EC HH The Idiot's Guide To High Frequency Trading

First, let me say what you read here is going to be wrong in several ways.  HFT covers such a wide path of trading that different parties participate or are impacted in different ways. I wanted to put this out there as a starting point. Hopefully the comments will help further educate us all.

1.  Electronic trading is part of HFT, but not all electronic trading is high frequency trading.

Trading equities and other financial instruments has been around for a long time. It is Electronic Trading that has led to far smaller spreads and lower actual trading costs from your broker. Very often HFT companies take credit for reducing spreads. They did not. Electronic trading did.

We all trade electronically now. It’s no big deal.

2. Speed is not a problem

People like to look at the speed of trading as the problem. It is not. We have had a need for speed since the first stock quotes were communicated cross country via telegraph. The search for speed has been never ending. While i don't think co location and sub second trading adds value to the market, it does NOT create problems for the market.

3. There has always been a delta in speed of trading.

From the days of the aforementioned telegraph to sub millisecond trading not everyone has traded at the same speed.  You may trade stocks on a 100mbs broadband connection that is faster than your neighbors dial up connection. That delta in speed gives you faster information to news, information, research, getting quotes and getting your trades to your broker faster.

The same applies to brokers, banks and HFT. They compete to get the fastest possible speed. Again the speed is not a problem.

4. So what has changed? What is the problem

What has changed is this. In the past people used their speed advantages to trade their own portfolios. They knew they had an advantage with faster information or placing of trades and they used it to buy and own stocks. If only for hours. That is acceptable. The market is very Darwinian. If you were able to figure out how to leverage the speed to buy and sell stocks that you took ownership of, more power to you. If you day traded  in 1999 because you could see movement in stocks faster than the guy on dial up, and you made money. More power to you.

What changed is that the exchanges both delivered information faster to those who paid for the right AND ALSO gave them the ability via order types where the faster traders were guaranteed the right to jump in front of all those who were slower (Traders feel free to challenge me on this) . Not only that, they were able to use algorithms to see activity and/or directly see quotes from all those who were even milliseconds slower.

With these changes the fastest players were now able to make money simply because they were the fastest traders.  They didn’t care what they traded. They realized they could make money on what is called Latency Arbitrage.  You make money by being the fastest and taking advantage of slower traders.

It didn’t matter what exchanges the trades were on, or if they were across exchanges. If they were faster and were able to see or anticipate the slower trades they could profit from it.

This is where the problems start.

If you have the fastest access to information and the exchanges have given you incentives to jump in front of those users and make trades by paying you for any volume you create (maker/taker), then you can use that combination to make trades that you are pretty much GUARANTEED TO MAKE A PROFIT on.

So basically, the fastest players, who have spent billions of dollars in aggregate to get the fastest possible access are using that speed to jump to the front of the trading line. They get to se , either directly or algorithmically, the trades that are coming in to the market.

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Comments

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Dan Tobias 4 years ago Member's comment

Nice to see that Mark has a basic grasp of the issue.

Now on to the important point. Because America is rapidly becoming a fascist police state due to citizens who are too self-centered, cowardly, ignorant and complacent, what are we going to do about it?

Bitching on websites, social sharing and "likes" isn't goint to get the job done. Direct political organization and action is required. Anything less is futile gesture and posturing.

Mark, you have money. If you really care about this issue, organize a group, lobby the appropriate people and do something about it.

Jibleanu Catalin 4 years ago Member's comment

In order to shake out and help the humanity you have to sacrifice you and your family for greater good of all mankind.The problem is that we have so short life that nobody knows if your gesture for all other people is worth the sacrifice?! For that reason, all these great antrepreneurs have time only for playing their own lifes and help their own kids.Put yourself into their shoes........then, if you think you can do better just act.Personal, i know when you have a lot of money,you tend to look away of the problems, and most of the time,problems tend to fix themselves :)

Jibleanu Catalin 4 years ago Member's comment

Great article. Also i have to mention that despite anything that is thought outhere, all markets are under an extreme manipulation trading techniques.Most of the trading these days is HFT.Regarding algorithms for great trading in any markets please all of you think about 1 thing that is making all HFT trading algorithms vulnerable for average traders. Because is very true, you can beat HFT at their own game.But that is possible only because now, HFT is generalized. Like any trading system before, once it get bigger, get more vulnerable. Also is perfectly true that you can predict more accurate bull market than bear market, beacause each of these 2 types of markets are driven by 2 different factors : bulls - greed, bear - fear. Fear is building up much faster than greed, that's why bull market is much easier to predict than bear market.

Main ideea is that every market is manipulated, because most of trading companies are using only HFT. Good luck to you all and remember, you can beat HFT at their own game.

Farah Kincaid 4 years ago Member's comment

Well put. And I have to say, great profile pic, very cute!

George Lipton 4 years ago Member's comment

Great read, thanks.

John Kilcock 4 years ago Member's comment

What is the stock market for? ie what is its purpose? If you think about it, then HFT among other practises have NO reason for being and should be terminated.

Robert Theriault 4 years ago Member's comment

I totally agree with article and believe this type of HFT needs to be stopped. It really isn't that difficult. As a start just require all orders need to be good for some minimum period of time before they can be withdrawn. BobT

Joe Black 4 years ago Member's comment

Mark mentions systemic risk to the global marketplace and I believe that therein lies the rub with regulation. It’s impossible to determine if our current market environment is being propped up by millions of arbitrage capitalists or not. If the last five years of “growth” has been synthetic, to what degree will the global markets be affected if our regulators remove HFT firms and their ilk from the exchanges? I think the uncertainty around the answer is one reason we see such a subdued reaction across the board.

Dick Kaplan 4 years ago Member's comment

Brilliant, concise explanation. Just leaves out the cause, which will also answer many of the questions posted. HFTs came about and thrived as a result of stock exchanges converting from private memberships to “for profit” publicly traded corporations. That is when and why they stopped servicing the customer and began exploiting them in an effort to create and exploit new revenue streams.

Had exchanges maintained a fiduciary responsibility to the customers they were built to serve instead of the shareholders and investors desperate for constant growth, this debacle never would have happened. The model of a “for profit” exchange is an unsustainable one as it is impossible to continue to exist when you put investor profits ahead of customer fills.

BreakingBad News 4 years ago Member's comment

I think Michael Lewis makes a good point in that the HFT firms take NO RISK. Once they invest in the tech, they basically mint money. And if this is the case, how are they ‘participating’ in the market?

They are simply ‘taxing’ everyone else. Question is, should they be allowed to? And more importantly, can you actually stop them?

Derek Snyder 4 years ago Member's comment

One thing no one talks about is the lack of system security. With all the high profile hacks of late, I believe HFT will likely become a target soon. Either to crash or manipulate the system.