High-frequency trading and the retail investor

Matthew Philips explains it clearly:

The idea that retail investors are losing out to sophisticated speed traders is an old claim in the debate over HFT, and it’s pretty much been discredited. Speed traders aren’t competing against the ETrade guy, they’re competing with each other to fill the ETrade guy’s order. While Lewis does an admirable job in the book of burrowing into the ridiculously complicated system of how orders get routed, he misses badly by making this assumption.

The majority of retail orders never see the light of a public exchange. Instead, they’re mostly filled internally by large wholesalers; among the biggest are UBS (UBS), Citadel, KCG (KCG) (formerly Knight Capital Group), and Citigroup (C). These firms’ algorithms compete with each other to capture those orders and match them internally. That way, they don’t have to pay fees for sending them to one of the public exchanges, which in turn saves money for the retail investor.

There is also this:

…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. That’s nothing to sneeze at, but it isn’t impressive once you put it into context: JPMorgan Chase (JPM) made more than $5 billion in profit in just the last quarter.

If that doesn’t convince you, just listen to all those Keynesians who are proudly calling this a form of useful economic stimulus, akin to pyramid-building, or an invasion from outer space…oh wait…


The counterargument of retail investors not being affected because their retail orders are not affected is ridiculous. Is it true that on their retail orders they are not directly impacted? Yes. Does that mean that retail investors are not affected? No.

Sure. But isn't the way that they're affected mostly that the bid-ask spread has declined as a result of HFT? And doesn't that help retail investors (and hurt the brokers)? Please correct me if I'm wrong.

Sure. But this decline that is attributed to HFT is about electronic exchanges and automation and really got nothing to do with the types of strategies that should not be allowed. Everything is cast under the HFT umbrella these days if it is automated, but most automated trading has got nothing to do with predatory strategies like quote stuffing, yet everything seems to be labeled as the same.

I am not anti-HFT. There were a lot more intermediaries taking a much bigger piece of the pie before, but automation and electronic exchanges have improved conditions for every investor out there. That does not mean one should not try and avoid some of the predatory strategies out there.

Well, isn't that a terminology question? Automation and electronic exchanges enable higher frequency trading, which enables potentially dubious strategies. I think that people do talk past each other a lot, like you're saying. It's not unreasonable to put everything to do with electronic exchanges and automation under the "HFT" rubric, though I can understand wanting to exclude it.

But no one is criticizing automation and electronic exchanges. Dubious HFT strategies might depend on these two factors, but automated trading and electronic exchanges does not depend on these strategies.

E.g. information should not be made available earlier to anyone. Today this is not always the case for trading and economic information. In essence this is facilitation of front running.

On the other hand I have no sympathy for the old school guys whining about their block trades moving prices because they have not adapted to the necessary use of algorithms to execute their trades (also, who told them that sales of big blocks of assets weren't supposed to move prices?). If someone wants to exploit these guys without quote stuffing or early information access, be my guest.

"E.g. information should not be made available earlier to anyone. Today this is not always the case for trading and economic information. In essence this is facilitation of front running."

I'm curious how you think this is happening. If you're talking about a direct exchange feed, anyone can sign up for one. The reason that I don't have a direct NASDAQ feed running to my house to trade my 401k is because it wouldn't matter for me. Even if all participants got all the information from the same feed at the same time, a computer can make a decision in 50 microseconds and a human cannot. In your hypothetical HFT-free but still electronic world would you also require a computer to wait a few seconds before making a decision? Computers can also analyze terabytes of data to discover tiny statistical edges, would you also outlaw this to since it's a form of information not available to the common man?

I just don't understand how you think it's possible to have a financial system where everyone's on equal informational ground. Do you also object to the fact that brokerage customers get access to sell-side research? How about that Wall Street Journal subscribers get articles that non-subscribers can't read?

@HFT Trader

Wasn't flash trading (perhaps obsolete / banned now) one such avenue to make information available earlier to some?

Quoting Wikipedia:

Flash trading is a form of trading in which certain market participants are allowed to see incoming orders to buy or sell securities very slightly earlier than the general market participants, typically 30 milliseconds, in exchange for a fee

Flash trading was discontinued years ago about all the major exchanges. So this may be a moot discussion, but here's my take on it. First off the way flash trades worked is that you'd send an order and designate flash-able. (Note that all the supposed victims whose orders were flashed and "front-runned" were voluntarily using the system.) If your order didn't match any liquidity resting on the book NASDAQ would display an Indication of Interest (IOI) on its flash feed for a short interval, usually 30 ms or so. After that whatever was unmatched in the flash would be treated it like a regular order, either resting it on the book, routing it or canceling it depending on the order specifications. (To add, anyone listening to flash IOIs were legally obligated not to use them to inform their regular market trading. You'll have to take this on my word, but my colleagues at the time, at one of the top tier HFT firms, who worked on equities took this very serious.)

If this sounds like a dark pool, it's because it's basically what it is. It's essentially the same thing Credit Suisse does when you send an order to their dark pool. First they try to match it on any resting liquidity, then if you indicate you want it the order will notify other dark pool participants and rest for a certain period of time, if it expires it will route to the lit exchanges. Same as the flash feed, Credit Suisse's dark pool IOIs are only displayed to subscribers and never go on the consolidated public feed. Now there's an argument to be made that all trading should take in the lit, public market. This is how futures work by their nature. But stocks traditionally have never worked this way, at the very least you always have the right to call up your friends and privately negotiate a sale of your stock. Dark pools are just an extension of this, and flash trading were just a type of dark pool that were run by the exchanges itself. So it seems to me that if you're going to make the argument that flash trading is bad because it's not done on public markets, it also has to apply to block trades that happen over the phone.

"Flash trading was discontinued years ago about all the major exchanges."
so totally dont worry about us. we are so harmless. hey look at that cat over there

But no one is criticizing automation and electronic exchanges

Actually, I've seen that. And someone (presumably a broker) posted a ton of comments on a thread here a couple of years ago insisting that we really did need higher bid-ask spreads and the old floor system in order to prevent HFT and corruption. Most of us were dubious.


If mutual funds are being front-run via HFT speed once orders are placed, "retail investors" in said funds are affected.

Unless the "retail investors" are on the other side of the transaction from the mutual funds. It used to be much easy to trade a large number of shares without moving the price. Now the market corrects faster. That might be bad for the party trying to trade the large number of shares, but it's good for everyone else.

Mutual funds are not being "front-run" by HFT because mutual funds have little to no alpha (sorry mutual fund managers!). Mutual funds simply do not need to trade on quickly declining information like sophisticated hedge funds and prop shops do. (Here's a hand heuristic to tell how much alpha a trader has, take the inverse how easy is it to invest in him). Unless you're sitting on market moving information you can just place a very patient VWAP order and let it work slowly so as not to impact the market. Doesn't matter your size as long as you're patient.

Without spending too much time thinking about it, I'm not sure that rings true. Assuming you're an index fund, true there's no alpha, but expenses are a huge factor, especially if you're rebalancing. Seems that alone would add up quickly.

Many index funds strive to minimize tracking error relative to their benchmarks, so they tend to trade in the closing auctions. This leads to extremely perverse and costly situations. However, they are not falling victim to HFT market makers.

Why do mutual funds think they can/should get better pricing that the VWAP? There are loads of good VWAP algos out there for free. Yet some funds seem to think that they can/should employ humans to try to get better execution.
What could be simpler than getting the AVERAGE price for the day?

What about the small guys indirectly exposed via mutual funds, pension funds etc.? How does the impact analysis of HFT look for them?

I would think that as my index funds adjust themselves each day/week, the HFTs would bleed them (us) for a few pennies at a time.

It wouldn't be so bad IMO, if the HFTs were actual traders, trading against the funds, but just front running them as a sure thing ... not so much.

I would think that as my index funds adjust themselves each day/week, the HFTs would bleed them (us) for a few pennies at a time.

Sure, but not as much as the larger bid/ask spreads back in the day. The "few pennies at a time" issue is smaller than it's ever been for an individual investor. The only real concern seems to be things like flash crashes and so forth.

As in the linked article:

Last year, I spoke with Gus Sauter, the former chief investment officer at Vanguard, one of the biggest buy-side investment firms in the U.S. By the time he retired in 2012, he had about $1.75 trillion under his watch. Rather than decrying speed traders, Sauter praised the benefits it had brought to him and his clients. By his estimate, speed traders helped him save him more than a $1 billion a year.

While we can get into the weeds of criticizing individual practices and strategies, on the big picture, the market is friendlier to individual investors than ever. Do the pros still have an advantage? Yes, but it's not like it was better with human floor traders making the market and pricing shares in eighths and sixteenths.

Apparently not as bad, and et cetera, but I'm not quite ready to accept "front-running as a service."

They are not affected because those funds don't have alpha and don't place giant trades all at once.

Seems like a small ding on mutual funds, smaller than other dings (portfolio churn, loss of some tax-timing management benefit) that accompany mutual funds compared to direct holding of underlying securities and all of which, for a typical investor, are outweighed by the benefit of cheap diversification.

Like Cliff said if you don't have alpha, you don't need to trade at a fast pace. If you're patient you won't move the market and won't incur cost. Liquidity providers and uninformed traders (both large and small) *want* to find each other in an anonymous market. But informed traders want to masquerade as uninformed traders. The most powerful signaling mechanism informed traders have is patience, which is really the one thing informed traders never have.

Imagine there's a thousand people who are all personally indexing their money. They each make small, individual trades. If the band together into a thousand person fund there's no reason their comingled trading would look any different than their previously individual aggregated activity.

Allowing the industry to be policed in current fashion is reckless. Best intentions aside, the SEC simply does not have the brain power or experienced staff to comprehend what is happening during trading. The exchanges do, but as for profit businesses (Missing Dick Grasso yet?) they will not kill their best customers. Current government agency oversight re HFT is akin to the FDA granting college biology students the ability to approve new drug applications. Unacceptable.

Note: FBI Seeks Help From High-Frequency Traders to Find Abuses http://bloom.bg/1iXIg1n via @BloombergNews

Good for the FBI, they recognize the deficient human resources currently engaged in their investigation. There is a small universe of folks knowledgeable enough to assist, hopefully a few will come forward. Unfortunately, there is no shortage of the well intentioned free marketers chiming in with useless bon mots.

>or an invasion from outer space

I do believe that's the closest Tyler has ever come to calling out Krugman for what he is.

Still can't use his name, of course...

Doesn't this brouhaha only apply to market orders? I only place limit orders, and often my order executes slightly more favorably to me than my limit, but I'm always happy whether or not that happens. I've never placed a market order, and I think those that do are the ones dangling their feet in shark-infested water.

I think you're right Mark, but perhaps it wasn't always that way, and the fact it's changed so much might be part of the brouhaha too.

I recall a story ca. 2007 that someone sold his share(s) of Berkshire Hathaway -A (which traded at the time for some $125K) via a market order and got filled at about a fraction of the market price. To an experienced investor, trading in such a thinly traded stock without using a limit order was foolish. These days, trading almost anything but the most liquid stocks without a limit order seems foolish (certainly with most ETFs).

Tyler has written on HFT before. In 2011 he wondered whether our economic intuition breaks down at small time scales. http://marginalrevolution.com/marginalrevolution/2011/05/do-our-intuitions-about-deadweight-loss-break-down-at-very-small-scales.html

I think that's part of it, but I also think it's a visceral loathing of middlemen, which Mike Munger has explored quite well. http://www.econtalk.org/archives/2008/10/munger_on_middl.html

I also think the fact you could witness the price of a market order tick up/down (to your disadvantage) the moment you get filled makes it feel like you got chiseled, even though you still just traded at a tighter bid/ask spread, and with cheaper commission than you might have done 10 years ago. http://www.portfoliowizards.com/why-its-so-easy-to-loathe-high-frequency-traders-you-can-see-them-profit/

One question I have is, how much of tighter spreads is due to HFT, and how much is due to decimilization? I don't recall seeing that attribution analysis.

Yeah. To be fair, though, sometimes those limit orders don't get filled, and by definition, that coincides with a rising price, and you get to sit and watch.


Exactly right. Market orders are subject to bid-ask spread costs. Limit orders are subject to adverse selection costs, i.e. you get your buy filled when the price is going down and when the price is going up you have to re-adjust it higher. If you look at the data a naive limit order placed at a random time on the bid or the ask almost exactly incurs the same cost (bid-ask spread) as a naive market order. Funny how market equilibrium works even at the microstructure level.

Great point. Are there discernible trends in the cost of market orders vs. limit orders?

Order flow from ETrade and the like is, on average, likely to be "dumb money". Anyone would want to trade against it, so the right to fill those orders is worth money. That's why the orders never see an actual exchange, not because of "cost savings".

Um, isn't that just competition?

Every grocer wants to sell me an apple, and will compete and lower their price to get my business.

The fact that they lower their price to get business for themselves, and the lower price to me is just a side effect - isn't that the same as this case?

By the anti-HFT logic, the grocer has an "unfair" advantage over you because you will never be able to obtain produce at his low costs. Therefore, he should be prevented from competing against other higher-cost grocers to "protect" you.

That's an internet version of falling flat on your face.

The anti-HFT example (not that I'm saying I agree) is that an HFT algo is lurking by the grocer's register. Just as you're reaching for your wallet to purchase an apple for $1.00, the algo buys it for $1.00 and, as the cash register drawer is closing, offers to sell the apple to you for $1.01.

'That way, they don’t have to pay fees for sending them to one of the public exchanges'

They don't have to, but is anyone here naive enough to think that such saving of fees paid to others is passed along to anyone that could be described as 'retail'?

And if yes, just imagine the possibilities of retail investing with other who have your best interests at heart - such as myself. OPM is a personal motto when it comes to investing.

Yes, I am naive enough to believe in competition lowering prices

Then send me ten thousand euros, an it will invested it in a way that is guaranteed to increase competition. Because I have your best interests at heart, after all. Trust me.

Yes, I'm naive enough to believe in micro-econ concepts like profit is maximized when MC=MR (come on guys! We're commenting on a blog called "marginal revolution"!!). If crossing trades internally saves me, the broker, money then I can lower my fees to attract more customers away from my competitors.

Also, I'm confused by your OPM comment. When you send an order through your broker, the broker isn't trading your money. It's just executing your order. If it wants to keep your business it'll find the best execution for you. Your broker benefits by your business and to keep it he must work in your interest or you'll find another broker - there's plenty of competition in that space.

' If crossing trades internally saves me, the broker, money then I can lower my fees to attract more customers away from my competitors.'

Does the word 'cartel' mean anything to you? Because I believe more in cartels (placing me firmly in the free market camp represented by Adam Smith) than in the idea of 'competition' somehow working out in a way that reduces the profit of those engaged in providing a service by passing that lost profit along to someone else.

After all, cartels are formed in major part to prevent exactly that form of 'competition.'

Yes, I understand the word "cartel" and apparently much better than you understand the concept of reality. In the real world brokers compete with each other for clients on price and service. You also don't seem to grasp the concept of "profit" because in that scenario there is no "lost profit" being passed on to anyone. The point is that profit margins can be maintained while taking market share by passing on the cost savings of internal crosses.

'I’m confused by your OPM comment'

See the answer above to Cliff. But for you, you can send me 9900 euros, and I promise to provide exactly the same services I will for Cliff. Because competition works, after all. Not everyone is willing to send me 10,000 euros to help increase competition, so in your case, you benefit from the savings inherent in using an Internet comment section.

Thanks for the offer, but i don't do negative expectancy trades.

How can one claim on one hand that the practice saves money then argue that it is Keynesian spending on folly?

It's an argument in the alternative: Even if you don't believe my [first argument], then [second argument] (which is based on the prior that the first argument is wrong). If first argument is not wrong, then second argument is irrelevant to the analysis.

That way, they don’t have to pay fees for sending them to one of the public exchanges, which in turn saves money for the retail investor.

What's the typical fee a wholesaler has to pay an exchange versus what the wholesalers charge the typical retail investor? Is the former a significant percent of the latter?

NASDAQ charges $0.003 to remove liquidity generally and $0.0029 for the largest traders. If you add liquidity you get a rebate that will be somewhere between $0.002 and $0.0029.


And NONE of that fee is charged to the retail broker; to the contrary, the retail broker gets
paid for its flow. So the percentage of the fee that gets passed to the retail end (retail broker) is not just
an insignificant percent; it's actually negative (*).
Now whether/how the retail broker passes these savings (which it DOES see, in full and more so)
onto the actual retail client is another matter and another market.

(*) How can the 'wholesaler' not pass on its costs? The answer is that they have another profit
center; e.g. part of the bid-ask spread. Wholesalers internalize to make money; avoiding exchange
fees is not "the" reason. Sure, if a wholesaler thought they would lose money on a particular
trade but lose less than the exchange fee they might still internalize it. So it's a consideration,
but is not the point of the actual business.

Thanks both of you.

Either way, that argument from Tylers post (saving money for retail) seems totally bogus.

HFT's respose might be too obscure for some.

By FAR, most retail orders are for 100 shares. Exchanges charge 30c to handle that
order if you take liquidity ("buy/sell this order NOW") and rebate say 25c or so (very variable)
to provide (i.e. "I'm willing to buy/sell, let me know if we have a deal".)

HFT net (after all profits) are almost never much more than this (and have gotten vastly
harder since 2007-200). 30c for 100 shares if predictable enough (today you WILL NOT get this!)
means your CEO gets her own private jet; if a small firm. And even if they get that, compare
this to your brokerage fees (or even worse, your mutual fund annual fees) and you will be
left with a WTF?!?!?!? feeling ... not centered on HFT :-()

So are there any moves to sideline the brokerages entirely? Perhaps for the larger retail consumers? It looks like the brokers like E-Trade are making a chunk of money whereas the charges from HFT or exchanges are fairly low if at all. Or are the overheads & investments of servicing infrequently trading retail consumers so high?

A lot of the counterparties that Citadel matches you with (say you placed the original order on E*Trade) are Citadel itself, or other prop HFT shops. That's one reason they are willing to pay so much for order flow ($70-80m for E-Trade last year; grew by ~20% from 2012) - they can give worse fills than you would get on the NYSE itself. Not saying this happens 100% of the time, just that it is much more likely to happen.

Also, the issue Lewis brings up that E*Trade receives a higher order flow payment for the same order from "some places" (read Citadel or BATS) than others (read NYSE), or would even have to pay to route its order flow to certain destinations, is a very interesting point. It means that the order flow BUYER must have his fee (paid to E*Trade) subsidized by another revenue source. Yes maybe it could be a totally legitimate counterparty and they want to avoid the "high exchange fees" - but in fact NYSE fees are very low, especially if you add liquidity/add to the bid book (they are negative in that case) and usually much lower than the price improvement you can get by executing on a fair exchange. THIS LAST SENTENCE is the key, and citing one anecdote from a Vanguard guy as refuting this is totally insufficient.

Also the fact that profits in high-speed trading have come down doesn't necessarily mean the retail guy placing the orders is getting screwed any less on a per share or per dollar traded basis. It likely just means that HFTs are now spending a whole lot more on software, hardware, connectivity, manpower, infrastructure, etc. than they used to; plus the payment for order flow from HFTs (directly or indirectly) to the retail brokers themselves has gone up a lot (which has NOT been passed on to retail customers - pricing on a per-trade basis has been basically flat at the 3 major retail brokers).

Does the reduced profit of HFT have anything to do with the decreased volatility in the markets today than say in 2008?

Glad you asked. Yes, HFT profits are *highly* correlated with volatility. For a stark example, check out section 5.2 of the Frequent Batch Auctions paper: http://faculty.chicagobooth.edu/eric.budish/research/HFT-FrequentBatchAuctions.pdf. Volatility explains ~90% of the prevalance of ES-SPY arbitrage opportunities.

I'll go ahead and forestall any objections of the "HFT creates volatility so that it can make money" sort. Neither I nor anyone else in my business has been able to stop the relentless decline in volatility since 2008 even though it would be very much in our interests to do so. I'm all ears if anyone can reconcile this observation with the above theory.

Thanks! No I wasn't planning on making that latter objection. :)

It was just my impression / intuition that you HFT folks would thrive on volatility. I take it, that the huge volatility back around 2008 was a key reason for HFT's stellar profits back then? Nothing nefarious about it.

Oh, that comment definitely was not meant for you. You are completely correct re 2008.

Generally speaking, all market makers benefit from volatility because vol creates more opportunities to trade and leads to more temporary mispricing. This was as true for non-algorithmic market makers on the floors of exchanges as it is for HFT shops today.

Rahul, virtually any market making firm (HFT or not) that wasn't short volatility going into the crash of 2008 made a lot of money. For a lot of us, 2008 was the best year we ever had. Examples of other good years include the year the NASDAQ crashed and 1987. HFT shops thrive during volatility not because they are HFT but because they make markets.

Liquidity providers dampen volatility, especially short term volatility. They like it, but they suppress it.

As 2008 shows, when the markets are going crazy, liquidity providers _are_ there; they make money
(lots of it) but things are arguably worse if they stepped away.

A lot is made of the flash crash showing that liquidity providers aren't there when you need it. But
what people don't get is that the markets were BROKEN then (not economically so, but technically) in those minutes.
Traders rely on data feeds and need some in particular, such as the "NBBO" quotes for important risk and legal reasons. These all went haywire.
No one should have been trading or quoting until systems were fixed. I'd love to go to the SEC
and say "No, we had no idea what our risk exposure was, because the prices were changing
insanely, second by second, but you want us to keep quoting and so we did so even though every
single risk alarm had melted down" and have them be happy. However they would NOT be.
2008 is "market functioning, high risk and volatility" and HFT was out in force. Flash crash
was "at this very minute, systems are broken" and _all_ trading should have paused. No HFT trader
destined for long term survival will ever blithely quote through "no, we have no idea what is happening,
it's just crazy" periods. SEC/FINRA wouldn't let them either (and rightly so.)

We are there because it's profitable to be there and by our action of providing bids and offers to capture theoretical edge resulting from mispricing, we dampen volatility and correct mispricing. A lot of retail guys think that "dampen volatility" means keeping prices the same, unfortunately. They think that if a security's fair value drops 10%, "dampen volatility" means being willing to buy it at the stale price. We dampen vol around fair value. We have no control over the fair value.

Designated Market Makers (unlike customer firms acting as market makers, which I belie e most HFT firms are) were required to continue to show a two-sided market during the flash crash. However, no market maker is willing to provide liquidity at his expense. When the markets are broken it's too dangerous and we too turned off our algorithms, leaving only stub quotes to fulfill our DMM obligations. The market was so completely broken that our stub quotes were hit. We did trade, but switched to manual trading where models and trader experience informed us that the mispricing was likely so huge that even in the case of a real collapse in FV, we still had positive edge. So even in the flash crash liquidity providers were there and by being there we dampened vol.

The SEC's response was to force DMM's to constantly quote in a band around the last print (it's a little more complicated, the formula, but the complications don't add to this discussion). The bands are not only wide but will move along with the falling or rising price and our algos are fast enough to move our bands so we stay in compliance but never actually trade on that market in another flash rash scenario. But, hey, even if it's totally useless, the SEC can be said to have "done something" about evil market makers unwilling to fall on their sword.

"Also the fact that profits in high-speed trading have come down doesn’t necessarily mean the retail guy placing the orders is getting screwed any less on a per share or per dollar traded basis."

Fiber optic cables, microwave dishes and laser beams do cost..

Sorry Sean, not how it works. Order internalizers do not buy retail flow to give worse fills--they are legally required to improve the National Best Bid or Offer (NBBO) by a small amount ($0.0001) in order to keep the order. They pay so much for retail order flow because it's innocuous. The investors placing the orders have roughly zero clue what prices will do next and are thus an easy way to make the spread. There's no need for subsidies from other revenue sources--two sided retail flow is an amazing cash stream in and of itself. You generally don't get price improvement by trading at an exchange, unless you a.) stumble across a hidden order in the lit markets or b.) send to somewhere with an inverted rebate model (like BYX or EDGA).

You are right to observe that there is a cost component to HFT profits, and it is always increasing. However, revenues have fallen off even more (they closely track volumes and volatility). The evidence for the retail guy getting "screwed" less has been discussed by HFT Trader in previous posts.

"You generally don’t get price improvement by trading at an exchange" - what about the results of Interactive Brokers Rule 605 and 606 reports (they consistently report the highest price improvement in equities, while consistently reporting the highest rate of routing to NYSE/Nasdaq)?



Also what about the RPI programs at Nasdaq and especially NYSE? (That allow retail to be liquidity-adder, and get improved price from market best/NBBO.)

And when I said "worse fill," I guess I really meant net of any applicable rebates/price improvement. (Since obviously if the SEC finds out you're violating Reg NMS, that's not good.) But maybe to the HFT trader/firm, it's really the brokers who are the corrupt ones? (Since they can basically keep the rebates for themselves as back-end commission; the lack of retail price improvement would benefit the HFT matching the retail orders though, but part of this gets regurgitated back to the broker as order-flow payment.)

In a larger sense, the practices of HFT diversion of retail order flow to several different matching centers/exchanges/pools does hurt retail in another way, IMO: the NYSE is no longer a massive pot of huge liquidity, so you get thinner markets in many names at any given single exchange (and it's better for retail to have all the liquidity in one center, isn't it - bid/ask would be narrower, people would jump on their market orders faster and at fairer prices, etc.).

Good point regarding RPI enabling price improvement on exchanges--I hadn't thought about that at all. I'll note that it does not enable retail to add liquidity; retail already had that ability, and (I believe) all retail RPI orders are treated as immediate-or-cancel. Rather, the program lets professional market makers do sub-penny quoting for retail orders, which makes the exchange look a lot like a dark pool from the broker's point of view.

As for the IB report, I'm frankly surprised at the degree of price improvement. My first instinct is it's a misprint, since they seem to be doing 4x better than the average and give more than the spread of many stocks! The other numbers are in line with my expectations. It's possible that IB's customers trade a very different basket of stocks with much higher spreads than that traded by Etrade's customers, but that seems like a stretch. Anyway, to be honest, I can't explain it.

You made a good observation regarding standard HFT's view of brokers and internalizers. I take a dim view of them. Most obviously, they take away flow that I would otherwise trade with and cause me to make less money. From a less selfish perspective, I believe they make markets worse and may even end up hurting retail. The flow that ends up on exchanges is more toxic as a result of this practice, and spreads are correspondingly wider. That's just another way of saying that the NBBO is worse, and internalizer prices are derived from those very quotes. In effect, retail gets price improvement, but from a worse level.


This TAG study (admittedly seems to have been ordered by Interactive - but I like and trust the guys) does show a clear advantage, but on a lesser magnitude than of the Nerdwallet 605 report analysis for U.S. names. (For European names, the advantage is huge though and actually BIGGER than Nerdwallet finding for U.S. - and I've seen many sources that indicate that retail-unfriendly practices are much worse in Europe than the U.S.)

Looking at the Nerdwallet page again, I agree it is really hard to believe that you could get a greater-than-penny improvement per share. I was simply too lazy to go through the latest Interactive 605 myself, but glancing at it there seem to be a lot of $.01 and a lot of $.00, so the Nerdwallet analysis does seem flawed in favor of IB (no idea how that happened). That said others like Glenn Chan and TAG have found significant + consistent price-improvement advantage from Interactive vs. other retail brokers, and the indisputable fact is that Interactive sends the significant majority of its equity trades to the two main exchanges (and internally crosses most of the rest) while the other major retail brokers do not.

My best guess about why this is the case is that

1) (For equities) Interactive allows traders to explicitly take advantage of RPI while other retail brokers do not.

2) (For options) Interactive passes on the net rebates for adding liquidity to the majority of its customers, which can be quite substantial (and this is netted against price received in the TAG analysis, but for the options only - so it makes the equity savings of "just" .2-.3 cents/shr even more impressive, since they pass on the equities rebates as well but for accounting purposes net this against commissions paid rather than price paid).

3) (For equities) What the Interactive CEO has claimed in the past is that the 2 major exchanges give slightly better actual fills, at the end of the day, than dark pools and internalizers. And he started saying this well before the exchange RPI programs were created in 2012-2013. I know that this can be disputed - you have to follow Reg NMS! That's not possible! - but as one of the largest US equities brokers in terms of stock shares, I'm guessing he has pretty good insights into this.

"It should be shocking, but it probably is not, that according to the Rule 606
reports mandated by the U.S. Securities and Exchange Commission, no major
online broker, with the sole exception of Interactive Brokers, sent more than 5%
of its orders to an organized exchange. More than 95% of their orders go to

These brokers ignore the exchanges and sell the orders to internalizers,
thereby avoiding exchange fees and getting a nice little payment from the
internalizers in return. This payment for order flow adds up to real money after
millions of orders are taken into account. The internalizers are supposedly
matching the best prices prevailing at the exchanges, so that they can argue that
the customers get the best prices.

But do they really? Of course not. If they did, an independent study
would not have found that the one broker that actually routes the vast majority of
its orders to public exchanges -- and I will not name this broker again -- obtains
executions that are on the average 28 cents better per 100 shares in the U.S.,
and an absolutely stunning 2.84 Euros better per 100 shares in Europe. As
much as I love this brokerage firm, it may not be doing anything all that special.
It is mostly just quickly routing each order, or parts of an order, to the public
exchange with the best posted prices for that order, and quickly rerouting if
another exchange becomes more favorable."



All interesting data points. Thank you for bringing these to my attention.

"they can give worse fills than you would get on the NYSE itself."

No, they really really can't. Reg NMS requires them to fill at or better than NBBO. The reason they can pay is because if they offer the same price on NYSE literally anyone, with any sort of market moving information, can trade with them, if they cross an order from E-Trade they know it's an E-Trade retail customer who almost assuredly isn't trading on market moving information.

Here's an analogy, imagine you running a hopping nightclub. People call ahead to make reservations to come to the club. You charge a listed rate for admission. But you have a certain preference of who you want to come to the club (young, female, attractive). The problem is it's hard to evaluate these properties over the phone when people call unsolicited. So you hire certain club promoters who have a reputation for attracting pretty young things to your club. You charge the people they're sending your way the same or better rate as your publicly listed one AND you pay the club promoter for sending a good crowd your way. Ideally you try to get as many visitors as possible to come by way of the promoters.

@HFT Trader

So, is the natural evolution of this a retail-only exchange that does not inter-route quotes with the general exchanges? That'd let you guys discriminate even better between the uninformed retails orders versus the riskier informed trades? If that makes sense, what's stopping it?

Background structure: is that there's a handful of major exchanges that display quotes (lit market) and a plethora of dark pools and internalization pools that act as black boxes (dark market). In the latter your order goes in it may get filled it may not get filled. But Reg NMS requires that dark pools meet or beat NBBO, which is calculated as the best displayed bid or ask on the lit market. Retail order flow is highly valuable for its uninformed nature, so a company like GETCO set up an internalization pool where it's the only counterparty to every trade. For incoming orders GETCO uses it's alphas and risk limits to decide if it wants to internally match at or better than NBBO, and if not it routes to the lit markets. It wants to make sure that it's not routing too many markets since it loses money every time both because it pays for every single order, and also it has to pay the exchange fees.

The thing is though that GETCO also trades on the lit market. If it converted its internalization pool to a traditional exchange it would also have to display its quotes. Unlike NASDAQ where we have no idea who that bid is from, in the hypothetical GETCO exchange where only it provides liquidity we'd know exactly what price GETCO is bidding at and in what size. Needless to say that would severely dampen GETCO's informational edge in the general market. So that's why internalization pools are always dark, and will never become a general exchange.

The second reason why there will always be activity in the lit market is because the barriers to entry are much lower so prices stay competitive, even when dealing with the informed flow. Setting up an internalization pool is an enormous task because you have to develop relationships with brokers, go through the hurdle of setting up a dark pool, capital requirements, etc. Trading HFT on the lit markets is quite a bit easier, develop a good model, co-locate your servers, get the data feeds and turn it on to trade. So GETCO has the advantage of getting uninformed flow, but it still has to meet or beat the best price from hundreds of lit exchange HFT market makers, many with mutual information to GETCO. So it still gets beat by the exchange quotes a not trivial amount of time and that keeps retail flow going to the lit markets.

As a final aside, the biggest boon to end consumers would be a reduction of tick size for large and liquid stocks. A stock like MSFT or SPY sits at a one tick bid-ask spread all day long. When you think about it this essentially is a price-floor imposed on the cost of liquidity. Many market makers would quote narrower spreads than one penny in these stocks if they were allowed, and consumers would get better prices. This system subsidizes the large internalization pools because is keeps NBBO spread artificially wide, since they only have to meet or beat NBBO, they're able to match the very profitable retail flow at inflated prices without having to worry about getting far back in the queue as they would in the public markets. It also subsidizes large informed traders at the expense of small uninformed ones. Since the spreads are artificially wide the queues become very long to get the chance to earn an artificially high spread. Those long queues give a ton of liquidity supply to large informed traders, but at the cost of expensive liquidity for small traders.

Fascinating! Thanks for the great comment.

As an aside, my wacky idea was intended a little differently: What about an exchange, that's serviced, not just by GETCO (as in your description) but where a bunch of HFT's were present with the only caveat that all trades accepted would only be from E-Trade etc. i.e. only servicing retail customers.

That was the hypothetical I was mulling over. Wouldn't the HFT's have access to a large but strictly uninformed pool of trades? Without each HFT having to replicate its own internalization pool. Plus E-trade etc. is no longer tied up to any one HFT but gets each of the trades it routes their way competitively serviced by a bunch of HFTs.

This would still protect GETCO’s informational edge in the general market, right? Since now GETCO is no longer the only HFT providing liquidity in this "safe" pool of retail-only customers.

Or not? Did I miss an obvious detail?

Hmm, it's an interesting idea. I believe NASDAQ is trying to do something like this with special order types that indicate whether it's a retail order. (Link at bottom).

But this actually brings up what I think is one of the coolest phenomenon in HFT/market microstructure. Let's say a bunch of mid-sized HFT firms joined together to form an internalization pool for retail liquidity, because it wouldn't be economic given their size to start individual pools. So a market buy order comes in and Alice Capital wants to take it, so she crosses it. But what happens if Bob LLC also wants to cross the order. There has to be some sort of arbitration mechanism. They could split the order, the could flip a coin for who gets it, could be who's faster to claim it, etc. But presumably the system has to be somewhat fair since they're equal investors, so if there's a conflict so the total shares that Alice and Bob both claim end up over time being divided 50/50.

Say an order comes in to buy 1000 shares. Alice's algos are deciding whether to buy it or not. But one thing to consider is that if Bob wants the order to, Alice will only get 500 shares in expectation, whereas she'll get 1000 shares if Bob doesn't want it. Since Alice's models aren't exactly the same as Bob's the fact that Bob doesn't want to buy should tell her something. It may be a good idea to buy given her internal calculations, but no longer worth it conditional on Bob not wanting it. Over time if Alice and Bob keep repeating this game, Alice's inventory of shares will fluctuate in the opposite direction of Bob's mutual information. Even though the two are only trading with uninformed flow and never directly trading with each other, their subjected to the same informational adverse selection as if they were.

That's why it still makes sense for the largest HFT firms that can afford it to maintain exclusive internalization pools where they don't have to worry about potential adverse selection in this form. (Though actually now that I think about it, you could share a pool with an arbitration mechanism that was deterministic ahead of time about who would get the right of first pick on each order that comes in. Alice gets first dibs on all the even orders, Bob on all the odd orders. Might not be a bad business...)


@HFT Trader:

Stupid question: Why do you need a novel arbitration mechanism? Why can't it be an order book as usual sorted by price priority and time priority?

Yes that last one is a very good point; however RPI programs of which the NYSE is most important offer sub-penny price improvements that do this in a de facto manner. So why on earth would a broker not do this on behalf of his customer in an ultra-liquid name, and instead sell onto an internalization pool??

Also Glenn Chan (linked below) and many other smart investors believe that retail brokers find ways around NBBO-based regulations.


Note the gist of that post is the various ways that RETAIL brokers screw their customers. At worst I think that some HFTs collude with these brokers, directly or indirectly. I think the brokers themselves are the "bad guys" (don't act in their customers' best interests) much moreso than the HFTs, and I think Michael Lewis shares this opinion.

You'd have to change NMS.

The underlying economic problem is that today's exchange quotes _necessarily_ reflect the right bid-ask spread for a market-maker who has to deal with a mix of customers, including big/informed (in the trade "toxic") orders, and so they are (again, necessarily) at penalty terms for most retail trades. But NMS simply does not allow differentiated visible quotes (I can't say "I'll buy at 40.003 but only from E-Trade customers").

The RPI try to finesse this within NMS, but you don't actually get clear "retail only" quotes. Until we can give differentiated and sub-penny quotes for retail orders only, there's going to be fight over who gets the premium for charging "all comers" rates to retail customers. Internalizers help _this_ particular problem a bit by letting
a substantial part of that premium get kicked back to the retail brokers (and what they do then is up to them) but it's sort of a hack (partially) around the underlying problem.


RPI is indeed an interesting idea. But I wonder how far we'd be willing to go with such attempts to discriminate between traffic. i.e. Is true & complete anonymity of an order a bug or a feature in a well functioning market?

There are Rules and Regulations governing the buying and selling of Stocks. The System in place can be seen as rigged in the sense that the Financial Services Industry has lobbied successfully for Rules and Regulations that favor them. Some people can hold the view that the buying and selling of stocks has to do with Research about how a company is doing. Much of the Financial Services Industry can be seen as unnecessary Froth upon the real business of buying and selling stocks.

In that sense, although HFT can be seen to be useful within the Froth, it is also a clear example of Froth, money churning around having nothing to do with the funding of businesses. Whether this is true or not, I'm simply trying to frame the issue.from the point of view of people who don't have a lot to do with this system themselves, but who need to know as citizens that the system in place is fair and devoid of Froth, if they so desire a Frothless System.

"Some people can hold the view that the buying and selling of stocks has to do with Research about how a company is doing."

Some people hold the view that the review of movies has to do with an appreciation of the art of film making. But at the end of the day Netflix still does an excellent job rating movies and it doesn't even know the first thing about what a movie is.

The Financial System holds a special place as regards whether or not citizens buy into our govermental system. It has a Soiled History at best, and it would be interesting to see how Film Critics are trusted as opposed to Financial Types. When people advocate Free Banking, I always ask them where Bankers stand in relation to the Trust Question. That's an empirical question unrelated to how someone in the Banking Industry feels about the Banking System. There are Rules in place precisely in order to make the unsophisticated person accept the system as fair. These rules are often bothersome or onerous to the sophisticated, but so goes a country with many different interests and positions.

So you're saying that market participants should have to comply with irrational regulation, because people hold uninformed opinions based on the prior history of other market participants who have absolutely nothing to do with them.

To be Rational means to have a Reason. Constraining some useful but iffy looking behaviour might be a small price to pay for trust in the system in general, and therefore a Rational Compromise. However, what I am saying is that Explaining the Issue to the satisfaction of average citizens is very important as regards the Financial System. To the extent that the Lewis book offers up a controversy, it is an opportunity for people to explain the issues in as clear and concise a manner as possible. That's important in our system. Making fun of people isn't a very promising beginning on your part.

@Donald Pretari:

Promising beginning?!! Look up last three days worth of HFT threads on here. The guy has been trying real hard to explain the issues. Give him some credit dude!

I'm sorry if you felt I was making fun of you. I wasn't, just trying to rephrase what you said to make sure I got the logic correct

As for your response I would retort: 1) There's no reason for the average person or voter to ever need to think about market microstructure and how stock orders are matched, anymore than there needs to be a public discussion about the technical implementation of IPv6. It's a highly esoteric topic that requires a good deal of education and intelligence just to understand at a basic level. Furthermore for the vast majority of people, even those who invest professionally, there's no personal benefit to studying it. You put in an order for some stock and it pretty much "just works." From a political perspective there's no issue either, since these aren't firms that requiring government backstops or guarantees in any form. Bringing up this issue to the common man is counter-productive because it frequently just causes paranoia leading to avoiding equity investment altogether, which is horrendously bad financial advice.

2) To the extent that there should be public discussion, Lewis' book which is demonstrably full of hysteria, exaggerations, half-truths and bias is not the vehicle for it. At least not any more so than Mein Kampf would be a good opportunity to start a discussion about the contributions of Jewish people to modern civilization. There has been many prior clear and concise explanations of the issue, look at what Cliff Asness has written about HFT. The difference is that clear and concise discussions about HFT are quire boring and complex, because nobody cares about the intricacies of Reg NMS, order matching algorithms, and liquidity provision models. But if you distort the issue into "Wall Street is RIGGING THE MARKET AND STEALING YOUR RETIREMENT" all of a sudden you have a best seller. That kind of yellow journalism doesn't improve our system one iota.

"There’s no reason for the average person or voter to ever need to think about market microstructure and how stock orders are matched"

There may not in fact be a good reason, but you can't stop people from thinking about it, and if the system is too complex to be transparent to such a person, suspicion and mistrust may outweigh the benefits that accrue "down in the weeds."

I don't know if that is in fact the case, but you can't rule it out just because, say, spreads are narrower.

Anyone else find it interesting that in the HFT "debate" the pro argument is being made within the constraints of non-fiction while the anti argument is being made through fiction?

Reading Michael Lewis' book (first chapter at least), it's clear that laying a direct fiber line was a useful economic stimulus - employed many construction workers at a time of low demand for them. That effect still holds, even if the use that line was put to was economically neutral or negative (which I'm not taking a position on).

Where does the money come from? They made the $1 billion from somewhere, if it's not from the retail investors then from where?

It's probably from investors, retail and otherwise. Apple made a lot of money last year too, mostly from consumers; where is the outrage?
In other words, your question is either silly or incomplete. It's OK to make money, even from consumers (retail investors) *_f you
are providing a service_. I.e. you can't be outraged simply because money is being made, you need to then explain why there is no corresponding

Market makers provide immediacy and more consistent prices. They are analogous to a used car dealership (perhaps that analogy
isn't entirely favourable!); I can walk in and sell my old car today, or buy a replacement of the type I want quickly, but the dealer
makes hundreds or thousands on the difference between buy and sell prices. You can basically avoid this "spread" by haunting
craigslist for a year trying to find a buyer yourself or find a suitable replacement, but some people don't find it worth that time or risk.

That's true, but there are a couple of further opinions I would have:
- I do not know (in fact I doubt) that immediacy is really that valuable. Who would be harmed if we could only trade
once per day? So market makers provide a service, and get compensated for it, but maybe the compensation far exceeds
the benefits?
- Market makers profitability has shrunk hugely. If you suspect (I do!) that we are paying more for immediacy today
than we really need or benefit from, this was 10x or 100x out of whack 20 years ago.
- The recent benefits (better spreads, lower market-maker profits) are due to computerization, decimilaization,
NMS, less corruption (yes, seriously, and this is huge!), and more. How much due to HFT per se is certainly arguable.
- One might compare the worse case estimates of how much HFT's cost per trade (whatever you think
the immediacy benefits are, even if zero) with the typical annual fees of a mutual fund. (Answer will be: former is about 100x smaller).
Even under the most cynical view of HFT, there are far bigger things for individual investors to get outraged about.

My reading of the article was the profits of retail traders were unaffected by the HFTs, that the HFTs profits came from elsewhere in the system that didn't affect retail investors. In fact the whole article claims that the HFTs don't get money by beating individual investors, and they don't get money by beating institutional investors, so the question is where do they get money?

As for the question being incomplete I figured there was no point debating the purported service unless you knew who the customer was. If it's price stability and immediacy then what's the counterfactual scenario where the HFT doesn't exist? Does the HFT mean the one of the buyer or seller get a slightly fairer price (and the other gets less of a steal)?

> As for the question being incomplete I figured there was no point debating the purported service unless you knew who the customer was. If it’s price stability and immediacy then what’s the counterfactual scenario where the HFT doesn’t exist? Does the HFT mean the one of the buyer or seller get a slightly fairer price (and the other gets less of a steal)?

People would argue that the market buyer (buy this "now", sell this "now") has got a MUCH MUCH fairer price with a robust market-maker ecosystem (including most "HFT" practices). I also tend to think that the investor for whom immediacy is less relevant (I've just retired, so sell 1/20 of my IBM holdings sometime over the next month or so") gets the short end of the stick.

Perhaps, I guess I'm not completely clear on how the HFT affects the market. I assume your claim is it makes the stock price more accurate? In what sense does this occur? Does it mean at any time the price is closer to the true value (regardless of change rate), or does it mean that as the price fluctuates it updates to the proper value more quickly?

Aaron, HFT shops provide the bids and offers for you to hit and lift. If you're trying to sell a security and you like the price they're showing you, you hit the bid. They then have that security you sold them in inventory and offer it at a higher price. They function like any dealer in any commodity. They're just trying to capture a tiny price difference between the fair market vale of the security.

By competing with each other for your business, the spread narrows and you pay less for a purchase and get more for a sale. You trade in and out of your security at a price much closer to fair market value than you would in their absence. So, the answer to your question is both. To trade around fair value and properly calculate theoretical edge, they are calculating fair value in real time.


But who would be the alternate bidder/offerer if the HFT wasn't there? Wouldn't it be another investor?

The HFT is giving you a fairer price but wouldn't they only make the price more fair when the order was unfair in your benefit? I'm not sure of the mechanism where you get a better price in general. How do trades happen with and without HFTs when I order at 12 and someone sells at 10?

HFT and market making does not make the stock price "more accurate". There are always TWO
stock prices (even that is an oversimplification): (1) the price you pay if you have
to buy right now and (2) the price you pay if you have to sell right now. Again, think
of used-car sales; I can easily today by a 2010 Honda Civic for some x$, but if I want to get rid
of the car _today_ I will likely be offered some y$ (likely < x). HFT reduce the gap between
x and y. They have no value in making sure that the overall price level (e.g. average
of the prices) is "accurate" in any sense. But they reduce the cost difference between
someone who wants to do something now (sell my IBM now, by a 2010 civic today) vs
someone who can be more patient (sell my IBM sometime next month, haunt craigslist
for six months looking for a 2010 civic).

I think the importance of "I want to transact immediately, without paying too much for being impatient" is
insanely overrated, but legitimate HFT practices _do_ help on that front. On that front, for what it is worth,
they help retail investors a LOT.


Since "investors", as that term is commonly understood, are generally takers of liquidity - that is, they are looking for bids and offers to enter and exit positions not to make a market around fair value - no, Putting up markets is not what investors do.

Market makers start by calculating fair value. That calculation depends on a variety of inputs and parameters, the details of which are both proprietary and not important for the purposes of this discussion. What's important is that they build some kind of dynamic model into which changing data is fed all day in real time. Then, they bid for shares at slightly below fair value and offer shares at slightly above fair value. The difference between the bid and fair and the offer and the fair is their theoretical edge - that is, if their calculation of fair value is correct, they will make money trading around it but not at fair value. That's the basic market making model. How wide that spread is depends on the number of competitors. The more competitors, the smaller the spread because price and size are the only thing on which market makers can compete. It's the only way to differentiate themselves to customers (investors). The smaller the theoretical edge (the tighter the spread) in those trades for market makers the closer to fair value the price you, as the customer, pay or sell at. Unlike investors who enter and exit positions infrequently as they execute their portfolio strategy, the market maker is always there because his strategy is just to capture that small (often razor thin) theoretical edge implicit in the spread.

So, in the absence of market makers, if you happen to have another investor who wants to buy the security you're selling at the price and size you want to transact, you may be selling to an investor. But, if you happen to want to unwind your long position on a day when there is no investor buying, you may not find a bid. That's the value of market makers to customers. They're always willing to trade. And if customers didn't find our liquidity valuable, they would simply refuse to trade with us. We can only post markets. We can't force anyone to trade with us.

Which brings me to another point. Making a market is simply posting both a bid and an offer. Technically, anyone with a brokerage account and a stock locate for anything not currently in inventory can post a market. That activity is not restricted to algorithmic traders or officially sanctioned DMMs. It's just that most investors don't want to post markets all day and manage positions. They have either other strategies they're running or a day job.


I'm not sure I agree with you. I understood "accurate" as "fair value". I read Aaron as asking if the customer ends up paying something closer to the entire market's current best guess of the fair value of the security than the customer would pay in the absence of market makers. MMs certainly do bring the transaction price closer to fair value. Also, since MMs are always incorporating information, the price moves to fair value faster.

Your answer is more nuanced - that is, that accepting a lower price for unwinding a large position quickly is "accurate". A customer may have to pay a liquidity premium to do that which might mean accepting a price even quite a bit lower than the current best bid. That price would be "accurate" in the sense that it reflects a perfectly reasonable liquidity premium (we know it's reasonable because the customer agreed to transact there). And that's why large orders are worked through dark pools, of course. However, the more MMs acting in that security, the lower the liquidity premium and the closer the customer will transact to fair value. Getting a price as close to fair as possible is what customers care about.

Thanks for both the answers, it clears it up some though I still need to consider the topic.

I do give HFT Trader Credit, which is why engaged him/her. In fact, I basically with HFT. I'm simply trying to voice what many people feel about the Financial Services Industry given Recent History, and to make clear a lot of possibly tedious, redundant work will have to be done to justify practices that can be credited as useful but must still operate within a distrusted system. One way to do that is to try to empathize with other people and understand that the argument isn't as simple as justifying one set of practices. It could be that I'm unclear about what I'm trying to get across.

I was not insulted by your comment, so much as trying to say that how you voice your opinion matters. The same is true about your comments about Lewis. Try to step back from the issue of HFT before stepping back in, and imagine the discussion taking place within a much wider discussion about the place of Financial Services in Our Country. He might be saying that the Rigging precedes the issue of HFT, which can make sense within a Rigged System. I don't like the word "Rigged" myself, I prefer "Lobbied," but I'm trying to understand some of these views myself. In that sense, it's not as simple as just not bringing up the issue. I guess that's where we disagree.

I'm long past being outraged by which book sells.

I think are going to hate me for this. Really, despise me and think the absolute worse of me
for my triviality. Be outraged, then annoyed. But IMO am stating a practical
truth that might one day sink in and be helpful ...
Your habit of capitalizing anything you think important marks you as an *UTTER NUT*. You should say (e.g.)
"our country" vs "Our Country" - either the former conveys information or it doesn't, capitalization
doesn't help. SOMETIMES you need to point out that what you say is more (or more important)
than your readers would otherwise get (this is rare!) then use italics. Stick with regular language (including
capitalization conventions) until you've been on this Internet-thingy for a few years longer...
And ignore my advice... No harm shall befall you. Rather a lot of people will skip past you after the
first line with Seemingly Random Capitalization But That's Up To You.

Alex, I agree with you that it's annoying. The problem is that I have problems with word order and seeing mistakes. This problem is compounded by having to write in little boxes, with a weird word correction function turning up occasionally depending upon what device I'm writing from, and MR having no preview function. When there is a preview function, I try and tone it down, although I still have problems. The alternative is seeing, eventually, what I've actually written and being embarrassed by what it turns out I've . Inadvertently written, and having to decide what to do about it. Perhaps it's time I take a break, since six years of annoying people is probably enough, but I do enjoy serious and respectful discussion.

I've been in the financial industry for a long time. The animosity toward the finance sector dates back to way before 2008. It has always been a convenient scapegoat whether it's because it's a socially acceptable way to express anti-Semitism or because people simply don't and don't want to understand it because that allows them to blame their own failures on some bogey man in finance. I don't find any need to indulge or lend credibility to either of those reasons. So, I understand what "the country" feels, but it's ugly and ignorant and uncivilized. I earn a spread dealing securities and that is somehow unsavoury while your earning a spread by dealing in sweaters is perfectly fine. That kind of nonsense doesn't deserve respect and consideration.

By the way, if you don't like lobbying, get rid of the regulator. Connected fir,s will always have the regulator write anti-competitive regs. Connected firms will be able to get away with downright fraud because they can lean on their friends in power to halt investigations. And as they add more and more onerous regs the barrier to entry increases and competition is dampened. Having run a regulated firm I can tell you that 99% of the current regs serve only to pile on costs.

Even reg NMS which has been discussed here was written largely by NYSE to favour NYSE and large exchanges, dampening competition and innovation among exchanges. The regulation heavily favours large exchanges, making it that much more difficult for competitors. Yet, retail always begs for more showy regulation that creates exactly the "rigging" they claim to want be free from. If you don't like what's happening in the industry, stop being part of the problem. The SEC very much responds to political pressure and it's largely the general public creating that pressure.

Sorry assclowns, but you may have to find a real job soon. The scam has been exposed.


Tyler, which of the specific points in this letter - from Charles Schwab and the current Schwab Corp CEO - would you disagree with? These two guys, along with the Interactive Brokers CEO who has also railed against HFT, have theoretically the best insights into HFT impact on retail investors/traders of ANYONE in the nation/world (just in terms of the real-world data and human capital they have access to).

All evidence points squarely to the fact that professional investors (Hedge fund or otherwise) perform no better than chance. I’ve always been amazed at how all these fancy stock pickers think they are doing anything other than flipping a coin.

You can build all the fancy models you want, perform your fundamental analysis, or throw around terms like “alpha,” but at the end of the you’re still flipping a coin. Its all like one massive rube Goldberg machine for the purpose of coin flipping.

What if insider information were rampant?

Rahul, for insider information to make a difference it would have to be material to the valuation of the stock. You overestimate the existence of material (significant price moving) nonpublic information. There isn't that much of it around.

Interesting. So you are saying even if I were a Dept. of Labor insider or a Fed insider or privy to Boeing's next quarter earnings or something I couldn't make some money from it by taking suitable stock positions? (assuming no legal restraints)

Are you saying there's no such info. at all or that the moment I try to take any significant position based on such info. the market will very fast move to compensate & stymie my efforts?

No, that's not what I'm saying. I'm saying that the world is not awash in as much material non-public information as you assume. You're confusing the ability to profit from material non-public information and the quantity available. For instance, just knowing Boeing's numbers doesn't necessarily help you if the numbers are where the market expected them to be because the current price has baked in those numbers already and you, the insider trader, can't benefit from having the information ahead of the market. BTW, while you have legal restrictions on trading on inside information, your congressman who might be sitting on a committee that has just received information about an impending approval of a valuable drug doesn't.

As for your final question, depending on the liquidity in the security, the moment you try to take advantage of that information your order reveals information to the rest of the market which will then incorporate it and move the price to a level from which you can no longer benefit (that is, to the new fair value). You could try to do a vwap order and patiently wait to build a position, but that puts you at risk of competing insiders letting the cat out of the bag. In fact, because of competition, the profit from insider trading would quickly evaporate because of competition from other insiders in the event that insider trading is again decriminalized. A large reason insider trading is profitable is that it's criminalized.

Mostly, to the extent we see insiders, we see them in options where they can hide in the forest of strikes and expirations. The most likely scenario is that the other side of your options trade is an options market maker who is very good at reading order flow and you'll get read quickly, he'll react and the underlying will reflect the information right away.

The analysis that compares active investing to passive investing take into account transaction costs and management fees. Back those out and there's no question that most professional investors do statistically significant better than chance. The primary issue is do they have enough edge to overcome the costs associated with their active management style. That's an important question for consumers looking at investment vehicles. But it's an irrelevant question as to whether active managers increase market efficiency, without doubt they do.

In addition I'd add that the investors that do significantly better than chance usually aren't soliciting investment. For example the Renaissance Medallion fund has never lost money in 25 years, averaging 50%+ returns, but the opportunity to invest in it is invitation only.

So does what you write contradict the Efficient Market Hypothesis, at least mildly? Or did I find just one more way of misunderstanding EMH?

I'd say it contradicts EMH, but I hate associating myself with the typical EMH-rejector. EMH is basically the limit of what happens when infinite effort is expended into maximizing investment returns. Is infinite effort invested in major financial markets? Of course not. But there's still a damn enormous amount of effort put into it (I think the annual revenue of the entire asset management industry's on the order of several hundred billion). If you're willing to expend the effort into competing, be it in the form of brainpower, capital, operational expenses, reputation, etc., then you can *may* have the opportunity to generate excess return.

But it's a damn high threshold to cross. And then we have Joe Sixpack, either trying to beat the market by actively picking stocks himself or trying to find a manager who's going to give him those returns without absorbing all the surplus in fees. He brings nothing to the table that tons of other people don't have, capital's cheap, risk-hungry and thirsty for yield. (I'd say the one time in recent memory that Joe Sixpack did have a chance to earn good excess return was circa 2008, when most institutional capital became extremely risk-averse). That threshold of effort and resources necessary to start generating excess return is so high that it might as well be infinite. For Joe, for all intents and purposes, the market basically is completely efficient.

Joe Sixpack apart, can even a professional investor (with oodles of brainpower, capital etc.), on average, deliver excess return? I'm skeptical but I'd love to know the empirical answer.


I know a lot of traders and a few money managers who have generated excess returns (that is, returns that are in excess of returns commiserate with the risk they took to get them) for many years. They are obviously in the minority by definition, but they exist. Joe Sixpack has no access to them. Renaissance is one, but there are lots of firms you've never heard of that have generated actual alpha for many years running.

"What if insider information were rampant?"

if it is, it doesnt seem to be helping much.

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