you know what you're talking about and are purposefully being misleading here, or you really don't understand electronic trading. I can't see any other possibility stemming from a post like this.
"Zero Hedge analyzed the explicit costs associated with HFT - namely implementation shortfall (slippage) and commission costs..."
And your "analysis" involves quoting some ITG numbers? Is that your "analysis" of explicit costs associated with HFT???