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Algorithmic Trading is Not High Frequency Trading

140 points by jeffmiller 15y ago

sspencer 15y ago
For one who works with HFT systems, an extremely refreshing clarification. Though I do get a chuckle out of the extremely bombastic stories ("MAN OBSOLETE? COMPUTERS TAKING OVER!!!"), it's nice to see the record set straight. Sadly this will get 1/10000th of the page views of the garbage articles it dissects.
- matthewcieplak 15y ago
  Kill yourself.
  - 0x12 15y ago
    That was entirely uncalled for and not one bit in line with the general level of conversation here.
  - drivebyacct2 15y ago
    Even if you must insist on being so wildly rude, couldn't you at least offer up some substantiation for your anger, something with a hope of a discussion?
joezydeco 15y ago
In your opinion, Jeff, was the 2010 Flash Crash the work of HFT, or Algo trading? Maybe both?
- fleitz 15y ago
  I'm not Jeff but perhaps I can provide some insight into the flash crash. Also, what IS algo trading? Is a margin call algo trading? Is a stop loss algo trading? What about technical analysis? (Flash) crashes should be expected anytime you over leverage your entire economy. See: George Soros and the pound. Imagine everyone you know has widgets, and you realize that most people like to keep their widgets in a warehouse. You setup a warehouse that stores widgets and people pay you to store their widgets. Everyone loves it, no more widgets around the house cluttering things up. Now since the widgets are identical and interchangeable you stop tracking whose widgets belong to who and throw them all into a big pile, and when someone asks for their 20 widgets you give them a random 20 widgets. Now you realize that keeping all these widgets around is a massive waste of time and money since only about 1% of widgets are actually in use before being returned to the warehouse. So you tell your customers, "hey, I'm not going to bother actually keeping all the widgets, and I'm going to stop charging you to store your widget and instead I'll pay you to keep your widgets, if you store your widgets for a year I'll give you an coupon you can bring back to me at the end of the year and I'll give you all your widgets back plus 10% more". This system works great and everyone is happy, after a few decades the coupons for the widgets outnumber the widgets by a factor of 10,000. Now some asshole with a basic grasp of mathematics invents a computer program to manage widget coupons and it realizes that if it buys 1/10000th of the widget coupons and redeems them for widgets that no one else can actually redeem any other coupons. So your computer takes delivery of all the widgets in the world and then redeems one more widget coupon and everyone loses faith because the coupons for widgets no longer get you widgets and suddenly widget coupons are only worth 1/10000th of a widget. Suddenly everyone is mad at the guy with the computer and basic grasp of mathematics because their widget coupons only buy 1/10000th of a widget, and he's making bank selling everyone their widgets back. Is the cause of the devaluation of widget coupons the fault of the algorithm, or the fault of the system that allowed more coupons than there are widgets?
- steve8918 15y ago
  The 2010 flash crash was caused by "blackhat" HFT traders trying to game the system. It was shown that one, some, or many HFTs were involved in "quote stuffing" which is bidding for stock and then pulling the order, something like 100k times per second. This gave the appearance of liquidity and demand, but it was fake, because as soon as someone would bid for the stock, they would pull their order. But another use of this was to essentially slow down the "ticker tape" of the NYSE. What was happening was that the "ticker tape" that showed the current bids and asks was slowing down, and by doing this, some HFTs could make use of the latency arbitrage. Colocated HFTs got their quotes for the best bids and asks directly from the exchanges, but other people were getting their quotes from the NYSE, so they were behind. I believe they were something like 30 seconds behind, so what would happen is that the HFTs had full reign to take advantage of others being blinded like this. Of course, the side effect of this was that they "broke" the markets. Because of this latency, the NYSE suspended the markets temporarily, which then had the unintended consequence of forcing all the bids and asks to flow into the smaller exchanges, which didn't have the liquidity to handle the orders. There were so many sell orders, that basically all the buy orders for some stocks got taken out, causing the prices to plummet down to 1 cent or something like that. I'm expecting another flash crash to occur at some point, so whenever I see heated market action, I place a bunch of trades around 25% below the current stock price, which I believe is just above the limits that the exchanges would use to roll back bad trades. (Un)fortunately, it hasn't happened yet, but I'm sure at some point it will.
  - eru 15y ago
    I guess you aren't the only one who started putting in trades within a reasonable margin around the market price after the flash crash. Thus it will be hard to repeat like that. Perhaps a flash crash could happen in the other direction as well? I.e. flash boom, maybe by squeezing the shorters? In that case buying way out of money call options and putting in automatic orders to sell those options if the stock price goes 50% (or so) over last minute's market price would be a viable strategy?
    - steve8918 15y ago
      There was something similar to this in August 2007. A bunch of quant shops blew up, and I believe if you look at the volatility index, it spiked up hugely during this time. http://www.argentumlux.org/documents/august07b_2.pdf http://www.argentumlux.org/documents/august07b_2.pdf
- kevinpet 15y ago
  Nanex makes a good case that it was HFT that caused the flash crash. http://www.nanex.net/FlashCrashFinal/FlashCrashAnalysis_Theory.html http://www.nanex.net/FlashCrashFinal/FlashCrashAnalysis_Theo...
  - anamax 15y ago
    http://www.ritholtz.com/blog/2010/05/the-flash-crash-of-1962/ http://www.ritholtz.com/blog/2010/05/the-flash-crash-of-1962...
czDev 15y ago
by the way, the original article (now) opens with "Algorithmic trading, including high frequency trading (HFT)" and not "Algorithmic trading, also known as high frequency trading (HFT)"
eftpotrm 15y ago
From the article and other sources I've seen before, it seems that algorithmic trading is not necessarily high frequency, but that high frequency trading is necessarily algorithmic. In which case is this not a rather thin hair to split?
- pemulis 15y ago
  Not really. HFT is a subset of algorithmic trading, where many small orders are placed to take advantage of intraday (or intraminute, or even intrasecond) shifts in the spread. A large strategic order executed through an algorithm is a different creature altogether. The big problem when you place a huge buy or sell order is that it shifts the price in a direction you don't want it to go. For a large sell order, the price goes down, as the market becomes skittish about the security. For a large buy order, the price goes up, as the market becomes bullish and arbitrageurs quickly buy up securities to resell to you. So, many traders use algorithms to hide their trades. The purpose of these algorithms is to avoid volatility, so they shouldn't be dangerous to the market, as long as they're designed correctly. (Although, to be fair, algorithms may automatically stop trading when the market becomes too volatile, which contributes to flash crashes by reducing liquidity.)
  - dholowiski 15y ago
    "so they shouldn't be dangerous to the market, as long as they're designed correctly". Even if we accept the author's position, why would we also make the assumption that this software is designed properly and bug free?
    - shabble 15y ago
      I guess it depends on the stakes, and how well the traders understand (the risks of) software development to pay for the quality, testing, and maintenance. "This isn't just some human lives we're playing with, this is serious! It could cost us billions!"
    - anamax 15y ago
      > Even if we accept the author's position, why would we also make the assumption that this software is designed properly and bug free? Is the software less reliable than people? http://en.wikipedia.org/wiki/Barings_Bank http://en.wikipedia.org/wiki/Barings_Bank Note that the recent flash crash had about as much do with computers as a significantly worse "flash crash" in the mid/early 60s.
joshu 15y ago
execution and portfolio construction are separate things. you can do both algorithmically, or manually, or a mix.
littlegiantcap 15y ago
I'd argue that there's more good than bad about algorithmic trading. People making decisions based on fear and adrenaline is much more dangerous than setting a pre-determined course and sticking to a mathematical model. Besides, it's not like they just set up these programs and forget about them. If there's some sort of flaw in the algorithm the trader isn't just going to bang his head into the wall while he loses millions; he's going to fix the algorithm.
icandoitbetter 15y ago
This is wrong. Algorithmic trading can be fully automatic as well. It just doesn't need to operate on short time windows as HFT does.
jackgavigan 15y ago
Approx 99% of what is written about algo and high-freq trading is written by people who don't have a clue, have never worked in a trading environment (let alone actually traded) and think they're some kind of expert because they've read an article or two. Just remeber that the next time you read an article (or a comment about an article) on algo/high-freq trading.
T_S_ 15y ago
Accurate article? Yes I think so. Hairsplitting? A bit. Any content about the big picture? Afraid not. Algo trading has been around longer than HFT. It was invented to protect the information that that a big order was being executed. This avoided the risk of front running by handing the order to humans or scaring liquidity providers by executing it all at once. HFT came about when computerized exchanges began to compete with each other for business. Nowadays you go hunting for liquidity. Speed differentials are more important. I think the OP is likely to agree up until here. Today HFT in its worst form amounts to high speed computerized rumor mongering. You game the market by bluffing orders and trading faster than your customers. The regulators will never catch on and try to fix it even thought the remedies are many and simple. Moreover our attitudes about who owns information make it very difficult for us to even consider these simple solutions.
- reverend_gonzo 15y ago
  There are a massive number of HFT shops. Most of these are prop-shops rather than funds, as in they trade their own money and don't take investors. They are physically unable to front run their customers because they simply don't have customers. I will give you that there are some big banks getting into HFT now, and that's a different story, but a statement like "HFT in its worst form amounts to high speed computerized rumor mongering." is wildly inaccurate and shows a complete lack of understanding of the industry. Furthermore, there is a massive difference between algo trading and HFT. Technically speaking, yes, HFT falls under algo. However, HFT is about speed and making very little profit many times throughout the day, usually by providing liquidity. Algos on the other hand, especially things like high end models aren't meant for HFT because they take larger amounts of time to run (ie: backtesting). These are used (for example) to determine misprices in the market that will pay off heavily in the long term, or (as others have mentioned below) to buy/sell a large quantity of shares in a way that it won't move the market in the other direction, rather than make an immediate, albeit tiny, profit.
  - mcphilip 15y ago
    OP's misunderstanding of prop trading vs funds aside, I still think it can be argued that "HFT in its worst form amounts to high speed computerized rumor mongering". For instance, take a look at the Nanex article What is the Bid/Ask spread of this stock? [1]. Rumor mongering in this case being gaming the weakness of the NBBO. On a side note, I highly recommend reading through Nanex's Strange Days research section if HFT related market anomalies interests you at all [2]. [1]http://www.nanex.net/Research/bloodbot/bloodbot.html http://www.nanex.net/Research/bloodbot/bloodbot.html [2]http://www.nanex.net/FlashCrash/FlashCrashAnalysis.html http://www.nanex.net/FlashCrash/FlashCrashAnalysis.html
flourpower 15y ago
Isn't the claim that algorithmic trading will never replace human decision making basically equivalent to the claim that humans will never construct strong AI?
- eru 15y ago
  Yes. But replacing (or augmenting) just most trading instead of all trading requires less than strong AI.
Game_Ender 15y ago
Are there not hedge funds that attempt to use algorithms to spot longer term (ie. days, weeks, months) market trends and then buy and sell on that information? I think it's pretty crazy to say that humans will always make the decisions, computer can process more information faster then any human can. At some point computer programs will be able to make more accurate market predictions then humans, and at that point the "robots" really will be in control.
- eru 15y ago
  Though we still haven't reached the level where programs write themselves.
steve8918 15y ago
Absolutely terrible blog post. Saying algorithmic trading isn't HFT is like saying a bird isn't an ostrich. HFT is a subset of algorithmic trading. It's as simple as that. Not all algorithmic trading is HFT. But all HFT is algorithmic trading. Algorithmic trading is any type of trading done based on an algorithm, and not based on "traditional investing principles". For example, "buy when the 10-day moving average crosses over the 20-day MA, and sell when the 10-day it crosses below 20-day". One of the most famous types of this is Richard Dennis and the Turtle Traders, where a successful commodities trader took a bunch of ordinary people and tried to turn them into traders using this method. I'm also an algorithmic trader. Not a wildly successful algorithmic trader yet, but I'm still learning and growing, and I love it more than any programming venture I've ever been involved with. And I haven't taken a catastrophic loss yet, so that's good. I trade on 3 separate markets using different algorithms, and for the most part it is fully automated. I'll hold futures contracts anywhere from 1 seconds to 20 mins. HFT is several orders of magnitude more intense. For the most part, they are types of arbitrage, where they can arbitrage a few cents worth of difference in stock prices between different markets, and make a few pennies per 1000 shares. Or they will arbitrage between the price of an ETF or futures contract and the underlying basket of stocks that it represents. These are the ones that need colocation and trade on the millisecond. The more nefarious ones are the ones that game the system, by "quote stuffing", by frontrunning large orders by institutions, or by creating volatility through momentum-trading. Is there a downside to algorithmic trading? Sure. Algorithmic trading is what has turned the stock market from a predictive market of future earnings, into essentially a casino, where the predictive nature of the markets is completely dead. Instead, it's about thousands of computers running random number generators and picking up nickels every 10 ms. This is why I believe there will be market crashes every 7-10 years, and long term investing is dead. But unfortunately, this is the reality of the system that we live in, and we have to adapt or die. Or you can just buy bonds and get a stable 3-5% return every year, which is nothing to shake a stick at.
- eru 15y ago
  If nobody were investing long term any longer, wouldn't there be less money in the system, and thus it would be relatively cheap to buy and hold?
paperwork 15y ago
I always find it interesting how much vitriol there is against automated trading, even among programmers. Too many people seem to believe that a small number of, ultra resourceful, nefarious folks are using unfair means to "game the system." The truth, as usual, is less interesting. Doing this type of trading doesn't require millions of dollars and teams of PhDs. You don't have to know the right people and you don't have to know any secret handshakes. Critics of high frequency trading are almost always misinformed. Some of the most informed critiques I have read about this stuff are the following books: "A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation" by Bookstaber "Traders, Guns and Money: Knowns and unknowns in the dazzling world of derivatives" by Das And Nasim Taleb's work. ------- More to the point, the author is explaining something very basic (which journalists don't seem to understand): -Algorithmic trading is NOT a general term for all trading done with algorithms/computers. It refers to telling a computer to EXECUTE a specific trade. In other words, when your retirement fund decides to buy A LOT of AAPL, they naturally need to spread that trade over the whole day (or even several days). In the old days, human traders used to do it. Now it is mostly done by computer programs. This is different from the kind of trading where a computer decides WHAT to trade (NOT HOW to trade). This kind of trading involves so many different strategies that it is silly to lump them together. There seem to be other misconceptions: -The best and the brightest are working in Finance, instead of doing things more beneficial to society. A quant colleague of mine, who has a PhD in Physics from an Ivy League school told me that he, and many of his friends, left academia because there were simply no positions for them. -75% of trading is now automated, it is just computers trading with each other. I hope someone will correct me if I'm wrong but I have never figured out if this 75% includes algo trading. If it does include algo trading (my guess is that it does), then I'm surprised it is not 100%. That is like saying 95% of TV channels are controlled by remote-control devices. -People seem to think that wall-street traders make their money by "trading ahead" of mom & pop investors: your Dad buys 1000 shares of microsoft, a wily trader puts your dad's order on hold, buys it for himself, raises the price, sells his shares to your dad at a higher price...thereby making money off your dad. Your broker is not allowed to 'trade-ahead' of you. At least in the places where I have worked, this is taken very seriously. Interestingly, high frequency traders (who are most frequently accused of this) don't actually have access to customer order-flow. High frequency trading hedge funds don't generally have any client orders. Places where the two co-exist are forced to have seperation. Traders from one department cannot share information with the other. As more and more client facing firms (sell-side) become automated, the chance of them actually coding up such cheats is even dumber. Flash trading is often given as an example of people, in cahoots with exchanges, trading on others' order information. As far as I know, "flash" functionality exists to help clients trade more effectively. Large traders are VERY concerned about letting the whole market know that they are interested in some stock. Some exchanges offered the following functionality: if you are interested in buying a stock, you have the OPTION of giving other members of the exchange a chance to trade with you. If no one takes you up on the offer, then the order goes to the wider market. I have to admit that a laywer friend told me that he opposes this functionality at his firm. If someone _really_ needs to know more, I suppose I could ask him to explain. -High frequency traders trade so fast that mom & pop simply can't compete with them. Their computers/networks are just too fast and they can get closer to the exchanges than anyone else. High frequency traders are not competing with mom & pop, they are competing with market makers. If two people hear a news item, the one closer to the exchange will naturally get the trade done faster (presumably at a better price). The same is (generally) true of people on the East Coast vs rest of the country (let's assume US financial system). The same is true of people who can click their mouse faster. Besides, there is no moral reason your Mom should be able to dump her Enron stock faster than Joe Trader. etc., etc., etc. ------------- I should add that I am actually not at all comfortable with the role finance plays in world economy. I can't call myself a critic since being critical requires more complete understanding. I am specifically opposed to things like direct market access. This is where any Joe Blow can use an API to setup his trading system. If he accidently leaves an infinite loop in his code, he can cause real problem. I remember sweating bullets (and almost trembling) when my boss asked me to flip the switch on the trading system I wrote. In reality, there are at least some protections built in to keep this from happening. However, I would like to see more uniform, consistent and better advertised rules. I am also against the ability to trade by borrwing money from brokers (margin trading or leveraged trading). If an individual trader screws up, they wipe themselves out. If they borrowed money, then the consequences of their bad trades starts to seep out to others. If more than a handful of traders, trading on margin, go belly up, the lender could be in trouble as well...you can see how this could ripple across a system. Closely related to allowing trading on margin is reliance on models. Say you have calculated that two stocks always move together. You _and your lender_ are so sure of this correlation that they think of it as the truth. What if your calculations or your assumptions were wrong? The consequences of this mistake may not be linearly related to the risk you thought you took. Read Nasim Taleb's work on this for more. Finally, those who smell something fishy should broaden their concern beyond just modern trading system or even complex derivatives. I can see no principal, within the framework of free markets and individualism, which leads to condemnation of ever more automated and faster trading, more complex instruments and more dependence of finance. The best moral principal, I can think of, which opposes the current state of affairs, is the one uttered by Martin Sheen's character in the movie Wallstreet: "Create, instead of living off the buying and selling of others." Wallstreet 2 was a piece of shit.
seanos 15y ago
For those that are interested: Here is a video of an extremely interesting talk, entitled "Human Traders are an Endangered Species!", by Dave Cliff who's involved with the Foresight project: http://trading-gurus.com/human-traders-are-an-endangered-species/ http://trading-gurus.com/human-traders-are-an-endangered-spe... and more information on the Foresight project itself: http://www.bis.gov.uk/foresight/our-work/projects/current-projects/computer-trading http://www.bis.gov.uk/foresight/our-work/projects/current-pr...
known 15y ago
Why HFT is opposing Tobin tax?
- gaius 15y ago
  Perhaps a better question is why Tobin himself now opposes the Tobin tax?
drstrangevibes 15y ago
I think the author is actually wrong on this algo trading is defined as programs taking the decision, how fast this happens determines whether it is high frequency. Computer aided execution is called smart order routing..... just saying :)

140 points by jeffmiller 15y ago

For one who works with HFT systems, an extremely refreshing clarification. Though I do get a chuckle out of the extremely bombastic stories ("MAN OBSOLETE? COMPUTERS TAKING OVER!!!"), it's nice to see the record set straight. Sadly this will get 1/10000th of the page views of the garbage articles it dissects.

matthewcieplak 15y ago
Kill yourself.
- 0x12 15y ago
  That was entirely uncalled for and not one bit in line with the general level of conversation here.
- drivebyacct2 15y ago
  Even if you must insist on being so wildly rude, couldn't you at least offer up some substantiation for your anger, something with a hope of a discussion?

joezydeco 15y ago

In your opinion, Jeff, was the 2010 Flash Crash the work of HFT, or Algo trading? Maybe both?

fleitz 15y ago
I'm not Jeff but perhaps I can provide some insight into the flash crash. Also, what IS algo trading? Is a margin call algo trading? Is a stop loss algo trading? What about technical analysis? (Flash) crashes should be expected anytime you over leverage your entire economy. See: George Soros and the pound. Imagine everyone you know has widgets, and you realize that most people like to keep their widgets in a warehouse. You setup a warehouse that stores widgets and people pay you to store their widgets. Everyone loves it, no more widgets around the house cluttering things up. Now since the widgets are identical and interchangeable you stop tracking whose widgets belong to who and throw them all into a big pile, and when someone asks for their 20 widgets you give them a random 20 widgets. Now you realize that keeping all these widgets around is a massive waste of time and money since only about 1% of widgets are actually in use before being returned to the warehouse. So you tell your customers, "hey, I'm not going to bother actually keeping all the widgets, and I'm going to stop charging you to store your widget and instead I'll pay you to keep your widgets, if you store your widgets for a year I'll give you an coupon you can bring back to me at the end of the year and I'll give you all your widgets back plus 10% more". This system works great and everyone is happy, after a few decades the coupons for the widgets outnumber the widgets by a factor of 10,000. Now some asshole with a basic grasp of mathematics invents a computer program to manage widget coupons and it realizes that if it buys 1/10000th of the widget coupons and redeems them for widgets that no one else can actually redeem any other coupons. So your computer takes delivery of all the widgets in the world and then redeems one more widget coupon and everyone loses faith because the coupons for widgets no longer get you widgets and suddenly widget coupons are only worth 1/10000th of a widget. Suddenly everyone is mad at the guy with the computer and basic grasp of mathematics because their widget coupons only buy 1/10000th of a widget, and he's making bank selling everyone their widgets back. Is the cause of the devaluation of widget coupons the fault of the algorithm, or the fault of the system that allowed more coupons than there are widgets?
steve8918 15y ago
The 2010 flash crash was caused by "blackhat" HFT traders trying to game the system. It was shown that one, some, or many HFTs were involved in "quote stuffing" which is bidding for stock and then pulling the order, something like 100k times per second. This gave the appearance of liquidity and demand, but it was fake, because as soon as someone would bid for the stock, they would pull their order. But another use of this was to essentially slow down the "ticker tape" of the NYSE. What was happening was that the "ticker tape" that showed the current bids and asks was slowing down, and by doing this, some HFTs could make use of the latency arbitrage. Colocated HFTs got their quotes for the best bids and asks directly from the exchanges, but other people were getting their quotes from the NYSE, so they were behind. I believe they were something like 30 seconds behind, so what would happen is that the HFTs had full reign to take advantage of others being blinded like this. Of course, the side effect of this was that they "broke" the markets. Because of this latency, the NYSE suspended the markets temporarily, which then had the unintended consequence of forcing all the bids and asks to flow into the smaller exchanges, which didn't have the liquidity to handle the orders. There were so many sell orders, that basically all the buy orders for some stocks got taken out, causing the prices to plummet down to 1 cent or something like that. I'm expecting another flash crash to occur at some point, so whenever I see heated market action, I place a bunch of trades around 25% below the current stock price, which I believe is just above the limits that the exchanges would use to roll back bad trades. (Un)fortunately, it hasn't happened yet, but I'm sure at some point it will.
- eru 15y ago
  I guess you aren't the only one who started putting in trades within a reasonable margin around the market price after the flash crash. Thus it will be hard to repeat like that. Perhaps a flash crash could happen in the other direction as well? I.e. flash boom, maybe by squeezing the shorters? In that case buying way out of money call options and putting in automatic orders to sell those options if the stock price goes 50% (or so) over last minute's market price would be a viable strategy?
  - steve8918 15y ago
    There was something similar to this in August 2007. A bunch of quant shops blew up, and I believe if you look at the volatility index, it spiked up hugely during this time. http://www.argentumlux.org/documents/august07b_2.pdf http://www.argentumlux.org/documents/august07b_2.pdf
kevinpet 15y ago
Nanex makes a good case that it was HFT that caused the flash crash. http://www.nanex.net/FlashCrashFinal/FlashCrashAnalysis_Theory.html http://www.nanex.net/FlashCrashFinal/FlashCrashAnalysis_Theo...
- anamax 15y ago
  http://www.ritholtz.com/blog/2010/05/the-flash-crash-of-1962/ http://www.ritholtz.com/blog/2010/05/the-flash-crash-of-1962...

czDev 15y ago

by the way, the original article (now) opens with "Algorithmic trading, including high frequency trading (HFT)" and not "Algorithmic trading, also known as high frequency trading (HFT)"

eftpotrm 15y ago

From the article and other sources I've seen before, it seems that algorithmic trading is not necessarily high frequency, but that high frequency trading is necessarily algorithmic. In which case is this not a rather thin hair to split?

pemulis 15y ago
Not really. HFT is a subset of algorithmic trading, where many small orders are placed to take advantage of intraday (or intraminute, or even intrasecond) shifts in the spread. A large strategic order executed through an algorithm is a different creature altogether. The big problem when you place a huge buy or sell order is that it shifts the price in a direction you don't want it to go. For a large sell order, the price goes down, as the market becomes skittish about the security. For a large buy order, the price goes up, as the market becomes bullish and arbitrageurs quickly buy up securities to resell to you. So, many traders use algorithms to hide their trades. The purpose of these algorithms is to avoid volatility, so they shouldn't be dangerous to the market, as long as they're designed correctly. (Although, to be fair, algorithms may automatically stop trading when the market becomes too volatile, which contributes to flash crashes by reducing liquidity.)
- dholowiski 15y ago
  "so they shouldn't be dangerous to the market, as long as they're designed correctly". Even if we accept the author's position, why would we also make the assumption that this software is designed properly and bug free?
  - shabble 15y ago
    I guess it depends on the stakes, and how well the traders understand (the risks of) software development to pay for the quality, testing, and maintenance. "This isn't just some human lives we're playing with, this is serious! It could cost us billions!"
  - anamax 15y ago
    > Even if we accept the author's position, why would we also make the assumption that this software is designed properly and bug free? Is the software less reliable than people? http://en.wikipedia.org/wiki/Barings_Bank http://en.wikipedia.org/wiki/Barings_Bank Note that the recent flash crash had about as much do with computers as a significantly worse "flash crash" in the mid/early 60s.

joshu 15y ago

execution and portfolio construction are separate things. you can do both algorithmically, or manually, or a mix.

littlegiantcap 15y ago

I'd argue that there's more good than bad about algorithmic trading. People making decisions based on fear and adrenaline is much more dangerous than setting a pre-determined course and sticking to a mathematical model. Besides, it's not like they just set up these programs and forget about them. If there's some sort of flaw in the algorithm the trader isn't just going to bang his head into the wall while he loses millions; he's going to fix the algorithm.

icandoitbetter 15y ago

This is wrong. Algorithmic trading can be fully automatic as well. It just doesn't need to operate on short time windows as HFT does.

jackgavigan 15y ago

Approx 99% of what is written about algo and high-freq trading is written by people who don't have a clue, have never worked in a trading environment (let alone actually traded) and think they're some kind of expert because they've read an article or two. Just remeber that the next time you read an article (or a comment about an article) on algo/high-freq trading.

T_S_ 15y ago

Accurate article? Yes I think so. Hairsplitting? A bit. Any content about the big picture? Afraid not. Algo trading has been around longer than HFT. It was invented to protect the information that that a big order was being executed. This avoided the risk of front running by handing the order to humans or scaring liquidity providers by executing it all at once. HFT came about when computerized exchanges began to compete with each other for business. Nowadays you go hunting for liquidity. Speed differentials are more important. I think the OP is likely to agree up until here. Today HFT in its worst form amounts to high speed computerized rumor mongering. You game the market by bluffing orders and trading faster than your customers. The regulators will never catch on and try to fix it even thought the remedies are many and simple. Moreover our attitudes about who owns information make it very difficult for us to even consider these simple solutions.

reverend_gonzo 15y ago
There are a massive number of HFT shops. Most of these are prop-shops rather than funds, as in they trade their own money and don't take investors. They are physically unable to front run their customers because they simply don't have customers. I will give you that there are some big banks getting into HFT now, and that's a different story, but a statement like "HFT in its worst form amounts to high speed computerized rumor mongering." is wildly inaccurate and shows a complete lack of understanding of the industry. Furthermore, there is a massive difference between algo trading and HFT. Technically speaking, yes, HFT falls under algo. However, HFT is about speed and making very little profit many times throughout the day, usually by providing liquidity. Algos on the other hand, especially things like high end models aren't meant for HFT because they take larger amounts of time to run (ie: backtesting). These are used (for example) to determine misprices in the market that will pay off heavily in the long term, or (as others have mentioned below) to buy/sell a large quantity of shares in a way that it won't move the market in the other direction, rather than make an immediate, albeit tiny, profit.
- mcphilip 15y ago
  OP's misunderstanding of prop trading vs funds aside, I still think it can be argued that "HFT in its worst form amounts to high speed computerized rumor mongering". For instance, take a look at the Nanex article What is the Bid/Ask spread of this stock? [1]. Rumor mongering in this case being gaming the weakness of the NBBO. On a side note, I highly recommend reading through Nanex's Strange Days research section if HFT related market anomalies interests you at all [2]. [1]http://www.nanex.net/Research/bloodbot/bloodbot.html http://www.nanex.net/Research/bloodbot/bloodbot.html [2]http://www.nanex.net/FlashCrash/FlashCrashAnalysis.html http://www.nanex.net/FlashCrash/FlashCrashAnalysis.html

flourpower 15y ago

Isn't the claim that algorithmic trading will never replace human decision making basically equivalent to the claim that humans will never construct strong AI?

eru 15y ago
Yes. But replacing (or augmenting) just most trading instead of all trading requires less than strong AI.

Game_Ender 15y ago

Are there not hedge funds that attempt to use algorithms to spot longer term (ie. days, weeks, months) market trends and then buy and sell on that information? I think it's pretty crazy to say that humans will always make the decisions, computer can process more information faster then any human can. At some point computer programs will be able to make more accurate market predictions then humans, and at that point the "robots" really will be in control.

eru 15y ago
Though we still haven't reached the level where programs write themselves.

steve8918 15y ago

Absolutely terrible blog post. Saying algorithmic trading isn't HFT is like saying a bird isn't an ostrich. HFT is a subset of algorithmic trading. It's as simple as that. Not all algorithmic trading is HFT. But all HFT is algorithmic trading. Algorithmic trading is any type of trading done based on an algorithm, and not based on "traditional investing principles". For example, "buy when the 10-day moving average crosses over the 20-day MA, and sell when the 10-day it crosses below 20-day". One of the most famous types of this is Richard Dennis and the Turtle Traders, where a successful commodities trader took a bunch of ordinary people and tried to turn them into traders using this method. I'm also an algorithmic trader. Not a wildly successful algorithmic trader yet, but I'm still learning and growing, and I love it more than any programming venture I've ever been involved with. And I haven't taken a catastrophic loss yet, so that's good. I trade on 3 separate markets using different algorithms, and for the most part it is fully automated. I'll hold futures contracts anywhere from 1 seconds to 20 mins. HFT is several orders of magnitude more intense. For the most part, they are types of arbitrage, where they can arbitrage a few cents worth of difference in stock prices between different markets, and make a few pennies per 1000 shares. Or they will arbitrage between the price of an ETF or futures contract and the underlying basket of stocks that it represents. These are the ones that need colocation and trade on the millisecond. The more nefarious ones are the ones that game the system, by "quote stuffing", by frontrunning large orders by institutions, or by creating volatility through momentum-trading. Is there a downside to algorithmic trading? Sure. Algorithmic trading is what has turned the stock market from a predictive market of future earnings, into essentially a casino, where the predictive nature of the markets is completely dead. Instead, it's about thousands of computers running random number generators and picking up nickels every 10 ms. This is why I believe there will be market crashes every 7-10 years, and long term investing is dead. But unfortunately, this is the reality of the system that we live in, and we have to adapt or die. Or you can just buy bonds and get a stable 3-5% return every year, which is nothing to shake a stick at.

eru 15y ago
If nobody were investing long term any longer, wouldn't there be less money in the system, and thus it would be relatively cheap to buy and hold?

paperwork 15y ago

I always find it interesting how much vitriol there is against automated trading, even among programmers. Too many people seem to believe that a small number of, ultra resourceful, nefarious folks are using unfair means to "game the system." The truth, as usual, is less interesting. Doing this type of trading doesn't require millions of dollars and teams of PhDs. You don't have to know the right people and you don't have to know any secret handshakes. Critics of high frequency trading are almost always misinformed. Some of the most informed critiques I have read about this stuff are the following books: "A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation" by Bookstaber "Traders, Guns and Money: Knowns and unknowns in the dazzling world of derivatives" by Das And Nasim Taleb's work. ------- More to the point, the author is explaining something very basic (which journalists don't seem to understand): -Algorithmic trading is NOT a general term for all trading done with algorithms/computers. It refers to telling a computer to EXECUTE a specific trade. In other words, when your retirement fund decides to buy A LOT of AAPL, they naturally need to spread that trade over the whole day (or even several days). In the old days, human traders used to do it. Now it is mostly done by computer programs. This is different from the kind of trading where a computer decides WHAT to trade (NOT HOW to trade). This kind of trading involves so many different strategies that it is silly to lump them together. There seem to be other misconceptions: -The best and the brightest are working in Finance, instead of doing things more beneficial to society. A quant colleague of mine, who has a PhD in Physics from an Ivy League school told me that he, and many of his friends, left academia because there were simply no positions for them. -75% of trading is now automated, it is just computers trading with each other. I hope someone will correct me if I'm wrong but I have never figured out if this 75% includes algo trading. If it does include algo trading (my guess is that it does), then I'm surprised it is not 100%. That is like saying 95% of TV channels are controlled by remote-control devices. -People seem to think that wall-street traders make their money by "trading ahead" of mom & pop investors: your Dad buys 1000 shares of microsoft, a wily trader puts your dad's order on hold, buys it for himself, raises the price, sells his shares to your dad at a higher price...thereby making money off your dad. Your broker is not allowed to 'trade-ahead' of you. At least in the places where I have worked, this is taken very seriously. Interestingly, high frequency traders (who are most frequently accused of this) don't actually have access to customer order-flow. High frequency trading hedge funds don't generally have any client orders. Places where the two co-exist are forced to have seperation. Traders from one department cannot share information with the other. As more and more client facing firms (sell-side) become automated, the chance of them actually coding up such cheats is even dumber. Flash trading is often given as an example of people, in cahoots with exchanges, trading on others' order information. As far as I know, "flash" functionality exists to help clients trade more effectively. Large traders are VERY concerned about letting the whole market know that they are interested in some stock. Some exchanges offered the following functionality: if you are interested in buying a stock, you have the OPTION of giving other members of the exchange a chance to trade with you. If no one takes you up on the offer, then the order goes to the wider market. I have to admit that a laywer friend told me that he opposes this functionality at his firm. If someone _really_ needs to know more, I suppose I could ask him to explain. -High frequency traders trade so fast that mom & pop simply can't compete with them. Their computers/networks are just too fast and they can get closer to the exchanges than anyone else. High frequency traders are not competing with mom & pop, they are competing with market makers. If two people hear a news item, the one closer to the exchange will naturally get the trade done faster (presumably at a better price). The same is (generally) true of people on the East Coast vs rest of the country (let's assume US financial system). The same is true of people who can click their mouse faster. Besides, there is no moral reason your Mom should be able to dump her Enron stock faster than Joe Trader. etc., etc., etc. ------------- I should add that I am actually not at all comfortable with the role finance plays in world economy. I can't call myself a critic since being critical requires more complete understanding. I am specifically opposed to things like direct market access. This is where any Joe Blow can use an API to setup his trading system. If he accidently leaves an infinite loop in his code, he can cause real problem. I remember sweating bullets (and almost trembling) when my boss asked me to flip the switch on the trading system I wrote. In reality, there are at least some protections built in to keep this from happening. However, I would like to see more uniform, consistent and better advertised rules. I am also against the ability to trade by borrwing money from brokers (margin trading or leveraged trading). If an individual trader screws up, they wipe themselves out. If they borrowed money, then the consequences of their bad trades starts to seep out to others. If more than a handful of traders, trading on margin, go belly up, the lender could be in trouble as well...you can see how this could ripple across a system. Closely related to allowing trading on margin is reliance on models. Say you have calculated that two stocks always move together. You _and your lender_ are so sure of this correlation that they think of it as the truth. What if your calculations or your assumptions were wrong? The consequences of this mistake may not be linearly related to the risk you thought you took. Read Nasim Taleb's work on this for more. Finally, those who smell something fishy should broaden their concern beyond just modern trading system or even complex derivatives. I can see no principal, within the framework of free markets and individualism, which leads to condemnation of ever more automated and faster trading, more complex instruments and more dependence of finance. The best moral principal, I can think of, which opposes the current state of affairs, is the one uttered by Martin Sheen's character in the movie Wallstreet: "Create, instead of living off the buying and selling of others." Wallstreet 2 was a piece of shit.

seanos 15y ago

For those that are interested: Here is a video of an extremely interesting talk, entitled "Human Traders are an Endangered Species!", by Dave Cliff who's involved with the Foresight project: http://trading-gurus.com/human-traders-are-an-endangered-species/ http://trading-gurus.com/human-traders-are-an-endangered-spe... and more information on the Foresight project itself: http://www.bis.gov.uk/foresight/our-work/projects/current-projects/computer-trading http://www.bis.gov.uk/foresight/our-work/projects/current-pr...

known 15y ago

Why HFT is opposing Tobin tax?

gaius 15y ago
Perhaps a better question is why Tobin himself now opposes the Tobin tax?

drstrangevibes 15y ago

I think the author is actually wrong on this algo trading is defined as programs taking the decision, how fast this happens determines whether it is high frequency. Computer aided execution is called smart order routing..... just saying :)