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Themis Trading On The "HFT Adds Liquidity" Defense
Written by Sal Arnuk of Themis Trading
There are two HFT-related articles this morning:
First, an article showcasing Getco LLC: http://online.wsj.com/article/SB125133123046162191.html
Second, an article by former POSIT founders defending Flash
Trading:
http://online.wsj.com/article/SB10001424052970203706604574374431720968204.html
I’ll start with the second article. It likens Flash Trading to
offering to sell your house to your neighbor before you list it. That
analogy is wrong. The correct real estate analogy would be that you are
about to close on selling your house to Joey for $500,000, and you
FLASH your neighbor (not Joey) about your impending deal with Joey, and
then your neighbor can step in and buy your house instead of Joey for
$500,001, or perhaps even drive to the closing before you get there,
and offer Joey his house instead of yours for $499,999. Get it now
guys?
The authors actually give an example of FLASH where a stock is
$10.00 by $10.50, where an order was FLASHED in Directedge and received
price improvement at $10.25. This FLASHED order detracted from
volatility, and added liquidity to the market. It is a philosophically
accurate and wonderful example, except for the fact that any buy side
small cap trader does not relate to that experience as much as they relate to not getting the offer, as someone “beat them to it”. And the
penalty for not getting that displayed offer is much harsher in a small
cap than in GE, where the buyer just maybe pays up $.01. Unfortunately,
we know that HFT has not added to liquidity in small caps, in which
incidentally a $.50 spread is common, but rather they have added
volatility.
Finally, the authors also say Flash Trading is no different than
shopping an order upstairs in the “pre-computer era”. The authors say
we had no problem with that shopping and process before, so why should
we now. Only they are wrong. They should ask the buy side trading
desks they used to service what they thought about the information
leakage from shopping. Heck POSIT was a huge success because it DIDNT
SHOP AND LEAK INFORMATION. Shocking.
Regarding the first article, which highlights Getco (a firm we
commend on its success and ingenuity), allow me to comment . The
article makes three points within 7 short paragraphs on the back page
of C1 : 1) Mr Tierney say that HFT’s October 2008 losses would have
been greater than the 14.1% decline the DJIA posted had it not been for
HFT. 2) Getco made $400,000,000 in 2008 in profits. 3) Getco holds few
securities by the end of each day (ie they go home flat). This does not
jive. This is a zero sum game. They went home flat. How is that adding
liquidity? How is that mitigating losses in the market? That sounds
more like adding volatility to me. No?
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Now CIT is getting in on the orgy.
Maybe this is the Goldie hedge on all those CDS that AIG is selling to the Fed..
REALITY: You fight with the strength of many men, Sir BULL.
I am Reality, King of the Markets.
[pause]
I seek the finest and the bravest traders in the land to join me
in my Court of Capitalism.
[pause]
You have proved yourself worthy; will you join me?
[pause]
You make me sad. So be it.
BLACK BULL: None shall sell.
REALITY: What?
BLACK BULL: None shall sell.
REALITY: I have no quarrel with you, good Sir BULL, but I must
make new lows.
BLACK BULL: Then you shall die.
REALITY: I command you as King of the Markets to stand aside!
BLACK BULL: I move for no man.
REALITY: So be it!
[hah]
[Market trading at $70 earnings when reality is about half that]
[parry thrust]
[REALITY chops the BLACK BULL's left arm off]
REALITY: Now stand aside, worthy adversary.
BLACK BULL: 'Tis but a scratch.
REALITY: A scratch? Your arm's off!
BLACK BULL: No, it isn't.
REALITY: Well, what's that then?
BLACK BULL: I've had worse.
REALITY: You liar!
BLACK BULL: Come on you pansy!
[hah]
[Top banks are insolvent and there are still over 5 trillion in off-balance sheet assets]
[parry thrust]
[REALITY chops the BLACK BULL's right arm off]
REALITY: Victory is mine!
[kneeling]
We thank thee Lord, that in thy merc-
[hah]
BLACK BULL: Come on then.
REALITY: What?
BLACK BULL: Have at you!
REALITY: You are indeed brave, Sir BULL, but the fight is mine.
BLACK BULL: Oh, had enough, eh?
REALITY: Look, you stupid bastard, you've got no arms left.
BLACK BULL: Yes I have.
REALITY: Look!
BLACK BULL: Just a flesh wound.
[bang]
REALITY: Look, stop that.
BLACK BULL: Chicken! Chicken!
REALITY: Look, I'll have your leg. Right!
[ 7% contraction this quarter, unemployment properly measured over 15%, world economy contracting]
[whop]
BLACK BULL: Right, I'll do you for that!
REALITY: You'll what?
BLACK BULL: Come 'ere!
REALITY: What are you going to do, bleed on me?
BLACK BULL: I'm invincible!
REALITY: You're a loony.
BLACK BULL: The Black Bull always triumphs!
Have at you! Come on then.
[yields creeping up despite monetization, commodities creeping up not on demand but production cuts and stockpiling, deleveraging continues in households, commons will be severely diluted, credit terminally distressed with expected defaults worse than the Great Depression]
[whop]
[REALITY chops the BLACK BULL's other leg off]
BLACK BULL: All right; we'll call it a draw. Oh, oh, I see, running away then. You yellow bastards! Come back here and take what's coming to you. I'll bite your legs off.
Citigroup says the same consumers that are either jobless or hanging on for their dear lives have tons of pent up demand and cannot wait to start spending again.
good articles; good articles 4 slow news day ..http://www..
hat tip: finance news & finance opinions
How can this guy not understand that you can go home flat, and have added liquidity throughout the day. At what length of holding time does he think liquidity would be added?
If you bridge the temporal gap between a buyer and seller for any amount of time that would not have been previously bridged, you have added liquidity. It can be a micro-second or a day...
Human market makers went home mostly flat too.
What the Themis guys never seem to address with regard to flash, is that using it is optional. If you don't like the execution (small cap and big position), then place your trade on a different venue. This is not hard. In fact, it is unbelievably easy (change of 4 characters).
Many of the people who don't like Flash and want to see it abolished are either:
1) mis-informed
2) want order flow back from Direct Edge (i.e. NYSE) or their proxies in Washington
Many others who proclaim publicly about the dangers of Flash are merely trying to drum up business for themselves, scaring dumb fund managers into thinking (perhaps rightly so) that they need help. This group includes Pipeline and Themis.... and of the 2, at least Pipeline does have a clue.
Flash is a total non-issue that has become politicized now, so it won't go away. Schumer will tell his ignorant constituents that he's fighting for them by working to ban flash, when, as you explained, it doesn't matter either way.
The key is: if you're getting frontrun on orders which you flash, then you will stop flashing your orders -because flashing is OPTIONAL. very simple concept.
optional by whom; exchanges or sellers ?
optional to whoever enters the order. Flash is a capability offered to order placers, not a burden foisted on the unsuspecting masses. The one who enters the order states at entry time whether they want their order to be flashed to the exchange/ECN where they sent the order (before being routed to some other exchange at higher cost). Oh, and the default is NOT to flash.
optional to whoever enters the order
that would technically mean that if 70% of the volume is " artificial " that the algos enter the order defaulted to flash; and other algos bid it up; and repeat the process; creating no liquidity; only churning; thus bidding the market higher and higher and higher; until it blows up; there is no way in hell that 100 human traders would bid indexes up when news come out catastrophic like they did since march. No way in hell, and i have traded stocks and there is no way in hell i would bid up AIG 800% in couple of days when i see the '10 and '11 Opt-Arm and Alt-A, and especially prime situation.
optional by the order sender... you can have your order NOT be flashed if you don't want it flashed. An obvious first step would be to make the default "flash" status "NO."
-KD
Chosen by the buyers and sellers - i.e. the parties placing the orders (aka the fund managers and their underlings).
They get to pick where to send the order to (BATS, Island, Direct Edge, NYSE, Instinet etc. etc. etc.).
If this is a foreign concept, it is likely because you have a retail trading account without "direct access", and you send your order into your broker's systems, and they route the order for you. If this bothers you and you want a better broker, take a look at Genesis Securities or Interactive Brokers (just to name 2 of many).
Were you managing hundreds of millions of dollars on up (or any amount really where you had to iceberg your orders and were worried about the information loss from your orders flashing), you would surely have direct market access, and the ability to place your orders on a great many trading venues (dark and light, flashed and non-flashed).
You choose when you place the order.
For a concrete example, at the bottom of page 4 of Nasdaq's BX spec you can see they added two new codes for flash orders so you'd change from one of the old codes to "S" or "F" to send it as a flash:
http://www.nasdaqtrader.com/content/technicalsupport/specifications/Trad...
If you think it's a disadvantage, don't use it.
To answer your last question: No.
Imagine the scenario where there are only three market participants (one buyer, one seller, and one third party), and one stock. The buyer enters the market wishing to buy 100 shares of the stock. The third party has previously posted an offer to sell, which the buyer is happy to accept. Some time later, the seller enters the market wishing to sell 100 shares of the stock. The third party has previously posted a bid to buy, which the seller is happy to accept.
At the end of the day, what do we have? One happy buyer, one happy seller, and one third party who provided liquidity to both trades, possibly made money on the difference in price between the two trades, and went home flat. Remind me where the problem is here?
Now, take the above example, add lots more buyers and sellers for the third party to interact with, and duplicate across the markets of lots more stocks. Now you've got lots of happy buyers, lots of happy sellers, and one high-frequency trader who, whether you like to admit it or not, provided liquidity, made a profit, didn't add to volatility, and went home flat. Oh, and was also responsible for 50% of the market volume. Scary, I know. You can close your eyes if you want to.
As with all thought experiments, this is an idealized example designed to illustrate that high-frequency trading can exhibit your stated evidence of wrongdoing (adding liquidity, being a substantial volume participant, and (gasp!) making money) without actually doing anything objectionable at all. Although I realize it serves your hysteria-inducing purposes to do so, don't forget that you could easily replace the single "third party" in the above example with two other parties (say, one retail buyer, one retail seller) without changing the outcome for the other participants or the effects on the market itself. Poof, no HFT wrongdoer, just a bunch of good guys trading away. See where your argument falls apart?
Except that when Larry Tabb looks at the end of the day, he says that 100% of the trades were HFT!
In your scenario, "the third party has previously posted a bid to buy" and an offer to sell.
That's not what HFTs do. They choose whether to trade based on opportune market conditions.
If HFTs were required to post resting orders and wait for buyers/sellers, as in your example, the marketplace would be VERY different.
Nothing in the example referenced resting orders. Just "waiting".
You can wait for a millisecond, and it is still waiting...
So long as the 2 orders placed by the "3rd party" were the best bid and ask respectively and they were placed before the "buyer" and "seller" placed the contra orders, then liquidity has been added.
Human market makers didn't post bids and asks and walk away from the screens... and their inability to react as quickly as machines contributed to the wider spreads that they produced (they countered the risk of their slow reaction time with wider profits when things went as planned).
Some HFT may wait for opportune conditions but many are almost always in the market posting resting orders and waiting for buyers and sellers exactly as you desire. Only difference is they're not required to do it. But nevertheless they seem to always be there, even when the market is melting down.
See the WSJ Getco example where Getco is bidding 24.10 and offering 24.11 on MSFT.
You are wrong. look it up in game theory
good articles; good articles 4 slow news day ..http://www..
hat tip: finance news & finance opinions
I'm not sure why high frequency traders need to defend themselves. They are not in the market in order to provide liquidity to others' benefit, but to make money. If you are against HFT in general you are essentially against people that have really really fast connections and take advantage of that. It does not mean they get information ahead of everyone else, it means they can act on that information more quickly. You seem to be more against flash orders and front running than HFT per se.
It is only a zero sum game if everyone is playing the same game. I don't believe that to be the case.
Liquidity is supposed to give information about a market. Liquidity tell you how many investors are interested in a particular stock. High liquidity used to mean that a stock was more fairly priced, because more people were trying to discover the fair price in the market. You always had to be careful of illiquid stocks because they were more risky investments - harder to get out of and more prone to gapping up or down.
HFT provides fake liquidity, since it doesn't tell us anything about price discovery, and as soon as the HFTs disappear, a stock can gap all over the place.
HFT is not useful liquidity. Illiquidity actually provides valuable risk controls in the marketplace.
Liquidity's primary benefit is to allow you to transact without moving the price which reduces transaction costs and makes the underlying price less volatile.
There's no such thing as fake liquidity. If I see a consistent 3000sh bid I can take it and be guaranteed that price. There's no opportunity for it to be fake.
mistakenly writing "jive" instead of "jibe" isn't intellectually endearing.
We're in bizarro-world. If you know what you are doing, you're getting killed or just waiting. Fucking brutal.
good articles; good articles 4 slow news day ..http://www..
hat tip: finance news & finance opinions
i think a very fundamental question should be asked: who said that adding liquidity where none previously existed is good?....(or increasing it over natural levels)
although i think some folks are creating much ado about nothing over this matter i still think that the liquidity argument is bogus....why should markets have increased liquidity beyond their natural limits?....i can see how it is a service but should the markets really be serviced this way? what are the long term effects of warping markets - even if only by a cents or fractions of cent per share?
on the other hand, pawn shops provide liquidity for all manner of crap so maybe it's not such a bad thing after all...
peterpeter,
A few points. Regarding having a choice for Flash, some venues give you that option, and some place the technological burden on third party OMS systems. Changing these systems for more flexible ones are a longer term decision and process, first of all, and more importantly, many buy side traders did not even realize their orders were "flashing". They mistakenly assumed that the exchanges they traded on would look after all participant's interests agnostically. The debate now has them at least looking into what they have to do to take ownership back of the information implied in THEIR orders.
Regarding your statement: "How can this guy not understand that you can go home flat, and have added liquidity throughout the day. At what length of holding time does he think liquidity would be added?" ...
Mr. Tierney made a statement that the October 2008 losses would be greater than 14% if it were not for HFT firms such as his, The losses would have been greater. I take issue with that statement. Logically, they made money (no issue there), they day traded around the general selling (no issue there), and they went home flat each day. So, the dollars they made each day taking pennies here and there, all day long, mitigated the decline how exactly?
I'd call you out about our not having a clue, etc., but it's just not that important. I'd rather debate the issues. The personal attacks are silly. Anyway, have a good day all of you regardless.
I can't read Tierny's mind, however I agree with his view (that the drop would have been greater) so I will share my own reasoning.
When markets hit an air pocket and move down with high volume and large percentage moves, people tend to freak out. It is human nature that causes violent market moves down that are not mirrored on the upside (i.e. there is no mirror image event to the 87 crash). There are many excellent papers which study this phenomenon (behavioral economics).
One mitigating factor in slowing down the speed of a meltdown are the computer algs which seel things falling below what they have just calculated as fair value, and step in to offer bids where normal humans (i.e. not always economically rational) would not be doing the same.
Sarnuk,
At what length of holding time would you consider a market maker to be adding liquidity? You discounted the ability to add liquidity on an intra-day basis (for reasons still unexplained), so what does it take? 1 week? 1 year?
As far as buy side firms not being aware of Flash - I do not doubt that was the case, and kudos to you and Joe at Themis for pointing out what should have been obvious but was not.
My biggest issue with Flash was that after you guys at raised the issue and Tyler and gang ran with it, there was no mad rush to understand the complexity (or really lack thereof) of changing order types and routes - but rather a call to arms against the venues that offer the order type and those who are harvesting information leakage from it.
People were getting upset about their orders being "front-run" (a grossly mis-used term - thank you for muddying the waters with that one) and were sending out notes to their hedge fund clients (I saw a 2 of these from very well known figures), rather than calling the tech guys and telling them to send the orders to XYZ instead of EDGX.
The Themis "White Paper" on the subject never mentioned the most obvious solution to the threat of flash trades - namely picking a better trading venue... Why is that?
You wrote: "and some place the technological burden on third party OMS systems. Changing these systems for more flexible ones are a longer term decision and process"
So you are saying that there are buy side firms who's systems have changed recently enough to know of the existence of ECNs like EDGX, but lack the flexibility to route orders to a particular venue? I find this really implausible. I could believe that it would require a few phone calls to deal with 3rd party companies (i.e. your OMS example), but I can't believe that there is any fund using infrastructure that can not be tailored in a matter of days to send an order to a particular venue (and I am quite willing to believe that the systems are in a state of technological dis-array).
sarnuk,
You seem to imply that this is a zero-sum game and that if GETCO made money in Oct 2008, then the market lossed that money, and shouldn't have been down as much as 14%. What GETCO was suggesting, was that by providing liquidity, they kept the markets from panicking EVEN more. Spreads blew out a fair amount, but without GETCO there, spreads could have really blown out, and then the market couldn't have REALLY shitted itself.
So GETCO's statement that they made money in the market, while helping the market from completely collapsing, might seem false at first glance, but could be (and probably is) accurate.
sarnuk,
> They went home flat. How is that adding liquidity?
Just like a specialist/MM, you can add tons of liquidity during the day and end fairly flat. If I bid 10,000sh MSFT at 24.10 and offer the same at 24.11, that is 10,000 more shares than can be bought or sold instantly with no market impact (pre-trade).
> That sounds more like adding volatility to me
No it is reducing volatility. If I need to unload a block of share of an illiquid stock and the price drops and then eventually returns to it's pre-trade level, that's unnecessary volatility. Add liquidity to the example and the price can stay relatively constant.
Several points--
Arthur Levitt is on the advisory
board of Getco--he is in favor of HFT but not
flash--gee like bite me--talking your book much??
And Getco is a "market maker--on like
what Planet?
Wait until the buy side tools up
and goes political like Getco and takes out HFT.
Allegation is that Sen Schumer went into the bag
for the NYSE, he is up for reelection?
Quelle suprise! (apologies Yves)
Soo to recap we are all huffed up on flash which
has been around since
Dick Donaldson let the CBOE
do Six++ Years Ago.
Direct Edge has been at it for 3 years.
Why the outrage now?
$$$$ and market share the Mother's Milk of Outrage Non?.
Do folks really Think that the poiticos are
out for Truth? Smell the napalm (in the morning)
Buys and Sells, Buys and Sells! The regulators are not completely politically independent. El-Erian talks of a "sugar" high. That's a joke when the reality is a crack house in Tijuana and the hard-working neighbors are looking to the Federales to do the right thing. So many fine points about market pick-pocketing! In 2000, the great specialist system was two minutes of "status"ing the GE specialist to repond to your order. This time the boys get you with speed. Tax the HFTs; that's where the money is. Wait for that to happen.....
I've heard of doing the devils bidding but isn't this just taking things a bit tooo far.
He's still lying about how it works though. It's got to be taking normalized buy sell orders and either crawling them to the top of the spread and dumping them or crawling them to the bottom of the spread and buying them up to turn around and sell them. It just all seems so interpolated and normalized on the charts.
Quick question. Where does that per share order flow rebate come from that encourages HFT- yeah the exchange- but where do they get it- it must be expensive??
There are two sides to every trade - one side adds the order to the exchange's book (this side is the liquidity provider) and the other side hits that resting order (this is the liquidity taker). A typical exchange offers the liquidity provider a rebate upon execution of their order, in order to encourage providers to place their orders on this exchange as opposed to any other. At the same time, the exchange charges the taker a fee for the privilege of trading on their exchange. The fee the exchange charges is slightly more than the rebate it offers. The exchange's gross profit is the difference between these two numbers. The important takeaway is this: the exchange profits on every trade. That is why they want to attract liquidity by offering rebates - the more orders on their system, the more likely takers are to use their system, and the more the exchange profits as a result.
Obviously the provider profits via the rebate, but in earning the rebate they're also engaging in a trade from which they must also profit in order to actually net any gain from the transaction. The typical rebate per share is far less than half a cent - anyone (HFT or otherwise) attempting to profit by collecting rebates without regard to price moves in the stock they're providing liquidity in, will very quickly find themselves out of business. The exchange, on the other hand, laughs all the way to the bank.
Thank you, I'm new.