Market Makers and High Frequency Trading

[skyQuake]

lol. It's written in the article what they do. They monitor order flow and front run big orders.

It's not a problem for any of us retail traders. But these guys are getting a free lunch, no risk. That's the definition of a parasite in my book.

Stop whining! Just cause someone else has gotten it down to a science.

What is reading the dom/course of sales? Frontrunning demand/supply

Any sort of decent chart analysis? Identifying buying/selling and getting in front of it.

Super is only a small % of daily market activity as their turnover/year is very low. Most of the times those algos are frontrunning insto money or overseas players trying to mask their activity.

One tries to hide market moving orders. One tries to seek them out and get in front. Neither can claim moral high ground.

Also:

GB Alan Kohler is a muppet.

 

[Gringotts Bank]

Stop whining! Just cause someone else has gotten it down to a science.

What is reading the dom/course of sales? Frontrunning demand/supply

Any sort of decent chart analysis? Identifying buying/selling and getting in front of it.

No sorry.

Decent chart analysis and reading DOM = "trading" and involves risk, because the outcome is uncertain.

Front running is when you have a certain outcome = zero risk. Their drawdown would be zero.

Just saying it exists and the playing field isn't level. Luckily it doesn't affect me.

 

[Trembling Hand]

No sorry.

Decent chart analysis and reading DOM = "trading" and involves risk, because the outcome is uncertain.

Front running is when you have a certain outcome = zero risk. Their drawdown would be zero.

Just saying it exists and the playing field isn't level. Luckily it doesn't affect me.

GB really!!!

That Muppet has taken the fact that there is servers co-located at the asx and draw the conclusion that they are all HFT algos robbing the poor mum & pop.

Its an utter disgrace!! Completely laughable conclusion. Anyone with half an understanding of market participants, especially the asx, can see how dumb that is.

 

[skyQuake]

No sorry.

Decent chart analysis and reading DOM = "trading" and involves risk, because the outcome is uncertain.

Front running is when you have a certain outcome = zero risk. Their drawdown would be zero.

Just saying it exists and the playing field isn't level. Luckily it doesn't affect me.

Having front run my fair share of things, I can safely say its not 0 risk.

What looks like a crude buy algo that ticks up every few minutes can suddenly disappear (or heaven forbid, flip). After you've identified an algo how do you know how much volume is left in the bugger? Is it a vwap order? Buy at best with limit?

 

[Gringotts Bank]

GB really!!!

That Muppet has taken the fact that there is servers co-located at the asx and draw the conclusion that they are all HFT algos robbing the poor mum & pop.

Its an utter disgrace!! Completely laughable conclusion. Anyone with half an understanding of market participants, especially the asx, can see how dumb that is.

Well it does exist in the US. You're saying it doesn't exist here. You're saying I should believe you?

This is quite a good article I found which points out the winners and losers of HFT. Some surprising ones on the winners list! It's from http://caps.fool.com/Blogs/high-frequency-trading/732120

Stock Trading- “The way we were”

In the “old” days, nearly all US stock trading was done on the New York Stock Exchange. This was before NASDAQ opened for business in 1971. Each stock on the NYSE had a “specialist” in charge of insuring orderly trading. The specialist had a physical location called “the trading post.” If you wanted to buy or sell that issue, you went to the trading post. The specialist would match up buyers and sellers. In those days, stocks traded in fractions of dollars, instead of decimals. It was common to have the bid-ask spread be “1/8th- 12.5 cents or “1/4” 25 cents per share. For example you might buy IBM for 10.00 per share and sell it for 9.75 per share. Aside from the very high commissions, this bid ask spread made short term trading very difficult for the small investor. If you lost 25 or 50 cents every round trip, it would rapidly add up.

As part of the specialist’s role, he also bought and sold for his own account. Nominally, he would step in to be the buyer or seller of last resort. Specialist trades were on the order of 5% to 10% of the trading volume. It was an open secret that occasionally specialists traded opportunistically even when they were NOT the last resort. If the specialist bought at 9.75 and sold at 10.00, he could make a nice profit. The specialist could also short a stock if he wanted to.

I have heard specialists from that era comment that you “really had to mess up to lose money.” Typically they would lose money one or two days PER YEAR. If they lost money on more days that two, they were doing something very wrong.

“Front running” is where you know FUND XYZ is about to buy a large number of say IBM shares. If you recognize that situation, you would attempt to buy IBM before the fund, then resell your shares for a quick profit. This type of front running was and is 100% legal. In the old days, “floor traders” working for other firms would attempt to front run anybody and everybody. Specialists certainly had the ability to front run orders also, despite the fact that it was against the rules. Off the record, specialists would give you a wink and a nod if you asked them if they ever did this. They only had to do it every once in a while to make a nice profit. Had they done it on every single trade, they would have gotten in trouble.

Bottom line of “old” trading was that floor traders and specialists were pulling off some percentage of your profits at every opportunity.

Stock Trading- “The way it is”

Other than the incredible improvements in technology, two large changes have occurred in stock trading.

Conversion from fractions to decimals occurred in 2001. [5] All of a sudden, stocks were trading in 1 cent increments. This as a large part of why/how the bid-ask spread for stocks shrank. Before decimalization, the smallest allowed increment was 1/16th or 6.25 cents although most spreads were 1/8th or larger.

Regulation National Market System (aka Reg NMS) [6] which became effective in 2007. Between the “old” days and the “new days”, you could trade stocks on many different electronic systems aka ECN’s, SRO’s, exchanges. In round numbers there are about 50 different electronic exchanges/ECN’s where a stock can trade today. One of the main points of Reg NMS was to require all of the exchanges to have the same bid and ask prices. This is known as the National Best Bid and Offer aka NBBO.

Before Reg NMS became the law, it was common to have different bid/ask prices on different exchanges. For example, the IBM bid/ask on the NYSE would be 9.99/10.00. On say the Pacific Stock Exchange, it might be 10.05/10.06. You can see what happened. A company with fast technology could buy shares on the cheaper exchange and sell shares on the expensive exchange. In theory, Reg NMS ended this practice. The goal of reg NMS was to insure that investors got the best pricing, regardless of which exchange executed the trade.

Winners and losers

1) Winner- High Frequency Trading that is faster than everyone else for arbitrage. In the real world, it takes some amount of time for all 50 exchanges to match bid and ask prices. If you had the fastest system, you could constantly monitor prices on all of the different exchanges. When they got out of sync, which would occur every single time the NBBO changed, you could legally front run the change. This is one reason why having the latest, greatest, fastest technology is so important.

2) Winner- High Frequency Trading, automated front running detection. In the old days, you had humans attempting to front run large buyers and sellers. These days, you have sophisticated algorithms running on “co-located” computers attempting the do the same thing. Long story short, sell side programs attempt to hide/disguise their trading patterns so that nobody can tell they are trying to sell a large quantity. Buy side programs are constantly studying each and every trade, attempting to ascertain when the sellers are trying to move a large position. If your HFT algorithm is better than the next guys, you can pick up some easy money.

3) Winner- High Frequency Trading- news scanners. There are a number of sophisticated programs that are constantly scanning news sources and tweets looking for breaking news. For example, if you knew that Warren Buffet was going to buy XYZ, a few seconds before everyone else did, you could front run that stock. Once again, there are a lot of PHD’s working on algorithms to detect this and act on it. Think about the IBM Jeopardy computer guessing on stock news.

4) Winner- Average long term investor- Without a doubt, the bid ask spreads have come down, in addition to commissions. IF you are a long term investor, you win, but at the same time, over the long term this should not amount to much. So you save 12.5 cents per share, but hold the shares for 10 years. Big deal.

5) Winner- Day traders. Like it or not, trading in one cent increments, plus HFT makes this entire industry possible. It is clear cut that day trading is a losing proposition overall with a reported 90% of day traders losing money. For that lucky 10%, HFT makes the trading possible.


6) Winner- High Frequency Trading- “liquidity rebates.” Long story short, the exchanges pay the HFT’s for “providing liquidity.” The rules have many moving parts, but for example the NYSE pays 0.3 cents per share for providing liquidity. This is ONE of the primary ways that HFT’s make money. Obviously, the more shares they can trade while providing liquidity, the more they can make. To paraphrase Everett Dirksen, .3 cents here and .3 cents there and pretty soon you are talking real money. If you are interested, you might read this NYSE ARCA link [7]

7) Winner-Average investor- liquidity. Probably 99.9% of the time on 99% of the issues, an investor will always find a willing buyer and/or a willing seller at a reasonable bid-ask spread. This is the definition of a highly liquid market

8) Loser- Average investor in illiquid market. For the .1% of the time, like in the Flash Crash, the HFT programs are TURNED OFF. There are NO willing buyers and/or sellers at any price. In theory, this would not occur if the specialist system was still in place. In the October 1987 crash, NYSE issues remained fairly liquid. NASDAQ issues which are more similar to the HFT systems of today were a disaster. There were no buyers or sellers of last resort on many NASDAQ issues then.

9) Loser- Small investor psychology- Without a doubt, many small investors were terrified that the flash crash was even possible. They could NOT rationalize how the Dow could drop that far, that fast. Some percentage of investors have given up on equities due to fear.

10) Largest LOSER- NYSE specialists- The public does NOT understand this point at all. The last figures I saw, showed that NYSE specialists used to skim about $4 billion per year off of stock trades. Specialists have gone the way of the dinosaurs. They are now called DMM’s- Designated Market Makers. Their role in stock trading is dramatically reduced. Essentially all of the electronic stock trading is directly at their expense. My guess is that their $4 billion in skimming’s has directly gone to the HFT guys.

11) 100% Speculation Winner- HFT front running. I will use my favorite whipping boy Goldman Sachs as an example. Goldman’s computers know about every customer order that is placed. Technically it would be trivial to program Goldman’s’ HFT computers to front run customer orders. Recall that Goldman is simultaneously trading for their own account, in addition to handling customer trades. I and many others suspect the Chinese wall between proprietary trading and customer trading has a few holes in it. If Goldman skimmed a penny per share per trade it would add up. Goldman had several quarters in 2011 when their proprietary trading was profitable EVERY SINGLE DAY. I don’t care how many MENSA members you employee, I do NOT think this is possible unless you are front running or using some other nefarious trick. 100% profitable days is not exactly a Gaussian distribution.

12) 100% Speculation Winner- HFT traders that cause different exchanges to become out of sync. For example, if you could force the price in Chicago to be different from the price in New York, you could quickly make a lot of money. The small garage shop NANEX has laid out a convincing case that this occurred on the Flash Crash. Some of the exchanges got out of sync, causing all Hades to break loose. I and others suspect that some HFT’s attempt to cause this situation to occur on purpose. The theory is called “quote stuffing.” NANEX has documented how some HFT customers request 25,000 quotes PER SECOND!


BOTTOM LINE is that the individual investors are NOT harmed as much as commonly thought by High Frequency Trading. On the other hand, the NYSE specialists are now selling apples on the street corners for a living.

BTW, my apology for the length but this is the condensed version. I left out a lot of details for the sake of brevity.


Thanks,

Yodaorange

 

[skyQuake]

Interesting read, looks like everyone is fine except goldman sachs clients!

 

[Trembling Hand]

Well it does exist in the US. You're saying it doesn't exist here. You're saying I should believe you?

You don't have to believe me. You just have to know who participants in the asx and what they do. If you knew that you would know that there is very legitimate reasons for those servers.

But I guess I'm wasting my time no? Muppets love this stuff.

 

[CanOz]

Thanks for that GB

 

[Trembling Hand]

Thanks for that GB

here is a better one.

http://www.businessweek.com/article...ts-lost-high-frequency-tradings-rise-and-fall

For the first time since its inception, high-frequency trading, the bogey machine of the markets, is in retreat. According to estimates from Rosenblatt Securities, as much as two-thirds of all stock trades in the U.S. from 2008 to 2011 were executed by high-frequency firms; today it’s about half. In 2009, high-frequency traders moved about 3.25 billion shares a day. In 2012, it was 1.6 billion a day. Speed traders aren’t just trading fewer shares, they’re making less money on each trade. Average profits have fallen from about a tenth of a penny per share to a twentieth of a penny.
According to Rosenblatt, in 2009 the entire HFT industry made around $5 billion trading stocks. Last year it made closer to $1 billion. By comparison, JPMorgan Chase (JPM) earned more than six times that in the first quarter of this year. The “profits have collapsed,” says Mark Gorton, the founder of Tower Research Capital, one of the largest and fastest high-frequency trading firms. “The easy money’s gone. We’re doing more things better than ever before and making less money doing it.”

“The margins on trades have gotten to the point where it’s not even paying the bills for a lot of firms,” says Raj Fernando, chief executive officer and founder of Chopper Trading, a large firm in Chicago that uses high-frequency strategies. “No one’s laughing while running to the bank now, that’s for sure.” A number of high-frequency shops have shut down in the past year. According to Fernando, many asked Chopper to buy them before going out of business. He declined in every instance.

Its all over. Make more money controlling the gold contract

 

[CanOz]

What happened, they all just arb away their edges?

 

[Trembling Hand]

What happened, they all just arb away their edges?

yep. As usual by the time the punters start screaming about something its the last gasp.

 

[skc]

It's not a problem for any of us retail traders. But these guys are getting a free lunch, no risk. That's the definition of a parasite in my book.

Front running is when you have a certain outcome = zero risk. Their drawdown would be zero.

Just saying it exists and the playing field isn't level. Luckily it doesn't affect me.

GB, they don't KNOW big orders are coming, the article didn't say that. It said "detect pattern" that "indicate" orders coming. They can get it right, they can get it wrong, they can get swept the other way when picking up pennies. They have risks and they are trading as much as everyone else is. Like SkyQ said, it's like one might use charts to "detect pattern" that "indicates" future buying, and position yourself in the same manner.

HFTs work in nano-seconds taking pennies, chart traders work in days/weeks taking larger chunks.

HFT's profits are result of risk taking. They have a technological edge - namely, being able to detect patterns better than you and react faster than you - but they don't have an unfair advantage.

What do the computers and their algorithms do? Well, as my relatively low-frequency brain can understand it, these machines constantly monitor order flow into the ASX servers, and the sophisticated programs can pick up patterns that indicate when a reasonably large order has been placed. What they then do, in effect, is "front-run" – that is, they buy ahead of the order and make a small spread selling into it.

In other words, by operating at the speed of light they can "feel" a buy order coming and can dart in front of them and ensure that the buyers pay a little bit more than they were going to, without noticing a thing.

In your other article, the example of Goldmans front running client orders is illegal and doesn't need HFT. Any traditional broker can do it.

There are some aspects of HFT that shouldn't be allowed, like order stuffing which are essentially DDoS attacks. I seem to have read about some exchanges "flash orders" to HFT firms before sending to the market which would in fact be unfair.

But a computer that's really good at picking up pattern and really quick to respond? That's a legit edge.

 

[Gringotts Bank]

I don't know about that skc.

My understanding is that the HFT traders see the large order that has already been entered into the system and will be executed. The large order is in the pipeline and can't be cancelled, is milliseconds away from completing the buy, and the HFT slips in ahead of it. Why else would you need a fat fibre optic cable right next to the exchange?

Compare that with watching for patterns, and no high speed connections would be needed for that...surely? If it is just about detecting patterns, then I would have no problem with it.

 

[CanOz]

Orders can be pulled anytime GB...that's what allot of the spoofing is.

 

[Gringotts Bank]

Orders can be pulled anytime GB...that's what allot of the spoofing is.

But not a buy order that is due to lift the offer, which is the sort of order they'd be looking for.

 

[CanOz]

But not a buy order that is due to lift the offer, which is the sort of order they'd be looking for.

Just get the book, pretty much explains everything there is to know.

 

[skyQuake]

I don't know about that skc.

My understanding is that the HFT traders see the large order that has already been entered into the system and will be executed. The large order is in the pipeline and can't be cancelled, is milliseconds away from completing the buy, and the HFT slips in ahead of it. Why else would you need a fat fibre optic cable right next to the exchange?

Compare that with watching for patterns, and no high speed connections would be needed for that. If it is just about detecting patterns, then I would have no problem with it.

No-one can "see" an order between you clicking buy and it getting to the exchange.

Simply put, order goes from your platform to broker to asx. The moment it becomes "live" in the market is the moment the world sees it.

Simple reason being: Time-price priority.

The HFTs that need fast executions are not predatory frontrun algos, but rather index arb bots or oppie bots that need to hit the liquidity before a competitor can, and before the opportunity disappears.

 

[skc]

I don't know about that skc.

My understanding is that the HFT traders see the large order that has already been entered into the system and will be executed. The large order is in the pipeline and can't be cancelled, is milliseconds away from completing the buy, and the HFT slips in ahead of it. Why else would you need a fat fibre optic cable right next to the exchange?

No that understanding is wrong. They have fast cables to the exchange, but large insto orders do not go through their servers before hitting the market. They are detecting patterns in trading behaviour, not actually getting a heads up. The article certainly did not make that claim, and I would like to see any reference you have that suggest it is the case.

If that's the case it would be uneven playing field. It's like the old days when a traditional broker gets a large client order to say buy 100,000 BHP, and decides to buy 1000 BHP in his house account before he executes the client's order. That I believe is illegal.

A third-party trader may find out the content of another broker's order and buy or sell in front of it in the same way that a self-dealing broker might. The third-party trader might find out about the trade directly from the broker or an employee of the brokerage firm in return for splitting the profits, in which case the front-running would be illegal. The trader might, however, only find out about the order by reading the broker's habits or tics, much in the same way that poker players can guess other players' cards. For very large market orders, simply exposing the order to the market, may cause traders to front-run as they seek to close out positions that may soon become unprofitable.

http://en.wikipedia.org/wiki/Front_running

I knew a guy who once worked out when a particular insto literally "turns on" their buy bot everyday in certain securities, and he just go there and front run them. Speed that up ten million times and you have one form of HFT.

 

[Gringotts Bank]

No-one can "see" an order between you clicking buy and it getting to the exchange.

Simply put, order goes from your platform to broker to asx. The moment it becomes "live" in the market is the moment the world sees it.

Simple reason being: Time-price priority.

The HFTs that need fast executions are not predatory frontrun algos, but rather index arb bots or oppie bots that need to hit the liquidity before a competitor can, and before the opportunity disappears.

ok thanks for clearing that up. So long as time-price priority is upheld! For a retail trader it isn't. Sometimes there's a human being checking a trade before it gets to market.

- - - Updated - - -

http://en.wikipedia.org/wiki/Front_running

I knew a guy who once worked out when a particular insto literally "turns on" their buy bot everyday in certain securities, and he just go there and front run them. Speed that up ten million times and you have one form of HFT.

thanks.

 

[skyQuake]

ok thanks for clearing that up. So long as time-price priority is upheld! For a retail trader it isn't. Sometimes there's a human being checking a trade before it gets to market.

Yep, usually its DMA though.

I believe they only check if the trade fails some filters (eg will push price 5% either way) or is 10% above/below market.