Sunday, December 16, 2012

On High Frequency Trading

The emails continue to come in with regard to High Frequency Trading.

Dave Narby emails:
 Hope you will give this a thorough read, as IMO your position on HFT is based on incomplete/incorrect information.  
I'm not sure how this link points to information that my view on HFT is incomplete/incorrect. I have never claimed that HFT doesn't occur. My point has consistently been "So what?"

There are people on Wall Street trying to pry you away from your money a million different ways---every day. In a truly free market, where it would be easy to set up competing exchanges, HFT probably would not exist. That said, the banksters have an edge on very short-term large block trading when they trade against institutions, because of the way the government protected exchanges are structured.  The banksters are simply going to use HFT to front run trades and clip a few pennies from each trade.

There is nothing you can do about that and it really shouldn't matter to a small trader.

Suppose 10 years ago, you learned that Apple was going to come out with a cool new cellphone and that they had a bunch of new products on the drawing board. Because of this you decided to buy in. On a pre-split basis, 10 years ago Apple stock was trading around $12 per share. Suppose that because of HFT front running, you ended up paying $12.02 per share or $12.10, what would it have mattered? The stock  at its peak earlier this year was up 13,687% from 10-years ago. There are many. many ways to make money on Wall Street. There are also many, many people trying to take the money away from you. You simply need to know where to play the game and how.

And BTW, unless you are a massive institution, you can use HFT to your advantage with limit trades. Put a limit below the market and if you are lucky HFT will knock the price down into your waiting hands.

I have always said that investing, especially with government protecting the big guys, is a dangerous place for those who don't know what they are doing. If you understand a game, even if it is rigged, like three card monte, there are ways to beat it.

Bottom Line: Don't worry about the game being rigged, there's nothing you can do about that--especially don't worry about something like HFT which is going to have little impact on your investing. Find the ways to make money and don't worry about bankster activity that is inconsequential to your trading and is really only a problem for large block traders like institutions and George Soros.

Dale Fitz emails:

I've read your defense of the HFT algos, and not being truly familiar enough decided to let it go. Small guys like me rarely see the 2-5 cent difference as worth bothering with. But I agree with this guy- they crowd out the pros (that aren't GSucks or BoA) and prevent market clearing. In this case, $25 bucks more is getting added to the big boys (500x.05) and passed on to small retail investors, while the power players get preferred treatment. Multiply that by 100,000 "small guy trades" and you're talking real money!
Care to clarify in a post in the next few days? And he then points to a Zero Hedge link that  contains this:
I was trying to buy 500 shares of a preferred stock this morning, Principal Financial Group Inc. series B (NYSE:PFG-B).  It is such a challenge to trade any type of illiquid issue as the execution of orders is nearly impossible in this HFT world.  Here is the sequence of events. 
At 09:39:08, the stock is offered on EDGX at $26.29. 

I place an order to lift the offer.  The shares trade but I get filled on zero shares.  Knowing that my bid will cause a bunch of HFT programs to penny-jump me (step ahead of my order by a penny -  which they immediately do), I cancel the order. The HFT penny jumper cancels their order as well. 
At 09:39:29, the stock is offered on EDGX again at $26.32.  I place an order to lift the offer.  The stock trades at the exact same second.  Again, I get filled on zero shares.  I cancel the order. 

 At 09:39:41, the stock is offered on PCSE at $26.29.  I place an order to lift the offer.  The stock trades at the exact same second again, but I get filled on zero shares.  I cancel the order. 
At 09:39:50, I place a hidden order to buy the stock at $26.32.  Five second later the stock prints in front of me at $26.33 (Obviously these hidden orders aren’t as hidden as they should be).  I leave the hidden order to buy at $26.32. 
At 09:40:05, the stock prints right through my hidden order on another exchange at $26.30.  So despite my bid being higher at $26.32, thanks to the fragmentation in the market, I get filled on zero shares again (and the seller gets a worse price!)At 09:40:20, the stock prints through my hidden order again at $26.30.  Again, no execution for me.  Frustrated, I cancel my order. 
A few seconds later, at 09:40:36 a couple of HFT programs battle out for the top of the order queue, and the bid changes rapidly, as you can see below: 
At 09:40:40, the HFT programs go to battle again fighting for the best bid. 

This battle continues for the next few minutes.  In fact, during one period of time from 09:44:53 – 09:46:35 (a total of just over a minute and a half), the best bid changes over 800 times, as these two HFT algorithms battle to be at the top of the queue. 
At 10:07:14, I finally lift an offer and pay up to $26.35.  The HFT firms scalps their few cents from me, and all the games are over. 
Some serious issues are highlighted in these few minutes of activity: 
1) Inability for market participants to access a quote.2) Excessive quote pollution as HFT algorithms battle each other.3) Market fragmentation can lead to inferior execution.4) HFT penny jumping can discourage market liquidity.The bottom line is that all of these issues discourage participants from trading illiquid securities – making these securities even more illiquid.
The problem with this ZeroHedge post is that the author of the post is clueless. He has no idea what he is talking about. The action he is referring to is BASIC market maker activity that occurs with almost all small cap NASDAQ stocks. There is no HFT "battle". It is not by any stretch HFT activity. It is market makers trying to catch stock to fill orders.

Actually, if you really know what you are doing and understand how market makers work, you can really set these guys up (especially if they do front run you) and dump a lot of stock on them. I admit, I have sent dogs to the market maker dog pound this way. And there is nothing more fun than messing with a lead market maker in a stock, who is probably trading from the short side. Put enough upward pressure on that puppy and you have guaranteed buying for your stock at a much higher price from the market maker.

As an aside and an example of how there are many ways to play the stock market game, if you are sharp and know what you are doing, consider the trader Blair Hull. When Obama ran in Illinois for the US Senate, in the primaries he ran against Hull, who designed a computer program that at the time was able to catch market makers who were a sleep at the switch. Traders like Hull were known as SOES bandits. LOL, they were called bandits because they were ripping off market makers, instead of the other way around. Hull made hundreds of millions and in the eyes of the Republicans, therefore, was an ideal candidate to run against Obama. Little did Hull know how much "help" Obama was going to get.

As for the final comment by the ZH author:
The bottom line is that all of these issues discourage participants from trading illiquid securities – making these securities even more illiquid.
This is a further idiotic commentary. There is nothing wrong with illiquidity in a stock.  It is really an edge. It means you have few competitors bidding against you, and you can pick up stock real cheap, with the proper use of limit orders. Some of the best investors I know only operate in illiquid stocks.

One of the greatest investors ever, Albert Hettinger, made huge amounts of money in illiquid stocks, as did Warren Buffett early in his career, when his portfolio was small enough and  illiquid stocks could have an impact on it.


  1. Thanks Bob. Very helpful.

  2. Hi Bob,

    Thanks for taking the time to discuss this.

    With respects to the ZH article I referenced it talks specifically about "Momentum Ignition", which is a form of market manipulation.

    Now, the illegality of such a tactic (similar to the debate over 'insider trading') is debatable, I admit.

    However, the end result of HFT is a reduction in liquidity, and a widening of the bid/ask spread (via quote stuffing, which is the offering of multiple bids (or asks) that are immediately withdrawn - they are never meant to be hit!). This ultimately hurts the retail investor (and distorts the market).

    A simple fix for this would be to require each bid or offer to stand for some small amount of time (e.g. 0.2 seconds would be long enough), in order to allow it to be met.

    Also, regarding your position on HFT, at one point you had this to say (perhaps your position has changed, if so, please make it clear):

    "If you are a long-term investor and know what the hell you are doing (and you should only be in the market if you know what you are doing), HFT is an advantage, since it is occasionally driving down stocks against the long-term trend. It is a gift to the long-term investor, providing discount prices. Never trust anybody coming out of Goldman Sachs. Cooperman's agenda is most likely concerned with front running by HFTs against his large trades, this battle has nothing to do with the average individual investor." via

    That's all fine and good if a stock is UNDERVALUED, but what if the opposite is true?

    Based on historical valuations (post crash P/Es that need to be reached indicating the malinvestment has been purged), this has not been the case. We have instead had three burst bubbles since the 70's onward that have been caused by repeated credit inflation.

    At any rate, I cannot see how HFT makes for a MORE efficient market - quite to the contrary.

    IMO, as long as the FED is distorting the market with unlimited credit creation, Congress keeps creating and keeping crony regulations in place, and the big banks can push stocks any which way they want (and further screw the retail investor in the process), NOBODY has any business being in these markets.

    They have BROKEN the engine of capitalism.

    IMO it won't get fixed until the whole rotten system has imploded... Which we can predict WILL happen - thanks to Ludwig Von Mises.

  3. Robert what are the best two books to read for a beginner? Should one start with Security Analysis by Graham and Dodd?

    I would love to be a buy and hold guy. I own some precious metals, and if and when I dumped stock that's probably where I would ultimately put my money.

  4. Some random thoughts:

    I think HFTs are part of the evolution of the markets (though not sold on ones that get special book access from exchanges to front run.)

    I would also note that less liquidity gives companies less access to capital through lower valuations. More liquidity is why publicly traded companies sell for higher multiples than private companies. People advocating for eliminating HFTs through taxation are going to reduce the money that companies can raise and make the markets less fairly priced.

    It's disgusting to me that people are willing to slice the throats of short term individual traders and HFTs. Trader taxes (along with the favorable capital gains treatment) are convenient for people like Buffett who hold companies forever. They also make the markets less efficient for him to profit. I don't understand why everyone thinks it's so noble to just be a value investor. Tech companies like Facebook need to raise cash and value strategies won't make money on those stocks.

    HFTs add liquidity on a day to day basis. The spreads on stocks have tightened dramatically over the last 5 years. HFTs are also the reason why buying 100 shares of Apple at Interactive Brokers costs $1 vs $200 20 years ago.

    1. All the analysis I've read about HFT on ZH indicates it reduces, not increases, liquidity.

      Quote stuffing (bids/offers that are extended and withdrawn before they can be hit, done for the purposes of moving the price) is fraud.

      If it's a legitimate bid/offer, let it stand for 0.2 seconds. Problem and controversy solved.

      But that won't happen, because without HFT, Ben can't lift the market...

    2. 1. Zerohedge isn't a credible source of anything.

      2. HFTs have nothing to do with Ben lifting the market

      3. Your solution seems fine. I'm worried that Congress will get rid of short term trading through taxation. That's what Mario Gabelli and Mark Cuban have proposed.

      4. The .25% per trade tax that was proposed in Congress is so insanely high that it would make virtually every form of speculation except long term buy and hope unprofitable. Keynesian economists, who hate speculation, have endorsed this idea of eliminating this "unproductive" activity through taxation.

      5. Eliminating HFT through taxation would be infinitely worse than keeping HFT and all the real and imagined ills that it causes.

    3. "1. Zerohedge isn't a credible source of anything."\


      I guess we can stop right there.

      Unless of course, you can find even one demonstrably falsifiable ZH article in the last 20 or so posted there.

      FYI, Bob Wenzel got a huge boost from ZH. Because they published an article on him...

  5. yeah don't worry. Next time May 6, 2010 happens and prices remain at $0.01 just say oh well, who cares. Or next time you find out the data your are getting is stale and false just saw oh well. Or next time you see trade prices at levels not matched by wuotes until milliseconds later just say oh well.

    Dude you're a pussy. Grow some balls, get off your ass, and change shit. Instead of telling this type of nonesense to people "here is nothing you can do about that and it really shouldn't matter to a small trader". you are terribly miss informed.

    $101 to $0.01 and back:

    RIMM news:

    who cares though right? You won't change anything dear reader, just sit on your ass and be a lazy nothing like this blogger and just toss up your hands and say "oh well"

    your message is "who cares what you think measly low cash player? without big bucks you're nothing so don't even try. just go sit on your ass". what do you take readers for?

    1. Your presentation is harsh, but I can't disagree with any of your premises.

      Unfortunately, it appears Bob isn't going to open his mind on this (and therefore change his position) any time soon.

      It doesn't even look like he's following this discussion... Sad.

  6. The shorter your time horizon the larger the transaction costs, and the higher the premium to be immediately right in your forecast. For most people (not insiders), trading short term makes money for brokers and exchanges but inholding something over many years, you may negate the those costs and compound your bet. And yet the buy and hope strategy is highly dependent on what and when you enter or exit the market. Look at Japan in the last 23 years!

  7. High Frequency Trading has been causing havoc for years in the financial markets. People like Carl Weiss a High Frequency Trading expert have been trying to come up with ways to combat it.Thankfully now at least the HFT's and their bots can be tracked in real time by anyone.Have a look at the way the bots were in action a few weeks ago during the US Presidential election courtesy of Carl Weiss from sceeto
    As you know High Frequency Trading and these type of algos as a matter of fact are responsible these days for more than 70 to 80% of all the daily US volume. hfts have been quote stuffing, i.e placing massive buy sell orders within milliseconds for a long time now. sceeto is one of the first small companies anywhere in the world that tracks the hft's in real time across various markets. Have a look for yourself ,Carl Weiss has done numerous videos on these algos. The chief software developer of sceeto he has for a decade tested to come up with software designed a system to sniff these out and try to at least again level the playing field a bit for the ordinary investor.