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Businesses Math The Almighty Buck Hardware

Barbarians At the Gateways 321

CowboyRobot writes "Former high-frequency trader Jacob Loveless gives an in-depth description of the math and technology involved in HFT. From the article: 'The first step in HFT is to place the systems where the exchanges are. Light passing through fiber takes 49 microseconds to travel 10,000 meters, and that's all the time available in many cases. In New York, there are at least six data centers you need to collocate in to be competitive in equities. In other assets (foreign exchange, for example), you need only one or two in New York, but you also need one in London and probably one in Chicago. The problem of collocation seems straightforward: 1. Contact data center. 2. Negotiate contract. 3. Profit. The details, however, are where the first systems problem arises. The real estate is extremely expensive, and the cost of power is an ever-crushing force on the bottom line. A 17.3-kilowatt cabinet will run $14,000 per month. Assuming a modest HFT draw of 750 watts per server, 17 kilowatts can be taken by 23 servers. It's also important to ensure you get the right collocation. In many markets, the length of the cable within the same building is a competitive advantage. Some facilities such as the Mahwah, New Jersey, NYSE (New York Stock Exchange) data center have rolls of fiber so that every cage has exactly the same length of fiber running to the exchange cages.'"
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Barbarians At the Gateways

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  • by Impy the Impiuos Imp ( 442658 ) on Friday October 18, 2013 @12:43PM (#45166163) Journal

    This isn't even gambling. It's pseudo-precognition, taking advantage of price differentials between computers in different cities or buildings, before the other guy's system promulgates the updated price.

  • by Ubi_NL ( 313657 ) <joris AT ideeel DOT nl> on Friday October 18, 2013 @12:49PM (#45166261) Journal

    The Zeconomist has a debate about it []

  • by ShanghaiBill ( 739463 ) on Friday October 18, 2013 @12:53PM (#45166299)

    Please teach me what purpose HFT serves to our economy.

    This question has been beaten to death every time a HFT related article is posted. But people still ask, so I will try to answer. High Frequency Traders (HFTs) are not investors, they are market makers. They find a willing buyer and a willing seller, arrange the transaction, and execute the trade. They make a profit on the spread between the buy price and the sell price. The problem is that once they locate the buyer and seller, they need to buy the stock from the seller first, then turn around and sell it to the buyer, but the buyer may have cancelled they transaction, or they may have already bought the stock from someone else, in which case the HFT is stuck with the stock and may have to sell it to someone else at a loss. If transactions are granulated to one second intervals, instead of say, millisecond intervals, then the risk of this happening is a thousand times higher , and the HFTs will insist on higher spreads, resulting in lower liquidity and higher transaction costs for both buyer and seller.

    Since the introduction of high frequency trading, transaction costs have fallen considerably, saving plenty of people a lot of money. The only losers are the old market makers that used to have lucrative sweetheart deals with the exchanges. Many of those old market makers are now bankrupt. Good riddance.

  • Re:Liquidity (Score:2, Informative)

    by Anonymous Coward on Friday October 18, 2013 @01:00PM (#45166397)
    The markets also used to have 12.5 cent spreads. The insiders still made gobs of money, there was just less competition between them. You had to have a seat at NYSE to be an insider, instead of buy some fast computers. Plus HFT profits are cratering (see Getco's financials) so in part thanks to competition between HFT firms they may have priced themselves out of the market. Even if they are profitable, they are hardly printing money. So if everything is so unfair and they could do half of what people say they can do, why aren't they making money now?
  • by kajsocc ( 2955535 ) on Friday October 18, 2013 @01:10PM (#45166523)

    Please teach me what purpose HFT serves to our economy.

    The best analogy I've heard is to transportation / shipping. Back when such transport was new, people scoffed at the idea of making money for moving things around. "You aren't producing anything, making anything, it's a complete waste." But today, we can see how moving goods around is actually of extreme importance.

    Trading moves another kind of economic good--capital. That is, trading is to capital as transportation is to physical goods.

    High-frequency trading is just trading... but faster. You'll notice how the summary mentioned New York and London. This is because the HFTs are arbitraging between those two major exchanges. If they were slower, you'd have more people getting "incorrect" prices, in the sense that there was a better price in NY but the information hadn't been priced into the London exchange yet. Hence, London traders would be getting screwed out of better deals that they technically could have known about.

    However, HFT has also become associated with a bunch of "dirty tricks", like flash trading, etc. These kinds of things actually CAN hurt investors and other traders. This gives HFT as a whole a bad name, as it is viewed negatively by those who feel they are taken advantage of by these tricks.

    In general, though, HFT has lowered market spreads, meaning it costs less to trade. Those lower costs show up in investors' bottom lines, which obviously include retirement accounts, so a lot of people are helped by HFT. However, I think a lot of people believe that without HFT, money would simply not be "leeched out", because they view traders as middlemen who are price gouging. The problem with this view is that all trading requires either paying middlemen, paying the spread, or taking on risk like traders do. So, take out the middlemen and you'll just pay higher spreads or incur larger risks, both of which are real costs, economically-speaking.

    Another thing is that if you check the trading volumes, you'll see that HFT makes up a substantial (50+%) of trading volume. People I've talked to often think this equates to 50% of the "profit" leeched by HFT. This is not so at all... the reason they have such high volumes is they'll buy and sell multiple things simultaneously, then trade back to a fully-hedged position moments later or at least by the end of the trading day. As an HFTer you might buy 100,000 contracts and sell them a bit later and net just $5-10 for the whole thing. Of course, there might be thousands of such opportunities in a given trading day, if you're a large firm with a competitive HFT program. As such, this type of trading incurs a very high volume-to-profit ratio. On top of that, a substantial portion of their would-be profits are eaten up by trading fees. And then, as the summary mentions, you've got substantial electricity costs, top-end hardware costs, collocation costs (which can be obscenely expensive for the prime real estate locations), etc., so it's not at all like HFT is making money hand over fist.

    HFT was a big thing a few years ago because it was a new thing, there wasn't much competition, and the profits were fierce. Now it's just the competition that is fierce.

  • by Anonymous Coward on Friday October 18, 2013 @01:11PM (#45166535)

    Please teach me what purpose HFT serves to our economy.

    ... they are market makers. They find a willing buyer and a willing seller, arrange the transaction, and execute the trade.

    Umm, bullshit. The exchange is supposed to match up buyers and sellers. That's what exchanges are FOR. If there is a buyer but no seller, then the market maker steps in and sells at a higher price. If there is no buyer, the market maker buys at a lower price. This is how price movements happen. HFT is a middleman. If there is no buyer or seller, then HFT wouldn't go in on the trade at all. If there is a buyer and a seller, HFT does not need to exist, since the exchange is supposed to match up the two parties already.

  • by ShanghaiBill ( 739463 ) on Friday October 18, 2013 @01:11PM (#45166543)

    I'm ok with paying a little for the service of buying a stock.

    You can! There are plenty of brokers out there that would be happy to charge you extra. Or you could just flush your surplus money down the toilet for the same end effect.

    What can't you do if you don't have quarter-cent microsecond trades?

    Let's turn the question around: What do you hope to gain by passing yet more laws that prohibit consenting adults from engaging in transactions that you think should be banned because you don't understand them?

  • by ShanghaiBill ( 739463 ) on Friday October 18, 2013 @01:20PM (#45166659)

    And in exchange for this liquidity, we get flash crashes

    The flash crash was not caused by HFT. In fact, the SEC investigation determined that most active HFTers were trading against the decline, thus making the crash less severe. One of the SEC recommendations was to find a way to keep more HFTers active during big swings because they help to keep the markets stable.

  • by ShanghaiBill ( 739463 ) on Friday October 18, 2013 @01:27PM (#45166769)

    Umm, bullshit. The exchange is supposed to match up buyers and sellers. That's what exchanges are FOR.

    The exchanges are made up of their members. The members are brokerages that execute trades on behalf of their clients. You, as an individual, cannot log into the NYSE computer and execute your trade anymore than you could have walked into the pit during the old paper-based days. So why can't you trade with a "member" instead of a HFTer? Because the members are the HFTers. For all practical purposes, the HFTers are the exchange.

  • by smaddox ( 928261 ) on Friday October 18, 2013 @01:48PM (#45167075)

    Interesting debate, I'll have to finish reading it at some point.

    After reading the opening statements, it seems to me that the pro-HFT guy, Jim Overdahl, is confusing the use of computer automation to reduce transaction costs (which benefits the whole market) with HFT firms that act only as middle men (which benefits only the HFT firms). I didn't realize people could get caught up on such a simple point, but perhaps this is the only way someone could think that HFT is actually a Good Thing.

    Of course computer automation lowers transaction costs, and of course that's a good thing. Adding a minimum hold time, or taxing very short term holds wouldn't eliminate that benefit, though. It would only eliminate the middle men.

  • by alexander_686 ( 957440 ) on Friday October 18, 2013 @02:59PM (#45168063)

    It has been tried. Look up Order Book exchanges. The Paris Bourse was one. The NYSE was a hybrid. They both converted.

    Empirically it produced (mostly) inferior results so everybody ditched it for a quote driven system.

    The problem with a order book exchange is the decreased certainty of trade executions which increased the risk to market makers which causes higher spreads and lower liquidity.

    Now Order Book markets still do survive where liquidity is low or cost is a driving factor. in Dark Pools like ICE. It survives because these trades are more concerned about anonymity and cost then certainty of execution.

I am here by the will of the people and I won't leave until I get my raincoat back. - a slogan of the anarchists in Richard Kadrey's "Metrophage"