EU: Let's cost financial traders $400m a day, because EVIL BANKERS. Right? Hurrah! The European Union has decided to save us from the perils of automatic trading! Also known as High Frequency Trading (HFT) or algo trading, this is simply the practice of writing a piece of code to do the buying and selling faster than a human being can possibly do it. We've talked about the basics of it here before at …
You obviously don't have any idea of what are you talking. It's like saying that HDDs in computers are parasitic because all they do is making a whirring noise and making a light blink.
Speculation is taking a risk (that is the definition), therefore, speculators are buying risk from those who want to reduce theirs. In doing so they automatically bring information to the market, assisting in price discovery. All of that also means that they create liquidity which makes markets more efficient and less costly for other participants.
A few fallacies to pinpoint here:
"Speculation is taking a risk (that is the definition), therefore, speculators are buying risk from those who want to reduce theirs"
True, HFT are taking risks. False, they are not taking it because someone else has asked them to do so. There's no explicit relationship between them, only implicit by their activities. Non-HFT sellers and buyers are not begging the HFTs to reduce their risk. By their own admission, HFTs traders are taking 1000s of cents of "risk".
"In doing so they automatically bring information to the market, assisting in price discovery"
They only bring noise to the market. The market should root its decisions on real economy conditions, and those don't change each tenth of a second.
"All of that also means that they create liquidity which makes markets more efficient and less costly for other participants"
This is the best fallacy. Who are those other participants. They surely are not the meat and bones investors, because they take advantage of price differences before these have any saying on what they want to do.
HFT is parasiting what is already a casino level operation whose roots on reality are long foregone.
I've gone to all SSD HDD's so no whirring noise for me.
But saying 'they're trading for more risk or for less' is an elementary understanding of the HFT sector that's the equivalent of saying supply & demand is actually what economies are built on. You've left out the 98% of what's actually happening.
'Normal' trading is basically what you've described, risk management, but HFT is exploiting time differentials through the application of technology. It has fuck all to do with the actual commercial value of a company and 100% to do with the lapse in everyone having the same valuation in their system.
Speculation is a time honored practice and is 100% of what business and business innovation is about ('guarantees' are what crooks and idiots promise). But HFT isn't speculation and actually degrades the value of end user action as the money is being made in change, not market health. HFT is fucking worthless to markets and gets away from why we allow companies and commodities to be traded in the first place.
We do that do that investors can compare various investment opportunities among competitors in a given sector and everyone has the same data with which to make their decisions. Ultimately those decisions are end user driven. If the end user is sufficiently dissatisfied with a company or product the valuation of that company falls, or increases if the end user is sufficiently satisfied.
HFT has precisely zero of those interests in mind, change in any direction is all they need and change in continued direction is even better (obviously). Because of the growing interest in the world of low risk HFT (it's all low risk), HFT is beginning to drive change itself as continued change gives everyone a good reason to see how far in any direction a company can go. Crash or soar, eat or starve, it doesn't matter. Change is all they need and they say fuck you to everything else. I say fuck them right back for not only not being interested in shared success, but for furthering a fundamentally flawed concept that is inherently broken and detrimental to everyone else.
I don't know. In my post I only addressed the issue of speculation per se. I did not talk about HFT at all. I don't think the OP did either (although [s]he seems to object to the use of the Hubble Space Telescope for some reason).
HFT is not speculation but rather an arbitrage process, so this aspect of the discussion is moot anyway.
"Speculation is taking a risk (that is the definition), therefore, speculators are buying risk from those who want to reduce theirs. In doing so they automatically bring information to the market, assisting in price discovery. All of that also means that they create liquidity which makes markets more efficient and less costly for other participants."
Bollocks. Speculation is part of the bubble process and in the medium term destroys liquidity by funnelling money out of the system and into the pockets of a tiny number of aristocrats who can then live the rest of their lives without contributing anything to the economy, as can their kids.
As to market efficiency, all speculators do everything they can to manipulate the market and make it more opaque as that gives them inside information which can be leveraged. Maybe in lala land where all the people involved are working for the Greater Good what you say is true, but it never has been and never will be in the real world.
"Bollocks. Speculation is part of the bubble process and in the medium term destroys liquidity by funnelling money out of the system and into the pockets of a tiny number of aristocrats who can then live the rest of their lives without contributing anything to the economy, as can their kids."
Bollocks to you, Sir. You have responded with some wild assortment of unsubstantiated ideological slogans at the level of instinctive class-based animosity. Messrs Marx or Lenin would have chewed your "argument" to pieces and spat it out in 2 seconds. :-)
But is any of this good?
Is it actually inflationary as nothing is invested, no service or good is produced?
Investment only occurs when people buy share issues, buying shares already on the market may make profit but it's not investment!
Speculation obviously makes speculators a profit. But that money has to come from somewhere (I know the Governments can print more when needed, which can but doesn't always devalue existing currency).
Speculation doesn't create liquidity. Actually sometimes it can do the reverse. The second evil after speculation is to loan people money they can't even pay the interest on, on the basis that what they are going to buy will be worth more than the loan when they sell it (soon). That increases when the economy is stable and results in a crash eventually when the leveraged buyouts / housing bubbles etc burst.
The 3rd great evil is to be a Dragon. That's to consistently manage to sell your goods or services to others and then sit on the profit made. Dragons also like to do this at higher profit margin than competitors of course. This sucks money out of the economy. This it problem with Offshore banking for individuals or Tax Havens for Corporations. How can they spend the money? So they borrow when they need to expand. Which reduces the amount others can borrow.
Making money from share dividends is acceptable. I don't care if you are a pension fund. Making profit from speculation isn't acceptable, especially if it's HST (High Speed Trading, I meant HFT), HFT (High Frequency Trading).
The system has worked so well over the past few years, why change it?
Hasn't it?
I see no reduction in the bonuses being paid out to the bankers or any perceptible will to change.
So, business as usual, oh and big bonuses all round. (For those inside the magic circle only.)
The rest of you, just keep paying up.
One wonders what the bankers want all that money for. After all, you can only buy so many fancy cars/houses/yachts etc.
Is it greed or is it just because they can?
As someone who had their small business go under because of the refusal of the banks to give me a business loan I wonder what bankers and their cronies are really for.
A complex issuue indeed, and with a whole fleet of vested interests circulating around. On the one hand we have the banks, who damn near trashed the western world a bit ago, facing off against the EU, a body which could drain an olympic sized swimming pool of gravy in 10 seconds. The EU is probably narked that London is Europe's biggest financial centre, so anythong to put the mockers on that is fair game for them. The traders, as Mage says, have never generated a penny of actual wealth in their lives, and make a living by digging holes and filling them in again. The pension companies continue to have it good, largely because, incredibly and uniquely in 2014, they are allowed to charge for pensions in secret and abstract whatever they want from your pot without even setting out the figues in an invoice. Whoa there I have reached MAXRANT, an algorithmic constant which stops commentards from going completely doolally and then--
Oh er, and yeah good article.
"this is simply the practice of writing a piece of code to do the buying and selling faster than a human being can possibly do it."
No it's not, it's digital coin clipping by parasites. If it was something an average person could do they would be thrown in jail. They are not even speculators.
Actually, many algorithmic trading shops started as one person playing with their own savings. So it very much *is* something an average person could do (and there are brokerage accounts which are available to pretty much any investor and have API access these days too).
Where it gets controversial is in the small number of algorithms where timing advantage is everything. Seeing the order flow before everyone else does and trading on the basis of that information is usually called "front running" and is highly frowned upon even where it's not illegal (which it is in most places nowadays). There is additional controversy about the extent to which exchanges/trading venues have been complicit in this as they got to make some nice additional fees by selling colocation space very near the exchange.
Despite all this there is still an argument that even those traders are adding at least some value (and probably also transferring value from big investors to smaller ones) by providing additional liquidity and narrowing bid-offer spreads. The dispute is about how much, and whether the cost (if it can be measured) caused by front-running type behaviour outweighs this.
What is quite ironic is the fact is that HFT of this sort has largely moved into markets like FX where there has always historically been less transparency and there are a huge number of different trading venues - not for reasons of regulation, but of profitability. So regulation is, as ever, targetting the behaviour of two to three years ago and not today and will probably make close to no difference to those it seeks to target. What is very unfair is that many other algorithmic traders who do not engage in this type of strategy are getting tarred by the same brush and these are the people who will be hurt by this. The usual government regulation story, in other words.
Speculators have value in a market. Markets need people willing to buy and sell.
OK, when I was taught about this it was still the old-fashioned stock exchange, slow to make trades and expensive to run. And you are correct that the modern world is insanely fast. And the modern speculation, high speed and based on small price differences, may be people skimming the froth off the top. It may be going too far.
The whole business happens so fast that the distance between computers becomes significant. We're used to measuring ping times in milliseconds. In this High Speed Trading microseconds matter, maybe even nanoseconds. In some ways, this starts to look like a computerised game of Snap.
As Tom 35 said "it's digital coin clipping by parasites"
The purpose of HST is to suck money out of the markets for the brokerage firms. The way HST works is the the software 'spots'a difference in the share price of a stock on two exchanges, it will sell the dearer one and buy the cheaper one.
For example; a brokerage house sees that microsoft is trading at $39.69 on the Chicago stock exchange and trading for $39.67 on the New York Stock exchange, the software will sell the brokerage firm's 1,000,000 microsoft shares in Chicago and buy 1,000,000 microsoft shares in New York netting the brokerage $20,000 less fees. The client's stock-holding is unaffected but the brokerage firm has somehow managed to siphon $20,000 out of the market.
It's just modren day coin clipping, it's also part of the reason why Lewis' claims that the American stock markets are rigged to the disadvantage of the non-HST trader.
Paris, see paragraph 2 above
Firstly, these 20k are not brokerage fees, they are the trading P&L and if a brokerage house is doing what you described in your example, that profit belongs to the principal client, not to the brokers.
Quite separately, the broker will charge the client its fee for doing the trades - those will be the brokerage fees. If there is very little or no benefit or necessity for the client to do these trades but the broker is doing them anyway, this is known as "churning" and is a form of fraud or breach of fiduciary duty, but that's a whole different story...
Back to your example - let's assume that the broker is acting in good faith and has found an arbitrage opportunity which is likely to benefit his client. Let's also assume for simplicity that the best offer in Chicago and the best bid in NY are precisely 1 million MSFT shares.
When the broker buys MSFT shares in Chicago at 39.67 the exchange fills the order and all offers at that price are taken up, the next best offer is 36.68. In New York, the broker similarly sells the million shares 36.69 and the new best bid is now also 36.68.
By making his arbitrage trade the broker caused the two markets to synchronise.
You call it "coin flipping" but it is exactly the opposite. It's known as "risk-free" transaction and whenever an opportunity for a risk-free profit exists it is a sign of inefficiency in the market. After that trade there is no more opportunity for a risk-free profit and therefore the inefficiency is gone (for now).
If, however, the broker were to just buy some MSFT shares for the client in the hope that eventually its value will rise - that would have been coin flipping, aka speculation. But, oh, wait - the ultra-leftist public here calls this an "investment", go figure...
Your pension fund will definitely lose from a decrease in high frequency trading. Precisely as the article points out. Transaction costs will be increased, thus costing your pension fund more when it trades. As a certain portion of your pension pot is likely to be in tracker funds, these have to trade in order to reflect the current state of the market. That's the whole point of them. They will have to charge higher fees.
There is a valid argument to be made that HFT is a risk to the overall functioning of the market, and therefore even the real economy. In which case they might also be a risk to the value of your pension. But the next point the article is making is that the legislators are not in the best position to make this argument, given that their legislation has shown itself to be ignorant of the biggest benefit of HFT to the market and economy overall. Which is its effect of decreasing transaction prices. A good that the legislation is directly attacking, by setting minimum increments.
There's another valid criticism to be made of HFT. In that it improves liquidity in the good times, but may not do so in worse times (for example liquidity has collapsed after a couple of the 'flash-crashes').
Firstly it competes with the market makers, taking away their profits, but HFT isn't necessarily being done in order to provide a market making service. Therefore the traders may withdraw it at no notice, removing normal liquidity from the market. Whereas the whole point of a market maker is to keep liquidity going, so that it's always possible to trade. So there might be an argument to regard the market makers as part of the market's infrastructure, and therefore offer them some protection from competition that's taking the easy profits, but fewer of the risks.
Another argument is about refused trades. This is where HFT will offer trades and then cancel them before they can happen - as the algorithm spots the opportunity another trader has seen - and basically nicks it. This might be a good area to legislate on. Or markets could set rules themselves. As I understand it this used to happen in open-outcry markets, the old style ones with a trading floor where the guys in blazers shout the deals. But a trader who people noticed "didn't hear" the bad deals would find that others wouldn't trade with him any more. Maybe the markets need to learn from this practise themselves, to avoid the need for regulation.
As a summary, it's bloody complicated. Greedy self-interested and short-sighted incompetents shouldn't be solely in charge or regulating such important matters. Which is why I think the European Parliament should be kept well away from anything really. Not that I have a high opinion of the markets at the moment. They need to have a long hard look at themeselves and start learning some lessons and being less shit. But I can think of few organisations I have less regard for than the European Parliament.
Surely trackers only have to trade when the composition of the underlying index changes (a company enters or leaves the index)? Sure, the trackers need to trade, but orders of magnitude less frequently than many other traders. I don't see this putting up the costs of trackers significantly.
> Surely trackers only have to trade when the composition of the underlying index changes
Trackers hold the shares in the same proportion as the underlying index.
You take the total market capitalisation of all the FTSE 100 companies and then work out what proportion of that value individual constituents are. For example HSBC is about 8% and Rio Tinto is about 3% so if your tracker was worth £1000 you would have £80 of HSBC and £30 of Rio Tinto. Since share prices change, next week you might have sell £10 of HSBC and buy £10 of Rio Tinto to reflect the change in prices.
Actually that is often completely wrong even though its what you might expect.
Many trackers (and lets take a FTSE100 tracker for example) do not contain the shares in the tracked index.
What they contain is a set of instruments which the traders believe will closely track the specific index, plus a selection of hedges if they are wrong - the hedges most likely being in the forms or options or derivatives or other complex products.
The reason this is done is the traders believe they can do better than the index, even with the hedges, and thus make a profit.
Do consider checking the listed holdings of a few tracker funds if you are interested.
It's the wrong solution. A Tobin tax would have been preferable to me.
##!/usr/bin/pythed off with doing quotes for high freak traders who want to know latency and circuit routing to the nanosecond. Especially when your algo box is as close to the exchange as you can get it and your procurement people are only looking at the price. And if they're trying to procure this kind of stuff via Ariba, I'd like to introduce them to a special circle of telecomms hell.
If you're really going to lose $400m a day on the back of this change, I could design and build you the lowest possible latency route between two points for a month's losses. You know the telecomms world has gone mad when the lowest latency transatlantic route is only available to a limited number of suck.. I mean discerning clients and everyone else gets latency added by virtue of a large pile of cable drums acting as delay generators. One has to admire that provider for their chutzpah though.
Tracking an index by naively owning the shares in the index means you will always underperform the index. This is because of a number of factors: friction costs involved in buying and selling shares in the right proportion each time the index composition changes (and the consequent market moves that the large number of people doing the same thing at the same time causes), the cost of providing liquidity if you are talking about an open-ended fund where people can decide to withdraw their money at any time (and the issue of how exactly you decide on the price at which they can do so), the administrative cost of employing people to run the fund, etc etc.
Using derivatives (options, swaps, futures) and leverage (borrowing money to invest more than what you have from investors) instead of or as well as owning some or all of the shares in the index allows for these costs to be avoided and/or mitigated, at the cost of creating some other slightly different risks. How good managers are at hedging or managing these risks is difficult to tell; but the market for index funds uses the level of underperformance/variance vs the index as an important benchmark, and this creates economic incentives which push managers towards using these types of structures. Not all index funds do this, but many do.
Your pension fund will definitely lose from a decrease in high frequency trading.
Wrong.
Yes, it improves liquidity, so on a simple buy-then-sell your pension fund may do better. But assuming your pension fund is investing rather than speculating, that's lost in the noise (indeed, 0.5% stamp duty will hurt an order of magnitude more than loss of HFT).
Meanwhile, the money that's not being siphoned off in unproductive trading can instead accrue to shareholders such as pension funds over the years they hold a share.
"Firstly it competes with the market makers, taking away their profits, but HFT isn't necessarily being done in order to provide a market making service."
Market makers are part of HFT as well. There are many types of HFT, both good and bad. Market making = good, quote stuffing = bad etc. Part of the problem I have with the comments on here (not yours) is that they are Daily Mail ignorant of what HFT covers and come up with stupid arsed statements about minimum holding periods such as 6 months. Idiotic ideas like this would utterly f*ck the market. You wouldn't be able to sell if you spotted an impending market crash unless you'd held for long enough and arbitrage free pricing would disappear. Oh no, that's right, mom and pop would be screwed but banks would just setup multiple holding entities where one bought and the other sold.
"it'd probably behoove the author to read it"
Hi new reader - Tim wrote about Flash Boys here, on the Reg, a couple of weeks ago.
C.
So instead of telling those guys to stop gambling my pension away and put that money to real use, the EU will review and approve their code before? I feel much safer now.
I guess there is a "sucker management/transaction fee" parameter in the code, easily adjustable to compensate any loss to the trader's CEO bonus.
"....So instead of telling those guys to stop gambling my pension away...." I doubt that your pension is solely invested in the type of high-risk funds you assume it is. You'll probably find there is a large chunk in 'safer' long term bets with a lower return to offset the risk of investing in the higher-return, higher-risk funds. If not, then I suggest you change pension providers. I assume, since you have expressed such moral indignation, that should your pension fund actually over-perform and those 'evil bankers' deliver more money than you expected, you will give that excess back, right? Yeah, thought as much.
Dear Mr. Bryant,
Although I've tried several times, i fail to draw a conclusion from your comment. Presumably due to the high number of meaningless "investor jargon" terms. Therefore, I believe that I owe you a chance to come up with a decent rant.
To make it simple, I believe investment funds should engage into both high-risk and low-risk investments to get a decent return. But I would like to find an investment fund which funds for example a start-up in India or an SME in Poland and the managers of the investment fund work their ass off to make sure those businesses grow and thrive, rather than have my pension invested into market manipulations, high speed transactions or other "complex instruments", which are nothing but blind bets.
HFT just appears to increase liquidity. Whenever there is a real demand for funds it dries up just like all the other instruments of "financial engineering" have done in the past. And it isn't really about bits of code but about being able to sting trades by acting faster than the trades can. This has as much to with laying optical cables in straight lines between exchanges than anything else.
Banning it would only encourage workarounds, taxing it into uselessness makes more sense.
Increasing market liquidity is a real-world purpose. There are risks in doing it, market makers will sometimes lose. Therefore market makers need to make profits to offset this. As well as to pay for expensive champagne, cocaine and hookers...
Increased liquidity = increased transparency. It's therefore good for investors. Particularly in niche areas.
HFT may not be the best way to do this, but a tobin tax punishes all market makers. And therefore all pension funds. Because costs will be passed on. As well as pension funds getting stuck with shares they are unable to sell at a good price quickly enough. This will have undesirable side-effects.
Tobin taxes will stop some 'unwanted' trading. Although unwanted by who is a fair question here. But it will also penalised market actors who are definitely fulfilling a social good, and damage the econony. Even the European Commission's own report into its own Tobin Tax proposals said that it would reduce European GDP by much more than it would raise.
Yes if you really want to destroy most of the investment as opposed to gambling industry a Tobin tax is a great idea, perhaps you should read up on the real effects that it will produce. It is interesting that areas that had no pension industry to think of, dreamed up what should really be called the nightmare tax or even the wealth destruction tax plan.
Thank goodness I have been drawing my pension for sometime, however, I would like to be able to continue to draw it for my remaining years.
Your pension pot is worthless now anyway, all the author in this article is advocating doing is backing the one set of people to personally make money from the banking crisis, the thiething scum in the banks.
If there was ever an industry that should NOT be in private hands its the finance industry. All these banks/institutions just carry a modern version of a letter of marque.
Why NOT reduce the amount of automated systems that allow them to turn small errors into massive errors?
What do we actually get from these guys that is worth us getting screwed time after time? We even have to smile and pretend to like it.
What have the markets ever done for us. Other than roads, railways, hospitals, the industrial revolution, pensions...
Where do you think all the money comes from to invest in stuff? It comes from savers - who are willing to accept some risk, in return for reward. People who take the smaller risk of government-guaranteed bank savings accounts get less reward. People willing to accept more risk go to the markets. Much of that capital gets mis-allocated of course.
One of the major reasons that the industrial revolution happened in Britain, was because we had well-developed markets to allocate capital to innovation. One of the reasons it spread round the world was that Britain invested much of the profits abroad in doing the same thing. Which reduced the industrial lead, but led to a massive increase in global trade and the growth of the City of London as a global trading hub.
"What have the markets ever done for us. Other than roads, railways, hospitals, the industrial revolution, pensions"
All of these done before HFT, again, who exactly HFT benefits from besides its players? The "liquidity" myth is widespread, but let me suggest another way of providing it: making easier for sellers and buyers to get in touch instead of relying on artificial barriers which are only able to be surpassed by a few privileged actors?
"Yes, the bubbles and crashes (from the tulip bubble onwards) have been so much fun."
Schumpeter, mate.
Are you arguing that we should have called off the industrial revolution, and continued a poverty stricken crofting existence, with infant mortality of one in three live births, life expectancy of mid 30s? If you want that you can still have it by moving to Wales.
Spartacus - you are making the mistake of believing correlation is causation. The industrial revolution - as all other growth spurts are fed by innovation. The reason why the markets boom at the same time is the same as unwanted fire insurance on your asbestos Italian restaurant. You need finance because if you dont take it someone else will and leave you stuffed.
It may have fed growth once but there are easier ways to make money so they do that instead.
None of this - investment, the industrial revolution etc. - needs HFT or the kind of casino finance we have now. Most of the money in the economy is actually debt; with vast amounts of interest going to banks and very little to savers. Even the bank owners - the shareholders (often pension funds) - don't get their fair share.
There's nothing wrong with true free market capitalism, but most of the profiteers in the finance industry don't want that because they're happy with their rigged markets, milking the rest of the economy.
For many decades, the productivity of British industry has been damaged by lack of investment; part of the blame for this is due to a financial sector that would rather put money into gambling and inflating asset bubbles like the housing market, and another part of the blame goes to tight-fisted bean counters running companies, who have no knowledge or interest in the business other than sweating the assets and running them into the ground while the founders spin in their graves.
The Register 
Biting the hand that feeds IT
Copyright. All rights reserved © 1998–2024
