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Interview With A High-Frequency Trader

Tyler Durden's picture




 

While the attached interview between the Casey Report and HFT expert Garrett from CalibratedConfidence will not reveal much unknown new to those who have been following the high frequency trading topic ever since ZH made it a mainstream issue in April of 2009, it will serve as a great foundation for all those new to the topic who are looking for an honest, unbiased introduction to what is otherwise a nebulous and complicated matter. We urge everyone who is even remotely interested in market structure, broken markets and the future of trading to read the observations presented below.

From Casey Report:

Interview with a High-Frequency Trading Expert

High-frequency trading (HFT) – wherein computers transact thousands of times per second with incomprehensible speed – now accounts for over 60% of all trades on American exchanges. How does this sweeping market change affect retail investors?
There are two very different answers to that question. Supporters claim that high-frequency traders (HFTs) are a net-positive market force because they provide liquidity and tighten bid-ask spreads. They say that high-frequency trading is rarely if ever used for nefarious purposes, and regulators make sure of it.

On the other side, detractors claim that HFTs regularly manipulate unaware investors and otherwise destabilize markets. They say that HFTs are a net-negative force on the market and should be reined in.

The answer surely lies somewhere in between. But which is closer to the truth? To find out, we talked to Garrett, an expert on market systems and high-frequency trading. Having experienced first-hand the problems HFTs can cause, he fits firmly in the “detractor” camp, for reasons you’ll read below. Garrett gave us excellent insight into how HFTs profit, along with tips on how to make sure they don’t profit at your expense.

I found this interview highly educational, and I hope you do too. It contains the kind of inside intelligence that separates the informed from the uninformed and allows us as individual investors to understand and adapt to our changing markets.

The Casey Report: Hello Garrett, and thanks for taking the time to chat with us. First, can you tell us your back-story and explain how you got into high-frequency trading and real-time trading research?

GARRETT: Sure. I worked for an asset management firm as a portfolio manager’s assistant. We used traditional fundamental analysis to calculate company prices. Beginning with the July 2011 crash, our strategy no longer seemed to be working. We lost a lot of our clients’ money – nearly 40%. It was brutal.

During that same time, I started to notice odd price movements on my charts, ones that I had never seen before. Prices would randomly spike in amounts and directions that made no sense. When I dug deeper, I realized the movements were too fast and too uniform to be human. Computers caused them.

My bosses didn’t understand this, and didn’t want to. I couldn’t raise my concerns because of the old-school culture of the firm. But that refusal to acknowledge the new reality – that computers were increasingly driving the market – was leaving my firm at an enormous competitive disadvantage. Essentially, the market was changing, and we weren’t adapting.

I began to study high-frequency trading on my own. I started by following a few professionals who were sounding the alarm, trying to alert investors that the game has changed. My favorite sources were (and are) Themis Trading and Nanex.

Eventually, I narrowed my focus to study the market micro-structure – which is basically what happens to orders after you click the “buy” or “sell” button on your brokerage platform. That’s where all the action is, and it’s where you can see exactly what the HFTs are doing.

I came to the conclusion that, because of HFTs, our markets are broken and fragmented. I left my old firm in mid-December, took my own money and started running my own shop, based on this premise. My strategy uses software to exploit the dislocations caused by HFT.

TCR: What made you think that high-frequency trading was behind those strange price movements you were seeing?

GARRETT: For one, the movement didn’t look like anything I’d seen in the past. It didn’t match human action. It was too fast, too consistent.

Anomalies would randomly pop up on my screen. A particular stock would drop 10% in one second, then run right back up a second later. I asked colleagues what these movements were and where they were coming from, but no one had an answer. Even the shortest-term charts, in which every data point represents one second and the data is extremely granular (or so I thought) didn’t yield any answers.

Eventually, through my own research, I realized that there was something more going on inside these one-second data points - something you can’t see on a standard chart. That’s where the HFTs operate – in milliseconds.

TCR: So you’ve made a career of exploiting the dislocations caused by HFTs. What’s your answer to the question on everyone’s mind: does high-frequency trading affect the average retail investor?

GARRETT: Absolutely, although the impact varies based on what type of investor you are. For a shortterm trader, someone who makes many trades per month, the effects are huge.

I think the best way to understand HFT’s impact on you is to understand its advantages over you. There are three major ones.

One, HFTs have better access to the market. They have what we call direct access, which means they don’t have to go through a broker to execute their trades. When you place an order with, say, Scottrade, Scottrade will choose which exchange the order goes to, and they’re going to execute the order where it’s best for them. They’re going to buy it at the best price they can and then sell it to you.

HFTs, on the other hand, can choose the exchange that they want to trade on. They can look at all the prices for a given stock on all of the exchanges and make their own decision, rather than having a broker make it for them.

Two, HFTs obviously have a major speed advantage over other investors. They glean this advantage in many ways: by putting their servers right next to the exchanges’ servers, by using very sophisticated equipment, and also simply by virtue of programming a computer to act on pre-set instructions, which it can do much, much faster than a human ever could.

Third, the best HFTs have an impeccable understanding of the market micro-structure: what happens after you submit an order to your broker? Where does your order go, how is it executed, how are orders prioritized? HFTs are experts on this, but very few retail investors even understand the basics.

TCR: It sounds like the average investor is seriously outgunned. But what about a retail investor with a longer timeframe who only makes 1-2 trades a month? Does he need to worry about high-frequency trading?

GARRETT: HFT affects all investors to an extent, because stocks are now priced differently than in the past. The market used to consist mostly of investors analyzing cash flows and balance sheets, trying to calculate a company’s fair value. HFTs, on the other hand, react to movements in stock prices alone. That is not necessarily a bad thing, but since HFTs are responsible for two-thirds of the trading volume, we have the strange situation where they can set the price based on what they perceive others’ perceptions to be.

Also, even long-term investors have to enter and exit their trades at some point, which is where the most risk is. You might enter the trade when the computers are doing their trending movements and inadvertently buy at a peak.

TCR: What are trending movements?

GARRETT: Trending movements are when an HFT deliberately moves a stock price up or down for its own benefit. For example, a computer can submit an overwhelming number of sell orders, knock the price of a stock down a few percentage points, then buy the stock back cheaply.

TCR: That sounds like overt manipulation.

GARRETT: It is, which is why investors need to understand how to protect themselves. One of the most important tips I can give you is to never enter stop-losses into the market. There are algos designed to sniff out stop-losses and manipulate them against you.

I’ve seen this many times: prices drop 2-4%, clear out stop-losses, then run up for substantial profits. So the poor retail investor gets his stop-loss tripped and sells on the cheap to an HFT, whereas the HFT buys cheap and profits once the price ramps back up.

TCR: Do HFTs target smaller or illiquid stocks because their prices are easier to move?

GARRETT: Sometimes, but I wouldn’t make that generalization. Counterintuitively, many HFTs target the most liquid stocks.

TCR: So what are some other ways that HFT shops make money?

GARRETT: There are many different strategies. Some take advantage of rebates, which are financial incentives the exchanges offer for being a market-maker.

Here’s where I should clarify that not all HFTs are bad. I’m very sour on HFTs in general because I’ve seen the havoc they can wreak, but there are good ones. Market-makers increase liquidity and make the markets more efficient. That’s great. There are good HFTs.

Some HFTs try to read and process the news quicker than everyone else. There are algorithms designed to read newspaper headlines, search for key words and execute trades based on what they read, all in seconds or less. I wouldn’t say this is particularly nefarious, because the HFTs in this case are just doing what humans do – trading the news – but faster.

That said, it can create problems. Awhile back, there was an errant news release about Boeing going bankrupt, and the HFTs started selling because they saw the keywords “bankruptcy” and “Boeing.” The story turned out to be an error.

In that situation, most human traders would pause and think, “Wait a minute, I’ve never heard a thing about Boeing going bankrupt. What’s going on here?” But the computers don’t think. They just execute their instructions, and in this case, it caused a crash.

Then there are the manipulative algorithms, the ones that prey on other investors.

TCR: Can you give us an example?

GARRETT: Sure. Many HFTs will make near-simultaneous trades on different exchanges and profit because of the delay in one of the exchanges. An example will help me explain: let’s use the NASDAQ and EDGE exchanges, and say that ABC stock is trading at $1.00.

The HFT will send a bunch of quotes (offers) to NASDAQ and EDGE, trying to sell ABC stock at $1.01. Once the NASDAQ order is accepted, the HFT can simultaneously cancel the $1.01 sell order on the EDGE exchange and replace it with a buy order at the original price of $1.00. EDGE immediately accepts that $1.00 order, because its system has not caught up to the new price of $1.01, and the HFT’s net position becomes zero.

This is possible because of latency, which is jargon for delay in the system. The net result is, the HFT captures a $0.01 arbitrage.

By scalping this tiny amount from many trades, the profits add up quickly.

A second example: HFTs can model other traders’ behavior. When someone trades through Scottrade or Interactive Brokers, their order has a unique number attached to it – the same number every time a client places an order. This number is bundled with all relevant trade information (time, price, etc.) and sold as an encrypted “enhanced data feed.” An HFT can then use those past results to predict the trader’s behavior.

TCR: So HFTs try to predict what you’re going to do before you do it. Do the brokers admit to selling this information? Can traders opt out?

GARRETT: This data is standard and available to anyone who wants to buy it, so it’s not that HFTs are purchasing illegal information. But the data set is huge and is only of practical use to players with very fast and powerful computers – meaning HFTs. And yes, most brokers I have encountered will allow you to opt out of having your unique number attached to your information.

To be clear, I’m not saying HFTs track your individual account and literally jump in front of you right before you trade. But they do use this information on the aggregate to model traders’ behavior. So an HFT could have a very good idea of when traders on, say, E*TRADE’s book will enter into a certain transaction.

TCR: Many defenders of HFT claim that it is a net-positive force in the market because it provides much-needed liquidity and tightens the spread between bid and ask. Are those claims true?

GARRETT: As I said earlier, there are many different HFTs that do many different things. But in my experience, in the aggregate, both of those claims are false. High-frequency trading will reduce liquidity when we need it most, and will flood the system with nonsense at other times.

Case in point, computers regularly withdraw liquidity just before news releases. Oil is a great example. The other day, there was a status report scheduled at 10:30, and around 10:28-10:29, the buy orders on USO (United States Oil Fund, an ETF that aims to track oil) dried up. That doesn’t happen with human traders.

So anyone who wants to get out of USO before the news release is out of luck; they can either take a bad price or wait until liquidity comes back.

Contrast that with the end of most trading days, when HFTs are unwinding their positions; I actually turn my platforms off for the last 10 minutes of the day because the action is confusing and useless. Sure, there’s plenty of liquidity as the HFTs unwind, but the action is just nonsensical. There’s no new information being introduced, no price discovery. It’s just scalping.

The whole liquidity argument is just a justification. On net, HFTs hurt liquidity more than they help.

I also don’t buy the argument that HFTs keep the bid-and-ask spread tight. I’ve seen algorithms that quote as far away from the NBBO as they are legally allowed to.

TCR: Can you expand on that?

GARRETT: SEC rules say traders can quote up to 8% from what the National Best Bid and Offer is, and they’re allowed to “drift” another 1.5%. So legally, traders can trade 9.5% above or below the NBBO.

Well, there are algos that probe the market, starting by submitting an order close to the NBBO, then working out to the fringes. These orders only last for milliseconds – they are not intended to be hit, only to sniff out other traders’ orders. So the algo works its way out, trying to get a bite on a price further away from the NBBO, and thus more favorable to them.

That is not a recipe for a tight spread. Now, the spread might look tight on your screen, but when you actually go to fill an order, you won’t get it, because the order has already been withdrawn.

Think of it like a dying star. When a star dies, we still see its light here on Earth, because the light is still traveling to earth. When an HFT cancels an order, your comparatively slow computer still sees the order for awhile. Then you try to fill it and it’s “Sorry, that order no longer exists.”

TCR: So are the quotes on Google Finance or Yahoo Finance reliable?

GARRETT: They are reliable enough to use as a broad snapshot. But I would not trade on them.

TCR: What markets are least affected by HFT?

GARRETT: I don’t know the answer to that. I see HFT the most in equities, but that’s just because I trade equities. It’s also prevalent in futures and Forex.

Within equities, HFTs tend to focus heavily on ETFs. The manipulation is far less in most individual stocks.

TCR: Good to know. What long-term effects do you see as a result of HFT?

GARRETT: I think the biggest issue is the erosion of trust. The markets are becoming so difficult to understand, and there are so many predators, that I think people will start to withdraw and place their money elsewhere.

When investors start to realize (a) they don’t know enough about the market, and (b) the learning curve is so steep as to be almost unnavigable for someone with a full-time job, they’ll start to take their money elsewhere. Instead of the stock market, why not go to lendingclub.com? Then they can at least invest money with someone in their community and actually know what’s happening with their capital. Not to mention, it will probably get them a better return.

This is a little off topic, but dark pools are another example of shady market practices. Dark pools are arrangements between large institutions to trade blocks of shares among themselves. The problem is, these trades can only be seen by the participants – you and I can’t see them. They occur outside the market.

Themis Trading did a white paper called the Phantom Indexes, and they found that only 30% of all traded assets are traded on visible exchanges. Think about that: it means that indexes – like the Dow and S&P 500 – are being calculated with only 30% of actual volume. The majority of trades – 70% – occurs in the dark and is not factored into the indices.

It’s a little bizarre if you ask me. I don’t understand why that’s allowed. But it’s another example of market trust being whittled away. It won’t be easy to earn it back.

TCR: So you think the average investor will begin to shun the stock market?

GARRETT: Yes, but I also think it’s possible that companies like PIMCO and BlackRock create their own exchanges and compete to make things fairer for their clients. That would be a viable alternative to our national exchanges, which are losing credibility fast.

The federal exchanges have sold their character. Take co-location, for example, which is when HFTs put their servers as close as possible to the exchange to gain a speed advantage.

I understand that NASDAQ wants to make money by selling these spots. But not everyone can be located directly next to the exchange. So Goldman buys a co-located spot for millions of dollars, which is great for them, but not so much for everyone else. Once again, the little guy gets bilked.

TCR: Do you think there will be regulatory responses? Might the government ban HFT?

GARRETT: I don’t see how. The quicker players will always have an advantage. There will always be traders located closer to the exchanges than others. But there are some steps that would help.

One proposal that I like is to mark the orders that are designed to last for 250 milliseconds or less – the ones that are designed never to be filled. That way, when I see an order on my screen, I’ll know if it’s a legitimate order or just a computer trying to accomplish who knows what.

The thing is, the SEC already has rules against placing orders not intended to be filled. Obviously, it doesn’t enforce them very well.

I think anything that would slow down the market a bit would help. That would bring more humans back as a percentage of traders, which is a good thing. TCR: What about a transaction tax?

GARRETT: That sounds like a sad excuse to raise revenue. It’s not going to deter the big guys with the deep pockets. Once again, it would end up hurting the little guys, who already pay much higher transaction costs.

As I’m sure you and your readers are well aware, raising the cost of doing something doesn’t usually have the intended effect. The government has tried to make it more expensive for people to get DWIs, guns and drugs. None of it has worked.

If anything, a transaction tax will hurt the marginal players. The big, deep-pocketed institutions would be fine with a tax. They might even welcome it.

Remember, it’s all about speed, and you’re not going to fill that gap by taxing people. You’re only going to fill it by controlling the way information is streamed. It needs to be slowed down.

TCR: Before we wrap up, can we recap and summarize how HFT affects the individual investor and what he/she can do about it? From our conversation, I count three broad types of manipulation.

The first occurs during the transaction, when you’re buying or selling a stock. For example, an algo could use your stop-loss against you.

GARRETT: Yes. Keep stop-losses in your head, not entered into the market.

Also, we didn’t talk about this, and it should be obvious, but I’ll say it anyway: don’t place market orders unless you want to get shammed. If you place an order and see the price is $15.60 on your screen, your order can be rerouted, filled on a different exchange for, say, $15.65, and you just donated 5 cents a share to an HFT.

TCR: We’ve always advised our readers to use limit orders, even before HFT. Now it’s doubly important. The second major impact is that HFT actually misprices stocks, meaning market prices are different than they would otherwise be in the absence of computers.

GARRETT: Exactly. Fundamental investors used to dominate the market. They would buy and sell based on companies’ results.

Today, HFTs outnumber humans in trade volume and thus are a stronger force on prices. HFTs buy and sell based on what they perceive others’ perceptions to be, as quirky as that sounds. So instead of analyzing revenue and expenses, computers analyze how other market participants act, and trade accordingly.

TCR: It seems that normal investors can counteract this by investing for the long term. HFTs create a lot of noise, trying to guess what other traders will do. But ultimately, if a company is profiting, its stock will do well.

GARRETT: Precisely. You don’t want to get into a trading battle with them. But if you have a long-time horizon, fundamental investing can still work.

TCR: Third, computers manipulate stock prices up and down, using the movement to their advantage. This seems to be the most nefarious and overtly manipulative. Is there any way to counteract it?

GARRETT: You can mitigate this risk by being patient with your orders. If you enter a limit order and it isn’t hit in the first hour, don’t impatiently move it. Stand your ground. That way, you can dictate the price you take, even in the midst of all the HFT noise.

Also, HFTs love to manipulate ETFs, much more so than individual stocks. So that’s something to keep in mind.

TCR: Great. Anything else?

GARRETT: I do want to add one more thing: talking to you about this actually hurts my trading system in the long run, but truthfully, my strategy of exploiting dislocations shouldn’t exist. For all I know, I’m taking money from my parents’ retirement fund because their financial advisor doesn’t understand what he’s doing. I want my kid to be able to invest legitimately when he’s older. Pillaging unsophisticated investors is bad for everyone in the long run, so I want this information out in the open.

TCR: Well, this has been a very educational discussion, so mission accomplished. Thank you very much for speaking with us today.

GARRETT: My pleasure.

An expert on market micro-structure, Garrett leverages his vast knowledge of stock exchanges to build trading
systems. A former “traditional” investment professional, Garrett now operates a profitable system that capitalizes
on the market dislocations created by HFT. He resides in upstate New York and has a B.S. in finance from Niagara
University with a concentration in economics. He is the founder of CalibratedConfidence.com and is a frequent
contributor to FloatingPath.com.

 

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Fri, 08/03/2012 - 16:09 | 2676723 alangreedspank
alangreedspank's picture

HFT hating = modern day Luddites. Now, I'm not saying the individual interviewed is a hater, I'm just saying. The stock market was always a brutal place to be, contrary to the governement spun propaganda to get you to fork over your money into a 401k.

 

Fri, 08/03/2012 - 16:10 | 2676735 CalibratedConfidence
CalibratedConfidence's picture

I'm just pissed because we have rules that the SEC is not enforcing and we have people making Headline claims that are not factual truths in the market.  I'm not a journalist.  I'm a trader who writes because MSM misses the ball.  I'm no hater on all HFT, just the bad ones and the ones that break the rules that are already in place.

Fri, 08/03/2012 - 16:15 | 2676744 alangreedspank
alangreedspank's picture

I hear ya. But I would not be looking for the SEC to save the day. The SEC is part of the problem. If you'd try to start your own exchange with HFT rules lots of other might find interesting to trade within, the SEC would jail your ass for not going through their hundreds of fire hoops to get approved.

Fri, 08/03/2012 - 16:38 | 2676795 CalibratedConfidence
CalibratedConfidence's picture

exactly. All we can do as human traders is know our enemy and understand the maker plumbing

Sat, 08/04/2012 - 15:15 | 2678354 Centurion9.41
Centurion9.41's picture

Okay.  But you explain things so poorly that you open your thoughts to looking naive and being torn apart.

Fri, 08/03/2012 - 18:04 | 2676985 Blankenstein
Blankenstein's picture

That's naive, not all technological advances are a positive thing.  I find HFT analogous to doping in sports.  The athlete is either not willing to work harder or not talented enough, but believes he deserves the medal or contract anyway.  And he doesn't care if his balls fall off or has roid rage.  

With HFT, just hire some computer nerds to write your programs, no need for researching and analyzing just "gimme the money I deserve it."  He doesn't care if he manipulates the market and jeporadizes the whole system.

Sat, 08/04/2012 - 14:53 | 2678318 billsykes
billsykes's picture

Not even close to doping. with sports you are competing against other humans. Maybe man vs dragracer with machine guns would be a proper analogy.

 

Fri, 08/03/2012 - 16:16 | 2676748 ObungaBoy
ObungaBoy's picture

It is very naive to believe that the market is under control of vicious computers which do not know what they are doing

HFT is just another tool in the hand of the 1% for rob and stealing small investors money and legalizing the flow of the new printed money into their pockets

Fri, 08/03/2012 - 16:18 | 2676753 alangreedspank
alangreedspank's picture

HFT like anything else is not free and easy money. Like any software, if you rely on it for your income and you're a piss poor developer, good luck.

Fri, 08/03/2012 - 16:21 | 2676763 divedivedive
divedivedive's picture

I'm going to show my age but in some ways it reminds me of the SOES bandits. What caused that to come to an end ?

Fri, 08/03/2012 - 17:10 | 2676863 CalibratedConfidence
CalibratedConfidence's picture

you do remember May 6, 2010?

Fri, 08/03/2012 - 16:19 | 2676754 divedivedive
divedivedive's picture

Personally I find this topic fascinating. Thanks for the post.

- How many HFTs are there ? Hundreds  ? Thousands ?

- Is this why all the banks seem to never have losing trading days ?

- Is there an easy way to look at a chart and see evidence of HFT involvement ? 

- Do they hang out in _every_ security ? If Knight's problems are HFT related, there were some symbols in that list of 140 I have never paid nay attention to.

- This stuff would make for a great book.

 

Fri, 08/03/2012 - 16:44 | 2676803 CalibratedConfidence
CalibratedConfidence's picture

Themis Trading wrote one called Broken Markets

Fri, 08/03/2012 - 16:19 | 2676755 lolmaster
lolmaster's picture

Lol another "old school" donkey with no f clue and ZH donkeys lap it up like true morons. This guy has no f clue about HFT

Fri, 08/03/2012 - 16:32 | 2676783 crawldaddy
crawldaddy's picture

douchebage says what?

Fri, 08/03/2012 - 16:40 | 2676798 resurger
resurger's picture

You explain, go ahead ...

Sat, 08/04/2012 - 08:24 | 2677722 Implicit simplicit
Implicit simplicit's picture

Hey Al-go to the delusions of grandeur center. You are being paged.

Fri, 08/03/2012 - 16:36 | 2676791 resurger
resurger's picture

Excellent read, thanks Tylers

Fri, 08/03/2012 - 17:02 | 2676845 Waterfallsparkles
Waterfallsparkles's picture

Is this any surprise?  Retail knows that the Market is rigged.

All of this HFT trading and snafu's has done nothing but convinced them to pull their Money out of the Market.  I mean really who wants to play when the Market is a game of Computers competing with each other and you are just giving them Money for the taking.

The Market has become just like on line Gambling where the Computers are programed to take your Money.  You cannot compete with a Computer.

This problem should have been resolved in 2008 thru the SEC but they turned a blind eye.  They should have stopped sub penny trading where the Computer can intercept an order and keep someone else in line to get a fill order.

SEC needs to stop sup penny trading.

SEC needs to put a speed limit on trading where an order stays for at least 1 minute.  Yes, 1 minute, enough time for someone to take that trade.  If they truly want to buy at that price than they should expect that someone could act on it.  Same with a Sell.  This placing orders and canceling before anyone can execute against is is criminal.

Fri, 08/03/2012 - 17:22 | 2676889 walküre
walküre's picture

SEC needs to ..

Are you suggesting the SEC really gives a flying fuck? The SEC is neither impartial nor objective.

The SEC is a PILLAR of the CRIME SYNDICATE a.k.a. Wall Street and D.C.

What better way for the royal crooks and bandits to lend their actions credibility and legality by running their own enforcement?

SEC clowns are from Wall Street. The SEC is a revolving door and should any enforcement officer get too cocky, they get promoted with a great job offer into the fangs of a big Wall Street financial firm.

The good SEC cops get bought into the ivory towers on Wall Street. Get it?

There is NO enforcement. There is NO oversight. There is NO rule of law.

Wall Street is a JUNGLE and only the FITTEST are allowed to survive there. Fit in the sense that they own the system and all its elements:

they own the exchanges

they own the trading softwares

they own the business media

they own the rating agencies

they own the legislative

they own the judiciary

they own the real estate

they own YOU ... if you park money with them

Sat, 08/04/2012 - 12:19 | 2678055 MsCreant
MsCreant's picture

Can't hit the up or down arrow. 

+1

Sat, 08/04/2012 - 14:33 | 2678291 emersonreturn
emersonreturn's picture

my up arrow didn't work either.  +1

Fri, 08/03/2012 - 17:07 | 2676855 Duke of Con Dao
Duke of Con Dao's picture

thanks Tyler. 

way cool.!!!

here's a Monster of a different kind. You Didn't Build that! Someone else Re-Animated that Dead Body!

https://www.youtube.com/watch?v=9nAhnhJgPPo

Fri, 08/03/2012 - 17:31 | 2676906 Axenolith
Axenolith's picture

There is absolutely no reasonable need for trading platforms that exceed human reaction time and the one rule they should impliment is a human reaction time rule.  Alternately, if the HFT use is seen to be some type of "trading right", then there should be exchanges set up that isolate human traders activities from them, if there is a rational basis for HFT, then let them trade amongst themselves and see how that market unfolds alongside a market where the bid/ask spread is human reaction time speed.  There would be interaction, but each crossing over to the others realm is subject to that realms rules.

I'd be willing to bet that if retail wasn't there to provide the "grass" for HFT giants to graze upon, they would dry up and die off fairly quickly.  That in and of itself would prove the assertation that they are somehow usefull as bullshit.

Fri, 08/03/2012 - 17:57 | 2676938 divedivedive
divedivedive's picture

I had the same thought regarding the human versus machine aspect.

In the late 90s I worked for a shop which had a room full of proprietary 'traders' to take advantage of SOES. The average age was maybe 20 and the screening process was how fast they could work the keyboard. (They went after gamers).

A twist on that (and I have a smile on my face as I write this) would be for the Fidelity's/iShares of the world to come out with new investment vehicle (perhaps a nice symbol would be HFT) which don't hold a portfolio of stocks etc but simply employ highly paid/proficient programmers and compete in the HFT world FOR the retail investor. 

THEN you might see the SEC's ears perk up.

 

 

 

Fri, 08/03/2012 - 18:37 | 2677075 Clowns on Acid
Clowns on Acid's picture

Define "human reaction time" please. Isolating humns reaction time (undefined) from HFT is a pipe dream.

Look at the Fed easy money policy as a reason for the hft's...financing equity trading is essentially interest rate free. The oppotunity cost for equity trading versus an alternative investment is zero.

There are many reasons why HFT exists other than the technology allows it .....let's not focus on HFT as the ultimate reason the markets are messed up...the Fed is at the core of the issue.

Fri, 08/03/2012 - 17:37 | 2676914 Clowns on Acid
Clowns on Acid's picture

Good, basic (very basic) primer on HFT trading.

Found this comment strange however, " One proposal that I like is to mark the orders that are designed to last for 250 milliseconds or less – the ones that are designed never to be filled. That way, when I see an order on my screen, I’ll know if it’s a legitimate order or just a computer trying to accomplish who knows what."

If an order lasts for 250 milli's or less, how does the author expect to see it on his screen? Even if he is only watching 1 stock.

The human eye will not pick that up, and unless the author is using his own HFT algo, his hand on the buy button or indeed his own algo will not be fast enough to process that information.

Am I missing something here? This article misrepresents a few things, while touching on a very high level some of the real aspects of HFT.

 

Fri, 08/03/2012 - 17:45 | 2676922 CalibratedConfidence
CalibratedConfidence's picture

A threshhold would be 1 or 2 seconds so anything less than that would never be shown to a user.

It would be a filter but in order to filter quotes, we need to identify them first

Fri, 08/03/2012 - 18:29 | 2677059 Clowns on Acid
Clowns on Acid's picture

Ok...so now it is 1 or 2 seconds...you use the term "filter" w/o really understanding how execution engines work or how actually your "timing" filter would work.

You are building complexity upon complexity. A real world solution might be to establish a minimum Fill to Quote (Order) ratio that would require that any trader (machine algo) not neeting the ratio to pay a "user fee".

This makes sense as Exchanges must pay increasing IT costs to manage the bandwidth issues arising from just pumping spoofing quotes / orders down the pipe.

Think in terms of monetary reward/penalties rather than building more complexity into the execution process.

Fri, 08/03/2012 - 23:49 | 2677335 michael_engineer
michael_engineer's picture

As a software engineer with market insights, I suspect that the quick algo swings up and down (and sometimes as shown at ZH before as growing in amplitude) are designed to increase nervous tensions that result in people or other algo's to adjust their limit orders or stop loss orders on both stocks and options. The algo may probe then stand back for 5 to 30 minutes to watch for changes then probe again. After determining weakness or panic then the algo can swing in for the profits such as in a short covering period.. An algo like this could easily be used in situations where the bid ask spread is large so no trades would even likely result but the information gained by watching the changes to the bids, asks, and limits in the next few minutes could be analyzed for exploitation.

Another manipulation could be to alter the true bid/ask prices towards the direction you want a stock to move, even though no trades may have occurred. The wildly swinging prices on sweeping orders might allow a trading house to claim any value in the swept through price range as the bid and ask values even though there was never any intent for the HF trade order to execute. An algo could even report one bid/ask spread to someone positioned long and a different spread to someone positioned short, and both of those bid ask ranges may have been true in the previous second. Does anyone know if the bid/ask spreads for all customer inquiries (or data pumps or data feeds) has ever been examined to look for a customer by customer bias where short and long positions are given slightly different sets of data?

That's how I would design the logic.

Statistics could be kept and a trading algo could become very confident in the outcomes. If an algo has been run hundreds of thousands (or even millions) of times in the past and fine tuned from the knowledge gained, then it could easily recognize places for it to attempt to step in with a trading strategy that has proven itself as successful in similar scenarios in the past. Part of the quants jobs are to quantify statistically the success of algorithms tried out on the markets

Sat, 08/04/2012 - 14:40 | 2678303 emersonreturn
emersonreturn's picture

mengineer.

 

thank you. +1

Fri, 08/03/2012 - 21:16 | 2677340 spooz
spooz's picture

Flimsy argument against a transaction tax. It would have little effect on small investors since it would be a very low tax, but it would wipe out a lot of the HFT.  That alone makes it a good thing.

Fri, 08/03/2012 - 21:42 | 2677367 Occams Aftershave
Occams Aftershave's picture

There are a few problems with this interview...

Fri, 08/03/2012 - 21:38 | 2677368 Occams Aftershave
Occams Aftershave's picture

Here is the interview annotatedf with comments:

https://docs.google.com/document/d/1-R1hTj-WsA_664AVo4JHkpLcDOJFRL5p4Coq...


Sat, 08/04/2012 - 06:37 | 2677676 Freewheelin Franklin
Freewheelin Franklin's picture

Who cares about high frequency trading as long as I can get free stuff? What is happening at Chick-Fil-A is much more interesting, anyways. Economics is hard and gay marriage is much more relevant to my financial well-being and future. Let's just tax the rich. That's easy.

 

[/sarc]

Sat, 08/04/2012 - 07:54 | 2677709 Reptil
Reptil's picture

01101111 01101111 01101111 01101111 01101111 01101111 01110000 01110011

Sat, 08/04/2012 - 10:59 | 2677914 tbone654
tbone654's picture

Two things you have to know...

It's not buy low, sell high... It's buy high, sell higher that's at work here...  In the early 80's I sat on Shearson's trading desk and watched the most AMAZING phenomenon...  My buddy Mike was the best offer on a stock with nothing to do, he would be willing to print 1000 if he got lifted, but he got an order from a non-market maker to sell stock, making his offering a little stronger.  instead of waiting to get taken at his offering, he went High bid and said "watch this"...  Within 10 minutes he was best offering again, based on the notion that Shearson was a buyer, based on the fact he went high bid, when in really he was a seller.  The power of Shearson moving the markets higher on reputation only...  He never had to buy on his new hig bid, but he was able to sell what he had much higher...  awsome concept, never forgot that lesson...

Second, I trade mostly index options now, but when I traded stocks I learned after much pain, that the idea was to always widen the spread...  I know that may be kind of old thinking now, but I think the theory holds true.  If you had an order in hand, you could always make more with a wider spread, obviously.  And they way to widen the spread is to take out the orders in the middle.  I see HFT being able to take out the middle so quickly and fill any market orders "wider" that it becomes such a huge advantage and suckers money, that I can't remember the last time I placed a market order, unless it was rushing to get out of a position headed the wrong way.  Thereby playing into the problem myself...

With decimal trading instead of fractions, the only way to make money as a market maker is speed. And for that you need algorithm's to accomodate trading...  If you want HFT to disappear, go back to fractions...  Think about it, as an individual investor when did you get screwed more, fractions or decimals?

 

 

Sat, 08/04/2012 - 12:51 | 2678115 Eric L. Prentis
Eric L. Prentis's picture


“Supporters claim that high-frequency traders (HFTs) are a net-positive market force because they provide liquidity and tighten bid-ask spreads.”

 

I am supposed to believe these bastards are paying the exchanges millions of dollars and making millions of dollars more, just to help me. Please! If you believe this crap, I have a bridge….

 

The first art of speculation is timing. HFTs are 60% of the market and control when they provide liquidity and tighten bid-ask spreads. At all other times, these major players are helping themselves, at the market’s expense. This is the definition of market manipulation. Retail and institutional investors are being screwed, royally.

 

 

Sat, 08/04/2012 - 14:45 | 2678310 billsykes
billsykes's picture

HFT's + stock exchange= rip off.

Total scam, the sad thing is the pensions are so fucking dumb that they are still allocating the majority to stocks.

Today's stock exchanges are not  where people come to buy and sell listed securities on an organized regulated platform.

scalping is not investing, scalping, wash trades and hidden volume do not help an exchange.

 

This is an exchange;

http://www.friedmanfineart.net/cme.html

 

bring back the old school pit, they can retro everything else.

Sat, 08/04/2012 - 16:25 | 2678459 Centurion9.41
Centurion9.41's picture

Overall, not impressed by the piece or Calibrated Confidence's responses to the rebuttals.

Fact is, as was pointed out by a few posts, most of the issues raised by those against HFT are BS.

There are valid questions and concerns regarding the effects of HFT on the market and on the more important concept of a market based on true fair market rice discovery. But this piece, nor many others lay out just those questions. Most of the HFT bashing pieces are written by people who the HFTs are putting out of business or simply beat folks who try to play in the same time frame.

One question that is central is this: can there be true fair market price discovery if 1% of the market participants are placing orders that make up 95% of the price discovery? I'd argue in such a situation the price discovery mechanism is not what the free market definition of price discovery is understood or intended to be.

As for those who complain about big money setting up co-located machines, wake up. Big money has and always will be the factor that moves the markets. It's the pure physics of it; fluid dynamics and mass. Guess what, if you have a small account YOU HAVE AN ADVANTAGE and should be able to outperform the market and fundmanagers. The fact you dont has zero to do with bad fills or slippage, those factors became insignificant when decimilzation compressed the spread to effectively a penny and commissions to nearly insignificant [if you're paying more than $8 per trade, you're a fool - and you should be paying no more than 2 cents a share]

If ZH's want to gain respectability rather than looking like the kids in the OWS "protests", then you really need to get up to speed a lot more than this poorly written piece.

Just sayin

Sun, 08/05/2012 - 16:10 | 2680052 CalibratedConfidence
CalibratedConfidence's picture

I should clarify for you that I manage my own money.  HFT has helped me add Alpha since I've began to capitalize off their manipulative practices.  I do not engage in any automated strategy outside of an automated tape reading platform I use to gauge a very concise and fast overall view of the order book.  I can assure you that I am not one of the frustrated voices that had HFT take my money, I've been able earn respectable returns.  I am offering a counter voice to Manoj Narang and other HFT advocates that claims HFT provide liquidity and tighten spreads.

The purpose of my interview with Casey Research was designed to help show people that the plumbing has become so fragmented that HFT effects on prices are predictable and regular and if we wish to maintain the integrity of our capital markets, we must put pressure on the SEC to enforce the rules they already have while at the same time trying to help educate those who aren't privy to what we know.  The long-term viability of this capital formation mechanism means more to me than grabbing as much money as possible. 

Not all HFT's are colocated.  The majority of them are scattered around the global, away from market centers.  My beef isn't with that, I wouldn't be highlighting an unfair advantage the floor trader has over me if this were circa 1980s. 

What is the point of putting in 20,000 quote changes in 1 second when any one of those quotes hasn't had enough time to leave the queue, be disseminated throughout the market and let any one of us take advantage of that offer or that bid (think of the Credit Suiss BLAST algorithm)?  If this behavior was taking place on an open out cry floor, no one would trade with that individual and they would be kicked out of the exchange. This behavior is now hidden from sight and takes place everyday and violates the SEC rule against placing phony orders.

Human's never would have beaten the BATS IPO to $0.0002 from $15.75 in 900 milliseconds.

http://www.zerohedge.com/news/skynet-wars-how-nasdaq-algo-destroyed-bats

Mon, 08/06/2012 - 14:03 | 2682261 NaN
NaN's picture

Now that it is clear that market orders, stop loss, oh, and limit orders by logical extension, are only used by stupid money, all the volatility seen in recent years makes much more sense

 

Wed, 08/08/2012 - 04:47 | 2686959 VRa
VRa's picture

I would really like a link to enhanced data feed or this whole interview is a hoax....

This is first of non anonymity I've ever heard on that scale (as the author suggest).

Wed, 08/08/2012 - 16:21 | 2688797 CalibratedConfidence
CalibratedConfidence's picture

DIRECT EDGE:

"Members seeking complete anonymity for reserve orders can now request a new, randomly-generated order ID be applied to the replacement order for the replenished amount.  This option will remove the link between the original order and its replacement on the book feed."

http://www.directedge.com/About/Announcements/ViewNewsletterDetail.aspx?NewsletterID=291

 

BATS: (see page five under "Add Order Message"

An add order message represents a newly accepted visible order on the BATS book. It includes a day-speci c
Order ID assigned by BATS to the order.

Note: If an order is repriced within the BATS matching engine, a Cancel Order Message will be immediately
followed by an Add Order Message with the same Order ID as the original order.

http://www.batstrading.co.uk/resources/participant_resources/BATS_Europe_PITCH_Specification.pdf

 

NASDAQ: 4.5 Modify Messages

Modify Order messages always include the Order Reference Number of the Add Order to which the update applies. To determine the current display shares for an order, ITCH 4.0 subscribers must deduct the number of shares stated in the Modify message from the original number of shares stated in the Add Order message with the same reference number

http://www.nasdaqtrader.com/content/technicalsupport/specifications/dataproducts/tvitch-v4.pdf

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