Saturday, April 5, 2014

High-Frequency Traders Can’t Front-Run Anyone

Rishi K Narang the founding principal of T2AM LLC, a hedge-fund advisory firm,co-founder, with his brother, Manoj Narang, of the high-frequency trading firm Tradeworx and the author of Inside the Black Box: A Simple Guide to Quantitative and High Frequency Trading, writes at CNBC:
 I have been involved in the capital markets for almost 20 years and I've specialized in algorithmic trading, so I know about HFT and there are a few things in the recent debate that warrant clarifying — first and foremost, this idea of front-running...

What's actually happening behind the scenes may be frustratingly complicated, but it's not immoral, unethical, harmful or illegal. Nor does it cost the non-HFT anything. HFTs generally use direct connections to exchanges in order to post bids and offers and collect market data, rather than relying on the centralized SIP feed. This is because the SIP feed is unacceptably slow. Surely we cannot expect market makers to make markets without actually knowing what the current market is. When an order is placed, it takes some time to be reflected in the NBBO. But that order is already in the market before the HFT can see it, even on the direct feed, by definition. HFTs never know what a customer's order is before it's in the market. HFTs have no customers.

HFTs cannot front-run anyone.

HFTs can, by virtue of having invested in superior infrastructure, react faster to the information embedded in a new order, but let us not confuse speed with front-running. This information is public and available to anyone willing to overcome the challenges of acquiring and processing it very quickly

Narang's entire essay is here.

RW note: I tend to agree with Narang here. I believe the brouhaha over HFT, following the release of the Michael Lewis book Flash Boys: A Wall Street Revolt, is much ado about very little. HFTs when they trade as HFTs can't front run. However, I am a bit suspicious about firms that pay for order flow, they might "peek" at that order flow. That said, even if this is going on, it is a tiny matter relative to overall market activity and would have near zero impact on an individual small investor.  As for HFT trading overall, a very strong theoretical case can be made that this type trading narrows spreads between bid and asks, which is an advantage for small investors. And, indeed, empirical data shows that since HFT trading has become common place, spreads have narrowed.


  1. CFTC Investigates The "Secret" HFT-Exchange Incentive Programs

    As WSJ reports, regulators are taking aim at the relationship between high-frequency trading firms and major exchanges, examining whether the preferential treatment market operators offer the firms puts other investors at a disadvantage. The CFTC probe is focused on complicated, often opaque incentive programs that give high-volume trading firms financial benefits such as discounts on fees the exchanges charge to execute trades.

    would you go to a casino that did this?

  2. LOL! The Market Is Rigged (HFT)

    I spat my coffee this morning....

    Eric over at Nanex has been on this for a number of years. I've been on it too. And now there's a new book and suddenly CNBC is talking about it to all three of their actual viewers.

    At the end of the day the problem is that providing someone a way to cut in line is against the law.

    But that doesn't bother the so-called "regulators" just like nothing else does, provided you make them enough money for them to look the other way. The price of that willful blindness can be shockingly cheap; in general the revolving door between Wall Street and Washington DC turns both fast and profitably for both cities.

    Everyone wants to wring their hands on this but the simple fact of the matter is that the exchanges, which are regulated entities, actually pay for so-called "quote traffic" under certain circumstances and they have set up structures that encourage this sort of behavior.

    The defenders of this behavior claim they're providing a "benefit" to investors usually related to alleged "liquidity." But as I pointed out years ago if you and I trade 100 shares of a stock back and forth 1,000 times there is the appearance of 100,000 shares of liquidity in that name but in fact there is only 100 shares of liquidity present. If some third party comes in and tries to buy or sell more than 100 shares this will become immediately apparent, because neither of us is willing to transact in more than that number at any given point in time!
    Finally, there is simply the law to consider. The Securities and Exchange Act makes unlawful "market manipulation" and Reg-NMS mandates that the consolidated quote be the actual best and time-sync'd feed of quotations. Selling a higher-speed feed is arguably a direct violation of the law.

    where the f do their riskless profits come from?...just look at the % their abnormally

  3. BATS Admits CEO Lied About HFT On CNBC

    It is now quite clear why BATS CEO Bill O'Brien was so agitated during the Tuesday's screamfest on CNBC. As The Wall Street Journal's Scott Patterson reports, under pressure from the NYAG, BATS has hurriedly issued a statement correcting the CEO's false comments during the exchange with IEX's Brad Katsuyama. After Katsuyama said "you wanna do this, let's do this" clearly giving him an out, O'Brien stated that BATS priced its trades off 'high-speed' data feeds when in fact they price their trades off a much slower feed (and therefore 'enable' the exact HFT-front-running that is in question).

    Here is the clip in particular where O'Brien lies following Katsuyama's question... that BATS uses the high-speed feed to price its trades...

  4. It is all a sideshow, distracting focus from the only manipulation (if HFT is even this) that matters: monopoly central banking.

    1. You win 9000 internets!

      Stay on target, bionic. You're our only hope in this insane world.

  5. Spreads have narrowed but market makers only have to fill 100 shares. It is good for a small investor, bad for a trader. The narrow spreads and liquidity are an illusion. I wasn't trading much pre-HFT. But the consensus among most short term traders is that markets aren't much more liquid. One of the HFT abuses that Lewis didn't talk about was spoofing where HFTs will flash orders on level 2 and immediately pull their orders when you try to get filled. It is way to get buying or selling going and then smash the market the other way.

    I do think the alarm is overblown. The markets aren't rigged and I am against government stepping in to regulate. But HFTs that front run serve no useful purpose in my opinion and hopefully are competed away.

    1. I already wrote a post (SEE: Forbes Is Clueless About HFT) noting that the claim that HFT improves liquidity is bogus. But, a small investor is going to be able to get off a much larger trade than 100 shares at the now narrower spreads. You are distorting the picture to suggest otherwise.

    2. It is kind of hard to describe what I mean. I'm not talking about trading Apple. All I'm saying is market makers who bid on level 2 only have to fill 100 shares. The tighter spreads on a typical Nasdaq or Amex that don't have fresh news are only there for a small number of shares.

  6. Front-running has been going on in Wall St from 1885 read Flash boys its in the book. The market is a fraud. The tax of this fraud is 3 billion shooters a year. Thank you very much HFT

  7. Must be an oddity in nature: sharks coming out to defend one of their own. The IPO pulled by HFT firm this past week, clearly illustrates the problem: Only 1 losing day in 4 years of trading. Couch it however you want, but that is not possible other than by stealing.

    And I can only assume there are other HFT firms far smarter, because who in their right mind would put in a prospectus only one losing day? At least 5 or 10%, and one might think they were exception traders, rather than mere criminals.

    And spreads have narrowed since HFT popularity? Everyone I know has aged since then too, but I would not blame, nor credit HFT. Post hoc ergo proctor hoc.

    As for the issue of this being just pennies, and/or not impacting the small investor, I don't think that true on a number of grounds. But even if true, a market sans justice will ultimately fail.

  8. Not only are the New York Stock Exchange and Nasdaq allowing high frequency traders to co-locate their computers next to the main computers of the exchanges to gain a speed advantage over other customers at a monthly cost that only the very rich can afford to pay but they’re now tacking on infrastructure charges that price everyone out of efficient use of the exchanges except the very top tier of trading firms.

    Lewis writes in “Flash Boys” that “both Nasdaq and the New York Stock Exchange announced that they had widened the pipe that carried information between the HFT [high frequency trading] computers and each exchange’s matching engine. The price for the new pipe was $40,000 a month, up from the $25,000 a month the HFT firms had been paying for the old, smaller pipe.”

    By late 2011, according to Lewis, “more than two-thirds of Nasdaq’s revenues derived, one way or another, from high-frequency trading firms.”

    And we’ll take Trugman’s analogy one step further: the cops on the beat who have had their palms greased to turn a blind eye to the brothels are drinking their coffee and gobbling their donuts at the Securities and Exchange Commission.

  9. Now, bloggers using twitter is one thing; conflicted insiders using television to make their HFT defenses are another. Manoj Narang is such a conflicted insider – which brings us to the number 1215095, which is the title of this morning’s note.

    Flash Boys closes with this paragraph:

    The application to use the tower to send a microwave signal had been filed in July 2012, and it had been filed by … well, it isn’t possible to keep any of this secret anymore. A day’s journey in cyberspace would lead anyone who wished to know it into another incredible but true Wall Street story of hypocrisy and secrecy and the endless quest by human beings to gain a certain edge in an uncertain world. All that one needed to discover the truth about the tower was the desire to know it.

    Michael Lewis is referring to the microwave tower in Pennsylvania with the FCC license number 1215095. It is located in Potter Township, PA (Lat: 40.849278 Lon: -77.710778) The tower is used to beam stock quotes between Chicago and Cartaret, NJ faster than even the fiber optic cable laid by Spread Networks (which Spread laid because it wanted to make faster the transmission of the same stock quotes than the prior mechanism which included slower fiber cable routes). Many now argue that the microwave networks being deployed to speed up stock quote transmissions are actually makes the Spread Networks fiber route obsolete.

    Who owns this tower? What about who owns this tower is mysterious, conflicted, and hypocritical?

    Manoj Narang, or the entities he has stakes in, owns the tower. The application for the microwave device was filed by Converge Towers LLC, which is located at 770 Broadway, Second Floor. And while Converge Towers LLC is a subsidiary of BCG Cantor Fitzgerald, the application was filed by a misses Elizabeth Kim, who works at Thesys technologies (BCG Cantor – Thesys partnership?) (This is an interesting blog post you should look at by the way… particularly the comments section).

  10. Capitalism is supposed to be about supply and demand. Suppliers and Demanders. Why am I hearing some CEO's saying they are not concerned with the needs and important agendas of demanders? Don't they think having demanders with a healthy ability to demand benefits suppliers? If they are not concerned with demand it follows they are not concerned with how much they supply. Capitalism is becoming something else. There are those who see it as a way to acquire capital without giving anything of fair value in return. Such are the HFTs. As Mr. Narang admits HFTs don't have customers. If as Mr. Lewis says on page 52 of Flash Boys HFTs take 160 million out of the system a day that is 58.4 billion a year. What do they provide that is worth that much? Aren"t they just parasites? This is a great example as to why demand is low. Think of all the ways that money is being taken out of the economy by those who are not providing fair value in return? Add it up and it is staggering!