60 Minutes lead story on Michael Lewis - Flash Boys

[rkbabang]

I'd just like to add a few points to the discussion.  If you are the type that likes to react emotionally and not think too far past your first instincts on any issue (most people it seems), than please ignore what comes next, because it will only frustrate you, or you won't get it.

 

In general, every complex evolved system has inner workings which are hard to understand, and at first can appear useless or even harmful (i.e. tonsils/appendix don't do anything, take them out).  It is also true that any sufficiently complex system will acquire opportunistic parasites.  Some of these are harmful (tapeworm), some harmless (most of the bacteria on your skin),  some beneficial and can even become essential as the organism and the parasite co-evolve (the micro-organisms in your gut).  For the most part what doesn't kill a system will make it stronger, so most harmful parasites should be left alone so that the system can fight them off and improve itself, or evolve defenses against it.  A careful balance has to be struck between fighting the harmful things and not hurting the beneficial, while not hampering the evolution of the system itself.  The problem with government regulations is that they cement in place procedures/technology and other parts of the system which can stop the evolutionary process.  It is the nuclear option, which if used at all, should only be used against the most severe and deadly threats to the system.  Anything we are talking about in this thread will seem so antiquated in 15 or 20 years as technology and the exchanges evolve that it will be funny to go back and read it.  You don't want to make permanent changes to an evolving system because of short term "problems" unless they are gigantic and causing massive harm. HFT isn't even clearly a problem at all.  It is a minor nuisance to frequent traders at worse and beneficial market making at best.  It isn't worth scheduling surgery, IMHO.

 

[randomep]

From WSJ this morning

 

High-Frequency Hyperbole - By Cliff S. Asness and Michael Mendelson

 

Thanks for the article, the following is most telling.

 

How HFT has changed the allocation of the pie between various market professionals is hard to say. But

there has been one unambiguous winner, the retail investors who trade for themselves. Their small orders

are a perfect match for today's narrow bid-offer spread, small average-trade-size market. For the first time

in history, Main Street might have it rigged against Wall Street.

 

I just don't see any problems in my orders of large cap trades. If I can buy and stock and instantly sell it, and only lose 0.1% (which I believe is the state of the market today), I think it is a very efficient system.  For comparison, imagine you going to a currency exchange kiosk at the airport. If you buy a currency and turn around and sell it back to them, you'll lose at least 10% of your money!  Just to put things in perspective.

 

I would think justice is much better served by the government punishing Steven Cohen instead of the people that are the target of this thread, I just can't believe he isn't in jail.

 

 

 

 

[20ppy]

When seemingly bids disappear on you as you enter your trade, it is a huge problem, isn't it?

[constructive]

When seemingly bids disappear on you as you enter your trade, it is a huge problem, isn't it?

 

No. You have no right to any particular price. Taking liquidity has never been and will never be free.

[ItsAValueTrap]

HFT isn't even clearly a problem at all.

 

I think you haven't realize that other parties have been front running and skimming small amounts of money from your trades.  It's usually very, very small amounts of money.  If you place limit orders then other parties cannot skim more than the bid/ask spread, which is usually a penny.  So on a buy and a sell order, you might lose some fraction of a penny for every share you trade.

*There may be exceptions where they can skim more.  For example, NBBO rules don't apply to the closing cross.

**For the sake of simplicity, I ignore rebates.

 

I suppose that institutional investors are bigger losers from the current market structure.

 

2- If you place limit orders, you will lose a small amount of money to front running.  There's the whole sub-penny front running game going on.  If you look at the time & sales for massively liquid stocks like Sirius XM or the old Citigroup, you will see lots of trades going off at sub-penny prices like $3.0001/share.

 

There are other games that go on.  For example, let's say that you are retail, you want to buy Intel, and your broker actually routes your order to an exchange (which rarely happens, but suppose that it does).  Let's say it goes to NASDAQ.  Those taking liquidity on NASDAQ pay a rebate of 29 cents for every 100 shares last time I checked.

NASDAQ - 29 cents

BATS - 25 cents

EDGEA - negative 2 cents

 

Sellers, if they are rational, will take liquidity on EDGEA first.  Then they try BATS next.  Then NASDAQ.  (Assuming that there is no price improvement going on.)

 

Most retail brokers will simply pocket these rebates.  So they post your order onto NASDAQ, where you are the last in line to get filled.  When you do get filled, the broker keeps the rebate.

If you wanted good execution, it might be better for you to have your order posted on BATS or EDGEA (or ARCA).  But because your broker wants to make money, they might post your order on NASDAQ (29 cents), NITE (30 cents), or ISE (31 cents).

 

3a- On most of the ECNs out there, market makers and HFT guys typically have orders for hundreds of thousands of shares already posted.  Most of those orders are fake and usually get cancelled.  But the reason they post those orders is so they get to sit at the front of the line.

 

The market makers and HFT guys might have orders for 500,000 shares of Intel at the bid (and another 500k for 1 cent less than the bid, 2 cents less, etc.).  They might only want to trade 50,000 shares or some small fraction of that 500k.  But they have their spot in line reserved for 500,000 shares.

 

3b- The real problem is the price improvement front running.  Institutional investors and retail investors aren't allowed to do it.  So those who have access to offering "price improvement" (a form of legalized front running) can cut in line if they offer some amount of price improvement, even if it is a miniscule amount like 1 penny for 100 shares.

[ItsAValueTrap]

Taking liquidity has never been and will never be free.

Um... yes it has.

 

You can get paid a negative rebate and/or get price improvement.  If you take liquidity on EDGEA, you get paid a negative rebate of 2 cents / 100 shares.  With CBSX it's more.  With price improvement it can be more.

 

This happens most frequently on highly liquid stocks with a low share price above $1, e.g. Sirius XM.  It's more likely to happen when spreads are very narrow and volatility is low, e.g. not near the market open or close.

[randomep]

When seemingly bids disappear on you as you enter your trade, it is a huge problem, isn't it?

 

Not if there is plenty of liquidity to replace it. If my $20.00 bid disappears and is replaced with a $19.98 bid (remember there is always a bid in the market), I'll eat the 0.2% loss. I am not a  trader.

 

BTW I really do assume such shenanigans go on, I have much bigger worries. For example,

 

- gas is higher at a pump close to my house, so I have to go farther to get a better price

- if I forget my credit card bill, I'll have a $20 late fee

- I paid $100 transaction fee for a trade done online, it would have been about $20 if I phoned (go figure!)

- etc etc, if we look at the world that way it sure aint fair but there is nothing I can do

 

HOWEVER, the government is sleeping at the wheel if SAC got away with what they did for so long, who knows they may have priced me out of some trades on CSCO or MSFT because they had some inside info!

 

[dcollon]

Some comments from Liquidnet

 

http://memberengagement.createsend4.com/t/ViewEmail/j/0B913C57CBF706B1/DDF61C646BBC251C0F8C96E86323F7F9

 

[Otsog]

I'd just like to add a few points to the discussion.  If you are the type that likes to react emotionally and not think too far past your first instincts on any issue (most people it seems), than please ignore what comes next, because it will only frustrate you, or you won't get it.

 

In general, every complex evolved system has inner workings which are hard to understand, and at first can appear useless or even harmful (i.e. tonsils/appendix don't do anything, take them out).  It is also true that any sufficiently complex system will acquire opportunistic parasites.  Some of these are harmful (tapeworm), some harmless (most of the bacteria on your skin),  some beneficial and can even become essential as the organism and the parasite co-evolve (the micro-organisms in your gut).  For the most part what doesn't kill a system will make it stronger, so most harmful parasites should be left alone so that the system can fight them off and improve itself, or evolve defenses against it.  A careful balance has to be struck between fighting the harmful things and not hurting the beneficial, while not hampering the evolution of the system itself.  The problem with government regulations is that they cement in place procedures/technology and other parts of the system which can stop the evolutionary process.  It is the nuclear option, which if used at all, should only be used against the most severe and deadly threats to the system.  Anything we are talking about in this thread will seem so antiquated in 15 or 20 years as technology and the exchanges evolve that it will be funny to go back and read it.  You don't want to make permanent changes to an evolving system because of short term "problems" unless they are gigantic and causing massive harm. HFT isn't even clearly a problem at all.  It is a minor nuisance to frequent traders at worse and beneficial market making at best.  It isn't worth scheduling surgery, IMHO.

 

 

I think we are all able to recognize disruptive technologies will likely have exploitable niches that were unanticipated before hand despite being an overall positive change.  Nobody is advocating for throwing the baby out with the bath water, I'm on the sidelines cheerleading computerized trading along with everyone else.  That straw man is really taking up a lot posts and obfuscating the issue at hand.  A lot of people (both here and in the press) very clearly disagree with you that ceratin HFT practices are a "minor nuisance to frequent traders at worst" and have presented very rational non-emotional arguments about market inefficiencies.  Absurd analogies, downplaying unknown costs and claiming unproven benefits as a defense is terribly unconvincing. 

 

Example of an absurd analogy:

 

Exactly.  If I have a computer program to scan "item wanted" ads as well as "item for sale" ads on Craigslist and it finds someone selling an item for $10 and someone looking for the same item willing to pay $15.  If my program automatically emails them both offering to buy/sell before they find out about each other, I have done nothing illegal.  Everyone got what they wanted and I made a profit.

 

This is not even close to what is being talked about.  Corrected version:

 

Craiglist now posts substitute items together on a non-geographical page.  You can search for basketballs and it will show you $10 for a basketball.  There are 10 basketballs available at that price at various locations, CL:Los Angeles, CL:New York, CL:Miami.  You don't think it matters where the basketball comes from because they are substitute products with the same shipping costs and delivery time. 

 

From San Diego you send an order to buy 10 basketballs.  Your order arrives at CL: Los Angeles first and you get the 3 basketballs offered at CL: Los Angeles.  Your order travels to CL: Miami but the 4 basketballs that were offered there have been sold and relisted for sale at $10.01, your order travels to CL: New York but the 3 basketballs that were offered there have been sold and relisted for sale at $10.01. 

 

The reason this happens is someone has rented server space inside all the CL locations, they have secured the fastest routes between CL locations, using information solely provided by your order they can plant themselves as a middleman. 

 

 

We obviously disagree whether that is good, bad or neutral for the market, I just want to point out your analogy has nothing to do with the issues being discussed in this thread.

 

 

 

 

[constructive]

Taking liquidity has never been and will never be free.

Um... yes it has.

 

You can get paid a negative rebate and/or get price improvement.  If you take liquidity on EDGEA, you get paid a negative rebate of 2 cents / 100 shares.  With CBSX it's more.  With price improvement it can be more.

 

This happens most frequently on highly liquid stocks with a low share price above $1, e.g. Sirius XM.  It's more likely to happen when spreads are very narrow and volatility is low, e.g. not near the market open or close.

 

It's not free if you look at all-in costs, including what the market makers are earning. Which is the whole point of the discussion, that HFT/market makers are part of the market ecosystem. If you remove them the exchange fee structure would need to be more expensive.

[ItsAValueTrap]

But that would be a good thing, because overall costs should go down.

 

The exchanges and market makers make money from skimming money from people who trade on exchanges.  If this skimming didn't happen, then sure the exchanges would probably need to raise their rates.  But overall, investors should benefit as their overall costs come down.

[20ppy]

When seemingly bids disappear on you as you enter your trade, it is a huge problem, isn't it?

 

No. You have no right to any particular price. Taking liquidity has never been and will never be free.

 

This has nothing to do with liquidity nor the need for intermediaries. When you bid, do you mean to bid or not?

[constructive]

But that would be a good thing, because overall costs should go down.

 

The exchanges and market makers make money from skimming money from people who trade on exchanges.  If this skimming didn't happen, then sure the exchanges would probably need to raise their rates.  But overall, investors should benefit as their overall costs come down.

 

You don't know that costs are lower with one system versus another. The only way to know is to test it. If IEX's total costs are less and they take business from the other exchanges, that will be proof they have a better model. Until then it's conjecture.

[ItsAValueTrap]

What I'm saying is that regulators, ideally, would get rid of unfair advantages.

 

1a- I think the easiest problem to deal with is the sub-penny front running (subpenny pricing + "price improvement").  I don't know if Michael Lewis talks about this in his book.  I think the sub-penny stuff is the easiest to understand: retail and investors are not allowed to buy shares of XYZ at $3.0001.  Other market participants can, and that gives them an unfair edge.

 

1b- Related to subpenny front running is the rebate structure, which can be thought of as another form of sub-penny pricing.

 

2- The speed advantage that HFTs enjoy.  I'm not sure if regulators should try to address that.  The private market might do it on its own with IEX.

 

3- The weird order types that allow market makers and HFTs to post huge amounts of liquidity that get cancelled when you try to take it.

 

4- There are obscure loopholes in NBBO rules that are being exploited.  I think regulators should address those.

 

Related to this is all the ways in which retail order flow is abused.  This leads to skimming and I think regulators should address that.

 

You don't know that costs are lower with one system versus another. The only way to know is to test it. If IEX's total costs are less and they take business from the other exchanges, that will be proof they have a better model. Until then it's conjecture.

As Thomas Peterffy argued, the futures markets have done pretty well without market makers.  The futures market has a few problems but it hasn't had a flash crash-esque type crash (other than the 1987 crash).

[Guest 50centdollars]

Lewis on Bloomberg today

 

http://www.bloomberg.com/video/lewis-nobody-understands-the-stock-market-oRy0FtO1RuOVl9A_kVG~cw.html

 

[yadayada]

So technically hes right. It is rigged right? BUT it is only rigged like a tiny percentage. So in the case of calling Einhorn a fish, he is wrong. Since einhorn makes like 20% a year or something, and only loses very tiny percentages over this.

 

It really seems the case here that nobody is truly hurt here. Only so little that it is barely noticable. But people have a feeling it is unfair, and easy money is made by rich people, so they are pissed.

 

Or they dont understand it, and think because of this you cant make money in the stock market.

 

Am I right here, or missing something?

[tiddman]

Well I guess the reason that it's debatable is that your typical investor is not affected much by this.  Certain investors such as the guy featured in Lewis' book is more affected, not only from worse prices but by more difficulty in closing trades.  So in that sense I guess most people can look the other way (and have been).

 

However the HFT people are clearly 1) not providing a service that anyone needs, 2) front-running which is illegal, and 3) are making way too much money for ostensibly providing some kind of trade fulfillment service to the markets.

 

Front running is when, for example, you ask a broker to buy IBM at $190, and he buys it for his own account at $189 and then sells it to you for $190.  This is illegal and any broker/dealer or advisor would get in big trouble for this.  You could debate the fairness or severity of this offense but this has been illegal for a long time.  I don't really see what the HFT guys are doing that is different than this, they're just doing it with computers, a lot faster, and in much higher volume.

[Otsog]

So technically hes right. It is rigged right? BUT it is only rigged like a tiny percentage. So in the case of calling Einhorn a fish, he is wrong. Since einhorn makes like 20% a year or something, and only loses very tiny percentages over this.

 

It really seems the case here that nobody is truly hurt here. Only so little that it is barely noticable. But people have a feeling it is unfair, and easy money is made by rich people, so they are pissed.

 

Nobody knows how much is being skimmed.  A lot of people in this thread have thrown around random calculations but they are all completely useless.  They are all numbers based on nothing cherry-picked out of thin air and steeped in confirmation bias. Nobody knows how effective the strategies are.  Because it was highlighted in the 60 Minutes piece this thread has primarily been about the scalping/front-running/skimming/whatever you want to call it.  As ItsAValueTrap has pointed out there are many other dubious strategies. 

 

I think inverting it and looking at the money being poured into it is a valuable exercise, although still not conveying the total depth. 

 

- Why are exchanges deriving 50+% of their revenue (billions) from HFT firms?

- Why is a fibre line from Chicago to NY that shaved 1.5 milliseconds and cost $300 million worth billions?

- How much more has been spent on infrastructure that otherwise wouldn't have been,  hundreds of millions? Billions?

- How many millions (billions?) have been spent on order flow?

- Are programmers with $20+ million annual salaries actually creating $20+ million of value? (along with the externality of mis-allocation of some obviously brilliant STEM minds)

 

If I was making billions a year on top of the above costs I would love to have the people I was ripping off not care. 

 

 

 

[Otsog]

Well I guess the reason that it's debatable is that your typical investor is not affected much by this.

 

How do we know this to be true? It's not like there is a marginal cost of labour with a running computer program.  What's stopping them from attacking every single spread and every single order they can get information on? Why is TD Ameritrade's order flow the most profitable?

[tiddman]

Nobody knows how much is being skimmed.  A lot of people in this thread have thrown around random calculations but they are all completely useless.  They are all numbers based on nothing cherry-picked out of thin air and steeped in confirmation bias.

 

Well there are numbers out there, for example, "[in 2012], according to estimates from Rosenblatt Securities, the entire speed-trading industry made about $1 billion, down from its peak of around $5 billion in 2009."

 

I dunno in my book $1 billion a year is enough that it warrants attention to see if it's actually legal or not.  My own opinion is that it is probably a lot higher, and the firms involved in this have figured out ways to make even more money from this strategy that is not disclosed, but that is just conjecture.

 

Well I guess the reason that it's debatable is that your typical investor is not affected much by this.

 

How do we know this to be true? It's not like there is a marginal cost of labour with a running computer program.  What's stopping them from attacking every single spread and every single order they can get information on? Why is TD Ameritrade's order flow the most profitable?

 

Well my point is that if you are a typical retail investor and buy $50k of a stock and lose $500 of that (0.1%) to the HFT's then you probably won't know or care very much.  If you don't trade much then this is just rounding error for you.  This I think is why it has gone on so long, it's an annoyance but not a deal breaker for anyone.

[Otsog]

The drag on the market is combined HFT/Exchange/Broker cronyism, not just HFT.

 

How do we know it's 0.1%?

 

Should we adjust for risk, that is virtually non-existent?

[morningstar]

Well I guess the reason that it's debatable is that your typical investor is not affected much by this.

 

How do we know this to be true? It's not like there is a marginal cost of labour with a running computer program.  What's stopping them from attacking every single spread and every single order they can get information on? Why is TD Ameritrade's order flow the most profitable?

 

The biggest way we know this to be true is that most liquid stocks, where HFTs are active, trade with incredibly small spreads - often a penny, basically the smallest spread retail investors will ever get by law. Just look on your brokerage site at midday quotes on a big stock and its likely to be something like 3 bps. And in retail size, you will generally be able to hit that bid or offer. Note that were it not for the SEC's rules against sub-penny orders and quotes, HFTs would likely drive these spreads even tighter.

 

TD or Fidelity order flow is profitable for the obvious reason, it is information-lite. Citadel knows when it buys orders from Fidelity to internalize them, that it's not trading across from someone like Icahn whose trades are predictive of stock price movement. So it's easy to clip the spread on that order flow (the 1-2 cents/share).

[wisdom]

Lewis was on Charlie Rose

[vinod1]

Good article in WSJ

 

Vinod

 

High-Frequency Hyperbole

Beware of critics who are 'talking their book' about trading that lowers costs.

By

Clifford S. Asness And Michael Mendelson

 

A few nights ago, CBS's "60 Minutes" provided a forum for author Michael Lewis to announce that Wall Street is "rigged" and for the sponsors of a new trading venue called IEX to promise to unrig it. The focus of the TV segment was high-frequency trading, or HFT, an innovation now over 20 years old.

 

The stock market isn't rigged and IEX hasn't yet generated a lot of interest. In our profession, what we saw on "60 Minutes" is called "talking your book"—in Mr. Lewis's case, literally.

 

The onslaught against high-frequency trading seems to have started about five years ago when a blogger made a wildly exaggerated claim about one firm's HFT profits. Nowadays after any notable market event, and again last Sunday for no reason other than a book launch, the world gets bombarded with arcane details and hyperbolic assertions about HFT strategies. If you find the discussion overwhelming, we have some good news: The debate can be understood without knowing how equity orders are routed, matched or canceled.

 

Few professionals completely understand the details of market microstructure. Rather, when someone has a strong opinion about the subject, it's likely to be what they want you to believe, not what they know.

 

Our firm, AQR Capital Management, is an institutional investor, primarily managing long-term investment strategies. We do not engage in high-frequency trading strategies. Here is where our interest lies: What is good for us is lower trading costs because it translates into better investment performance and happier clients, which makes our business slightly more valuable.

 

How do we feel about high-frequency trading? We think it helps us. It seems to have reduced our costs and may enable us to manage more investment dollars. We can't be 100% sure. Maybe something other than HFT is responsible for the reduction in costs we've seen since HFT has risen to prominence, like maybe even our own efforts to improve. But we devote a lot of effort to understanding our trading costs, and our opinion, derived through quantitative and qualitative analysis, is that on the whole high-frequency traders have lowered costs.

 

...

 

How HFT has changed the allocation of the pie between various market professionals is hard to say. But there has been one unambiguous winner, the retail investors who trade for themselves. Their small orders are a perfect match for today's narrow bid-offer spread, small average-trade-size market. For the first time in history, Main Street might have it rigged against Wall Street.

 

Mr. Asness is managing and founding principal of AQR Capital Management, where Mr. Mendelson is a principal and portfolio manager. Aaron Brown, chief risk officer at the firm, also contributed to this op-ed.

 

 

[ni-co]

Lewis was on Charlie Rose

 

http://www.charlierose.com/watch/60368500