High-frequency trading is a misnomer. It’s actually short-latency trading, a name that makes clearer why it is so unsavory. As Michael Lewis explains in Flash Boys, short-latency traders use a buy order on one exchange to quickly buy that stock on other exchanges before the original buy order reaches the other exchanges. Lewis writes:
The deep problem with the system was a kind of moral inertia. So long as it served the narrow self-interests of everyone inside it, no one on the inside would ever seek to change it, no matter how sinister or corrupt it became — though even to use words like “corrupt” and “sinister” made serious people uncomfortable.
I thought of health care. Our health care system — centered on treating symptoms with drugs you take for the rest of your life — serves the narrow self-interests of those inside it, such as doctors and medical school professors. That is surely one reason its predatory aspect is rarely mentioned.
But I also noticed how poorly Lewis, an excellent writer, describes the problem. “Moral inertia”? No, the problem is not that Person X or Person Y is slow to get outraged. “Corrupt”? No, no one is being paid off to look the other way or vote a certain way or introduce a certain bill. “Sinister”? It’s unclear what that means. Is Lewis just using a fancy synonym for “bad”?
Elsewhere Lewis uses the word predatory, which seems accurate. Short-latency traders preyed on those who sold stock, taking advantage of their ignorance. Of course, no one is forced to buy or sell stock and the loss on one trade is small. But everyone gets sick.
I think Lewis was almost forced to use inaccurate language. To call these pricks what they are would, over the length of a book, become wearyingly coarse and shrill.
It’s difficult for outsiders to follow, but Lewis’ book is essentially a fiction. What’s really happening is that one rich group of guys is furious at another rich group of guys that are eating their gourmet lunch. How does that affect you and me and grandma? Not at all.
Almost everyone with a little money saved is more or less forced to participate in the market, through vehicles like the California Public Employee Retirement fund, their 401K or their IRA. These vehicles are pretty much designed by law to be invested exclusively in stocks and bonds.
A few people with truly self-directed IRAs do have a chance to invest retirement money in other vehicles (e.g. real estate, small private businesses, etc). But these are neither widespread nor easily available to employees at most organizations.
And, with interest rates so low and food, fuel, and education prices rising at faster than “inflation” these days, it’s very hard to justify parking your cash in a money market account over the long term.
Don’t forget that Wall Street sometimes tries to force you to put more of your cash into their market. (Remember George W. Bush’s attempt to privatize social security?)
Maybe Lewis does a poor job describing the problem because he doesn’t understand it and it’s not clear what’s wrong with it. HFT involves a great many strategies – not just that one – and it’s not at all clear there’s anything “predatory” about that one.
There is no universal human right to have orders filled across every market simultaneously at the same price. If you don’t want to be “preyed on”, there’s a simple solution: don’t place orders that large. Trades that are so large they can’t be fulfilled on one market are big enough to move the market. When the market moves, entities that trade across many exchanges need to either quickly adjust the prices they offer or lose a lot of money.
This “predation” makes markets more efficient price-finders as it enhances a small preexisting diseconomy of scale. Yes, HFT can make it slightly more expensive to make truly massive moves in the stock market than it might otherwise be. But that’s only a *bad* thing if you think there’s some moral reason why huge trades over many markets should be exactly as cheap to carry out as tiny trades on one market.
“It’s not clear what’s wrong with it”? It’s clear what’s wrong with it to the persons who want to buy or sell — they pay more. You mean it’s not clear what’s wrong with it to you? That’s what you seem to be saying but maybe I am misunderstanding.
A larger reason that HFT is bad is that it makes the stock market less attractive. HFT contributes nothing to the economy and to the extent it makes the stock market less attractive it is destructive.
Al:
“Don’t forget that Wall Street sometimes tries to force you to put more of your cash into their market. (Remember George W. Bush’s attempt to privatize social security?)”
I’m no fan of Dubyah, but his plan was VOLUNTARY. No force at all. And for the sake of my grandchildren, etc., I wish he had succeeded. Wall Street can’t force anyone to do anything, but the government can, and does.
Given the FREEDOM of putting my money under the care of the government, or investing it in the market (thus being able to leave those assets to my children, etc.), I’m going with the market. Every. Single. Time.
Unfortunately they tried to sell social security privatization at the exact moment it became clear that Wall Street was behind the trillion dollar mortgage fraud that cost so many their homes.
Oopsie.
Andrew, Wall Street wasn’t behind it, but they weren’t blameless either. They allowed the government to shove them around, by threatening them with more regulation, disallowing mergers, expansion, etc., if they didn’t loosen credit standards. You’ve heard of the Community Reinvestment Act, right? That’s when it started, and it only got worse over time, with Freddie and Fannie gobbling up anything the banks could throw at them.
The heavy hand of government caused the meltdown, and that’s a fact.
Note: There’s another meltdown yet to come, which the US taxpayer will also have to bailout: Student loans. About a trillion dollars worth. Just about anything the government touches turns to c&$p. And just wait until you see what it does to health care!
Very simple world you got there, Joe. Looks a bit cramped.
Seth said:
” ‘It’s not clear what’s wrong with it’? It’s clear what’s wrong with it to the persons who want to buy or sell — they pay more. ”
“They pay more” – Maybe, maybe not, this is far from clear, especially for the proverbial “little guy” (e.g. anyone who doesn’t trade multi-million dollar blocks of stock). And even if people are paying more, it’s tiny. HFT traders are looking for pennies per share on a trade. If a penny or two per share is going to have any effect on your retirement, then you’re also worrying about what color to paint your Gulfstream Jet because you are super-rich. For the rest of us, this makes no difference.
Still mad about a penny difference? Remember, until 2001 stocks traded by the sixteenths, so you couldn’t even change your buy/sell price by 1 cent, you had to do it by 1/16th of a dollar (6.25 cents)!
Not to mention all this investment in bringing technology to the stock market is why you can sit at home and get real-time price quotes in your pajamas, and why you can get $8 stock trades. Just because someone else is getting rich doesn’t mean you’re getting ripped off.
Simple, Andrew? Blaming everything on Wall Street is simple. But how could you leave out the part the government played? Surely you weren’t unaware of it, right?
Did you follow the Cliven Bundy situation in Nevada? If so, you got to see the heavy hand of government in action. Should a desert tortoise be able to effectively put a rancher out of business? A rancher who has been peacefully ranching those lands since 1874? Was it really necessary to have armed federal agents, along with K-9s and armored vehicles, remove Bundy’s herd? Couldn’t the government have simply filed a lien on his ranch? Yes, legally, Bundy was in the wrong. But the government breaks the law every single day. They also simply ignore many laws they don’t like. Only the government can get away with c&$p like that. I think that’s wrong. YMMV.
“legally, Bundy was in the wrong”: jeeze, that was a lot of words to camouflage a simple point.
The answer to your complaints about The Government is, of course, to have them sell off most federal land. Alas, they would handle it so that Harvard advice would result in most of it ending up in the hands of oligarchs. Just as Harvard advice managed to bring that about in Russia. Comparing the USA to Russia: can that be valid? Probably not; Russia is run with greater intellectual rigour.
Another thing that’s wrong with HFT to people who buy and sell is that the prices they see on their computer screen at the moment they do a trade are not the prices they end up paying.
Dearieme, I wasn’t trying to camouflage anything. That should have been obvious, no? And no “point” is simple around here, apparently.
Selling off federal land is, of course, one solution, especially when considering our 17+ trillion debt (and growing by the day). But it won’t happen. It makes too much sense. The real question is: How did they end up owning all that land to begin with, and why do they still own it? Our Constitution actually prohibits it. But our Congress enjoys ignoring the Constitution. And so they refuse to divest it. Ah, the wonders of government.
Also, how much “intellectual rigor” must the Russians have if they were stupid enough to take advice from Harvard “economists”? How do they think WE ran up our 17+ trillion debt?
Russia is essentially a banana republic that happens to have a lot of oil. Let’s see how that works out for them in the long run.
Seth said:
“Another thing that’s wrong with HFT to people who buy and sell is that the prices they see on their computer screen at the moment they do a trade are not the prices they end up paying.”
This is exactly how it is for any individual (you or me, e.g. non-professionals) who buys or sells stock. If I’m placing an order to buy a stock, just because the screen says the “ask” (what someone is trying to sell their shares at) is at $50.27, doesn’t mean I’ll be able to buy at that price, and this makes complete sense. By the time my computer screen loads the price information, and I enter my sell order and click “Submit”, the market may have moved. The $50.27 ask may have already been filled (someone else bought it), and the next cheapest ask is now $50.35. So now I have to up my bid. This is far from ‘bad’ (or ‘good’ for that matter), it’s just how markets work. And this just as often can work in your favor with the price dropping as you enter you bid, and thus you get a cheaper price than you were expecting.
Thus if HFT traders were guaranteed the price they saw on their screen they would have a significant advantage over non-professionals/individuals.
So I’m confused by the point you’re making here. The only explanation I can think of is you’ve never bought or sold stock, or if you have, you were hands-off about it and didn’t pay attention to the price movements as you were placing your order.
Seth: HFT caused prices to move away from sellers and buyers. For example, if you are buying, the price goes up. This is different than random fluctuation.
“How did they end up owning all that land to begin with”: well, in Nevada they stole it from Mexico, fair and square.
The Russian government improved its intellectual rigour by expelling Harvard economists, and having a drunken president retire. You may be able to think of equivalents that the US federal government would benefit from.
I prefer to think of it as stealing it back from the Europeans, dearieme. Stealing land is something you Brits are familiar with, no?
I think we should do with Harvard economists what the Mormons do. Send them out into the world on missions, for not just two years, but for the rest of their lives. Let them help other countries run up mountains of debt, devalue their currencies, and generally screw up their economies, like they did to ours. They won’t go voluntarily, or pay their own way, like Mormon missionaries do. But a guy can dream, can’t he?
High-frequency trading is a misnomer. It’s actually short-latency trading, a name that makes clearer why it is so unsavory.
The fact that the trades are short-latency means that the can be, and are, if I’m not mistaken, made with high frequency.
And it’s unclear to me how ‘short-latency’ is any more or less unsavory than ‘high-frequency.’
Seth: The term short-latency makes clearer the problem (from the point of view of ordinary traders): use of very short latency to front-run. Frequency has nothing to do with it. The trades could be high frequency without the extremely short latency. It is the extremely short latency that matters.