Results for “high frequency trading” 43 found
My conversation with Cliff Asness
Here is the full transcript, video, and podcast of the chat. Cliff was great from beginning to end. The first thirty minutes or so were an overview of “momentum” and “value” trading strategies, and to what extent they violate an efficient markets hypothesis. Much of the rest covered:
…disagreeing with Eugene Fama, Marvel vs. DC, the inscrutability of risk, high frequency trading, the economics of Ayn Rand, bubble logic, and why never to share a gym with Cirque du Soleil.
Here is one excerpt:
COWEN: I think of you as doing a kind of metaphysics of human nature. On one side, there’s behavioral economics. They put people in the lab, one-off situations, untrained people. But here it’s repeated data, it’s over long periods of time, it’s out of sample. There’s real money on the line, and this still seems to work.
When you back out, what’s the actual vision of human nature? What’s the underlying human imperfection that allows it to be the case, that trading on momentum across say a 3 to 12 month time window, sorry, investing on momentum, will work? What’s with us as people? What’s the core human imperfection?
ASNESS: This is going to be embarrassing because we don’t have a problem of no explanation. We have a problem with too many explanations. Of course, we can observe the data. The explanations you have to fight over and argue over. I will give you the two most prominent explanations for the efficacy of momentum.
The first is called underreaction. Simple idea that comes from behavioral psychology, the phenomenon there called anchoring and adjustment. News comes out. Price moves but not all the way. People update their priors but not fully efficiently. Therefore, just observing the price move is not going to move the same amount again but there’s some statistical tendency to continue.
Take a wild guess what our second best, in my opinion, explanation for momentum’s efficacy is? It’s called overreaction. When your two best explanations are over- and underreaction, you have somewhat of an issue, I admit. Overreaction is much more of a positive feedback. It works over time because people in fact do chase prices. So if you do it somewhat systematically and before them you make some money.
One of the hard things you find out in many fields but I found out in empirical finance is those might be the right explanations but they’re not mutually exclusive.
And here is from the overrated/underrated part of the chat:
COWEN: …In science fiction, the author Robert Heinlein.
ASNESS: Early stuff, underrated. Later stuff, overrated.
COWEN: What’s your favorite?
ASNESS: That is a really — Methuselah’s Children.
COWEN: Ah, good pick.
ASNESS: I could have gone with the obvious. I’m a bit of a libertarian. I could have gone with, The Moon Is A Harsh Mistress. It’s his most famously libertarian book.
COWEN: But it doesn’t age so well.
ASNESS: No, no. I like Methuselah’s Children.
This was the funniest segment:
ASNESS: I live in Greenwich, Connecticut. In some parts of the world, if you said, “my daddy runs a hedge fund,” I’d say, “what’s a hedge fund?” In Greenwich, Connecticut, the kids say, “what kind of hedge fund is your daddy running? Is he event arbitrage? Trend following? What does dad do?”
Interesting throughout, as they are known to say…
Father of HFT: Slow Down
Thomas Peterffy is one of the pioneers of automated stock trading. From NPR’s Planet Money:
…The company he started, Interactive Brokers, does electronic trades on a mind-boggling scale. Forbes estimates his net worth is now over $5 billion.
Peterffy says automation has done some very good things for the world. It’s made buying and selling stocks much much cheaper for everyone.
But Peterffy thinks the race for speed is doing more harm than good now. “We are competing at milliseconds,” he says. “And whether you can shave three milliseconds of an order, has absolutely no social value.”
Here are previous MR posts on high frequency trading.
The Volume Clock
That is the title of a new paper by David Easley, Marcos M. Lopez de Prado, and Maureen O’Hara:
Abstract:
Over the last two centuries, technological advantages have allowed some traders to be faster than others. We argue that, contrary to popular perception, speed is not the defining characteristic that sets High Frequency Trading (HFT) apart. HFT is the natural evolution of a new trading paradigm that is characterized by strategic decisions made in a volume-clock metric. Even if the speed advantage disappears, HFT will evolve to continue exploiting Low Frequency Trading’s (LFT) structural weaknesses. However, LFT practitioners are not defenseless against HFT players, and we offer options that can help them survive and adapt to this new environment.
The paper has many interesting bits, such as this:
Databases with trillions of observations are now commonplace in financial firms. Machine learning methods, such as Nearest Neighbor or Multivariate Embedding algorithms search for patterns within a library of recorded events. This ability to process and learn from what is known as “big data” only reinforces the advantages of HFT’s “event-time” paradigm, very much like how “Deep Blue” could assign probabilities to Kasparov’s next 20 moves, based on hundreds of thousands of past games (or more recently, why Watson could outplay his Jeopardy opponents).
The upshot is that speed makes HFTs more effective, but slowing them down won’t change their basic behavior: Strategic sequential trading in event time.
One message of the paper is that sequential strategic behavior will occur at any speed. I liked this sentence:
As we have seen, HFT algos can easily detect when there is a human in the trading room, and take advantage.
And the ending bit is this:
There is a natural balance between HFTs and LFTs. Just as in nature the number of predators is limited by the available prey, the number of HFTs is constrained by the available LFT flows. Rather than seeking “endangered species” status for LFTs (by virtue of legislative action like a Tobin tax or speed limit), it seems more efficient and less intrusive to starve some HFTs by making LFTs smarter. Carrier pigeons or dedicated fiber optic cable notwithstanding, the market still operates to provide liquidity and price discovery – only now it does it very quickly and strategically.
Decentralized Finance and Innovation
Decentralized finance to date seems mostly to be about speculatively trading one cryptocurrency for another. I see little real investment. But in my post on Elrond, I also wrote, “The DeX’s or decentralized exchanges have shown that automated market makers can perform the services of market order books used by the traditional exchanges like the NYSE at lower cost while being easily accessible from anywhere in the world and operating 24/7/365. Thus, every exchange in the world is vulnerable to a DeX.”
One of the reasons that I think DeFi has a big future is that there is much more innovation in the space than in traditional finance. Decentralization is really not a big deal for consumers–it’s even a negative in some respects–but it’s a huge factor for producing innovation.
As an illustration the excellent Bartley Madden (note my biases!) has an interesting idea for reformulating order books on size rather than time.
- One patented concept is that at a specified limit price, priority is based, not on the time when the order was received, but on order size, which incentivizes placing larger orders.
- Additional issued patent claims concern variable prices on limit orders depending on the number of shares traded and other technical details for new ways to facilitate the matching of institutional orders with large retail orders.
- The reason this platform would actually build liquidity is because of the preference given to the largest orders. In operation, a slight price advantage is achieved by the larger investors while the counterparty smaller investors achieve a very quick fill of their entire order.
Or consider the Budish, Crampton, Shim idea for batch auctions to avoid resource waste (rent-seeking) from high-frequency trading. Are these good ideas? I don’t know. But what I do know is that there is little chance that either will be adopted by a major exchange–the transactions costs, including bureaucracy, fear and complacency (why rock the boat?) make it very difficult to innovate. But these ideas could be implemented very quickly by a DeX.
DeFi illustrates “the perennial gale of creative destruction,” and right now we are in the creative phase. New ideas about how to exchange assets are being rapidly deployed and destroyed but a few will prove robust and then watch out. The destruction phase has yet to be begin. Wall Street is unprepared for the onslaught.
Addendum: See also Tyler’s post Will the Future be Decentralized?
Should hiring schools coordinate on delaying their interviews?
The AEA emails me this (web version here):
The AEA suggests that employers wait to extend interview invitations until Monday, December 7, 2020 or later.
Rationale: the AEA will deliver signals from job candidates to employers on December 2. We suggest that employers wait and review those signals and incorporate them into their decision-making, before extending interview invitations.
…The AEA suggests that employers conduct initial interviews starting on Wednesday, January 6, 2021, and that all interviews take place virtually; i.e. either by phone or online (e.g. by Zoom). We also ask that all employers indicate on EconTrack when they have extended interview invitations (https://www.aeaweb.org/
econtrack). Rationale: In the past, interviews were conducted at the AEA/ASSA meetings. This promoted thickness of the market, because most candidates and employers were present at the in-person meetings, but had the disadvantage of precluding both job candidates and interviewers from fully participating in AEA/ASSA sessions. Since the 2021 AEA/ASSA meetings (which will take place Jan 3-5, 2021) will be entirely virtual, we suggest that interviews NOT take place during the AEA/ASSA meetings to allow job candidates and interviewers to participate in the conference.
Perhaps not surprisingly, they don’t offer much economic analysis of this recommendation. I have a few remarks, none of which are beyond the analytical acumen of the AEA itself:
1. This proposal could well be a tax on the more conscientious departments, which will abide by the stricture while the more rogue departments jump the gun, giving them a relative advantage in finding job candidates.
2. It is common practice for the very top departments to make phone calls to advisors early, well before Christmas, and in essence tie up their future hires before the rest of the market clears (even if the ink on the contract is not dry until later on). Whatever you might think of this practice, have any of those departments vowed to stop doing this? If not, is the new recommendation simply an exhortation that other departments ought not to copy them, thus giving them exclusive use of this practice? And did the AEA — which essentially is run by people from those top schools — ever complain about this practice?
3. In the more liquid market, as this proposal is designed to create, the better job candidates are likely to end up going to the more highly rated schools. That is the opposite of how the NBA draft works — this year the Minnesota Timberwolves (a very bad team) pick first. So maybe the more liquid market is best for the most highly rated schools — is that obviously a good thing?
4. Many job candidates don’t get any early offers at all, and this is likely to be all the more true with Covid-19 and tight state budgets. Aren’t they better off if the market clears sooner rather than later? Then they can either move on to other jobs searches, take jobs with community colleges, look for postdocs, or whatever. Why postpone those adjustments? Is their welfare being counted in this analysis? Aren’t some of them the very neediest and also most stressed people in the economics job market?
5. Let’s say instead the market is done sequentially, where first you “auction off” the candidates in highest demand, ensuring that say a department rated #17 does not tie up an offer (fruitlessly, at that) to one of the very top candidates. Won’t that #17 school then bid harder for the candidates one tier lower, thus making that part of the market more liquid? I know it doesn’t have to work out that way, but surely that is one plausible scenario?
6. In finance, there are some results that you get less “racing” behavior with batched rather than continuous trading auctions. Again, that doesn’t have to be true, but surely it is no accident that many high-frequency traders oppose the idea of periodic rather than continuous securities auctions? What exactly are the relevant conditions here?
7. Would many economists recommend that say the top tech firms not make any offers before a certain date, so as to keep that labor market “more liquid”? What exactly is the difference here?
8. Might it be possible that a permanent shift to non-coordinated interview dates, and less temporally coordinated Zoom interviews and fly-outs, would permanently lower the status and import of said AEA?
I do not wish to pretend those are the only relevant factors. But here is a simple question: does anyone connected with the AEA have the stones to actually write a cogent economic or game-theoretic analysis of this proposal? Or does the AEA not do economics any more?
Cryptocurrencies don’t belong in central banks
That is the topic of my latest Bloomberg column. Here is one excerpt:
An additional reason for skepticism stems from the nature of crypto assets. The word “cryptocurrency” is far more common than “crypto asset,” but it’s a misleading term. Bitcoin, for instance, is used only rarely in retail transactions, and for all its success it isn’t becoming more important as a medium of exchange. Bitcoin thus isn’t much of a currency in the literal sense of that term. There is a version of bitcoin, Bitcoin Cash, that changed the initial rules to be better suited as an exchange medium, but it isn’t nearly as popular.
If you think of these assets as “cryptocurrencies,” central bank involvement will seem natural, because of course central banks do manage currencies. Instead, this new class of assets is better conceptualized as ledger systems, designed to create agreement about some states of the world without the final judgment of a centralized authority, which use a crypto asset to pay participants for maintaining the flow and accuracy of information. Arguably these innovations come closer to being substitutes for corporations and legal systems than for currencies.
Put in those terms, an active (rather than merely supervisory) role for central banks in crypto assets is suddenly far from obvious. Consider other financial innovations: Does anyone suggest that central banks should run their own versions of ETFs or high-frequency trading? Is there a need for central banks to start managing the development of accounting and governance systems?
Central banks are too conservative anyway, which of course is how they should be. Don’t forget:
…consider a simple question: Would any central bank have had the inspiration or taken the risk of initiating the bitcoin protocol in the first place?
Against a financial transactions tax
Maria Coelho, job market candidate at UC Berkeley, studied this topic and came up with this:
This paper analyzes the effect of the introduction of financial transaction taxes in equity markets in France and Italy in 2012 and 2013, respectively, on asset returns, trading volume and market volatility. Using two natural experiments in a difference-in-differences design, I identify bounds on elasticity estimates for three categories of avoidance channels: real substitution away from taxed assets, retiming (anticipation of transaction realizations and portfolio lock-in), and tax arbitrage (cross-platform and financial instrument shifting). I find large responses on all margins, that account for significantly lower revenues than projected. By far the strongest behavioral response comes from high-frequency trading lock-in on regulated exchanges, with a high tax elasticity of this type of turnover in the order of -9. The results shed light on overlooked features of optimal FTT design, suggesting they may be poor instruments for both revenue-raising and Pigouvian objectives.
The paper is called “Dodging Robin Hood.” This is consistent with earlier findings on Sweden’s transactions tax, and that proposal continues to be one of the more overrated ideas in American Progressive political discourse.
Assorted links
Assorted links
1. Will you hire someone to do your grocery shopping for you?
2. New DSGE blog.
3. The Philadelphia Eagles are now targeting college graduates. Educational signaling comes to NFL football.
4. Can conservatives be funny?
5. Bill Gates on Jeffrey Sachs.
*Flash Boys*, the new Michael Lewis book
For all the criticism the book has received, I liked and enjoyed it. It illuminates a poorly understand segment of the financial world, namely high-frequency trading, and outlines some of the zero- and negative-sum games in that world. The stories and the writing are very good, as you might expect.
It is a mistake to take the book as a balanced or accurate net assessment of HFT, but reading through the text I never saw a passage where Lewis claimed to offer that. Maybe the real objections are to be lodged against the 60 Minutes coverage of the book (which I have not seen).
Why not read a fun book on a fun and understudied topic? Just don’t confuse the emotional tenor of the stories with a final and well-reasoned attitude toward the phenomenon more generally. Surely you are all able to draw that distinction. Right?
A study of limiting HFT
These advantages were demonstrated in a recent natural experiment set off by Canada’s stock market regulators. In April 2012 they limited the activity of high-frequency traders by increasing the fees on market messages sent by all broker-dealers, such as trades, order submissions and cancellations. This affected high-frequency traders the most, since they issue many more messages than other traders.
The effect, as measured by a group of Canadian academics, was swift and startling. The number of messages sent to the Toronto Stock Exchange dropped by 30 percent, and the bid-ask spread rose by 9 percent, an indicator of lower liquidity and higher transaction costs.
But the effects were not evenly distributed among investors. Retail investors, who tend to place more limit orders — i.e., orders to buy or sell stocks at fixed prices — experienced lower intraday returns. Institutional investors, who placed more market orders, buying and selling at whatever the market price happened to be, did better. In other words, the less high-frequency trading, the worse the small investors did.
…In a paper published last year, Terry Hendershott of Berkeley, Jonathan Brogaard of the University of Washington and Ryan Riordan of the University of Ontario Institute of Technology concluded that, “Over all, HFTs facilitate price efficiency by trading in the direction of permanent price changes and in the opposite direction of transitory price errors, both on average and on the highest volatility days.”
The pdf of the paper is here. Here is the conclusion of a Charles M. Jones survey paper on HFT (pdf):
Based on the vast majority of the empirical work to date, HFT and automated, competing markets improve market liquidity, reduce trading costs, and make stock prices more efficient. Better liquidity lowers the cost of equity capital for firms, which is an important positive for the real economy. Minor regulatory tweaks may be in order, but those formulating policy should be especially careful not to reverse the liquidity improvements of thelast twenty years.
Matt Levine and Felix Salmon on Michael Lewis and HFT
In my alternative Michael Lewis story, the smart young whippersnappers build high-frequency trading firms that undercut big banks’ gut-instinct-driven market making with tighter spreads and cheaper trading costs. Big HFTs like Knight/Getco and Virtu trade vast volumes of stock while still taking in much less money than the traditional market makers: $688 million and $623 million in 2013 market-making revenue, respectively, for Knight and Virtu, versus $2.6 billion in equities revenue for Goldman Sachs and $4.8 billion forJ.P. Morgan. Even RBC made 594 million Canadian dollars trading equities last year. The high-frequency traders make money more consistently than the old-school traders, but they also make less of it.
There is more here. Here is Felix Salmon on the book:
Similarly, Lewis goes to great lengths to elide the distinction between small investors and big investors. As a rule, small investors are helped by HFT: they get filled immediately, at NBBO. (NBBO is National Best Bid/Offer: basically, the very best price in the market.) It’s big investors who get hurt by HFT: because they need more stock than is immediately available, the algobots can try to front-run their trades. But Lewis plays the “all investors are small investors” card: if a hedge fund is running money on behalf of a pension fund, and the pension fund is looking after the money of middle-class individuals, then, mutatis mutandis, the hedge fund is basically just the little guy. Which is how David Einhorn ended up appearing on 60 Minutes playing the part of the put-upon small investor. Ha!
Lewis is also cavalier in his declaration that intermediation has never been as profitable as it is today, in the hands of HFT shops. He does say that the entire history of Wall Street is one of scandals, “linked together trunk to tail like circus elephants”, and nearly always involving front-running of some description. And he also mentions that while you used to be able to drive a truck through the bid-offer prices on stocks, pre-decimalization, nowadays prices are much, much tighter — with the result that trading is much, much less expensive than it used to be. Given all that, it stands to reason that even if the HFT shops are making good money, they’re still making less than the big broker-dealers used to make back in the day. But that’s not a calculation Lewis seems to have any interest in.
*Particle Fever*
That is the new science documentary about the Hadron Collider and the search for the Higgs particle, reviewed here. I enjoyed it very much, and it makes being a scientist seem glamorous, in the good sense of that concept. The visuals of what goes on at CERN are striking, all the more so for being juxtaposed against mooing Swiss cows. And reheating a super-cooled magnet, and removing some helium contamination, is not easy to do.
The scientists in this movie seem to think their success will be measured in binary up/down fashion, and yet so far the results are mixed and inconclusive, as if they had been doing macroeconomics.
During one early part of the movie, at a public meeting, a self-proclaimed economist stands up from the audience and asks what is the economic rationale for the project, in front of a group of people drawn mostly from the scientific community. The man presenting the project responds proudly that such a question does not really need to be answered, and his audience of scientists cheers. The film audience in Greenwich Village was emboldened by this retort and there was audible positive murmuring, and some apparent scorn for the economist.
I wonder how the same scene would play out if the question concerned high-frequency trading?
Assorted links
1. The first robot?, and are real-life Transformers on the way?
2. There is no great stagnation: shelf life of the Twinkie extended from 26 to 45 days. One email correspondent suggested to me that the de facto shelf life of Twinkies is already two to three years.
3. Which are the most abandoned books?
4. Good review of a good book on drones.
5. New and important critique of high-frequency trading (pdf), though I am not persuaded by their claim that batch auctions will lower the bid-ask spread.
How to save the world — earn more and give it away
Dylan Matthews reports:
Jason Trigg went into finance because he is after money — as much as he can earn.
The 25-year-old certainly had other career options. An MIT computer science graduate, he could be writing software for the next tech giant. Or he might have gone into academia in computing or applied math or even biology. He could literally be working to cure cancer.
Instead, he goes to work each morning for a high-frequency trading firm. It’s a hedge fund on steroids. He writes software that turns a lot of money into even more money. For his labors, he reaps an uptown salary — and over time his earning potential is unbounded. It’s all part of the plan.
Why this compulsion? It’s not for fast cars or fancy houses. Trigg makes money just to give it away. His logic is simple: The more he makes, the more good he can do.
He’s figured out just how to take measure of his contribution. His outlet of choice is the Against Malaria Foundation, considered one of the world’s most effective charities. It estimates that a $2,500 donation can save one life. A quantitative analyst at Trigg’s hedge fund can earn well more than $100,000 a year. By giving away half of a high finance salary, Trigg says, he can save many more lives than he could on an academic’s salary.
…In many ways, his life still resembles that of a graduate student. He lives with three roommates. He walks to work. And he doesn’t feel in any way deprived. “I wouldn’t know how to spend a large amount of money,” he says.
The full story is here. Here is commentary from Salam and Sanchez. And I have just received the new book by Michael M. Weinstein and Ralph M. Bradburd, The Robin Hood Rules for Smart Giving, an analytical treatment written by two economists.