Which brings us to the next question: What is the social benefit of a slightly smaller bid-ask spread and a few milliseconds of faster liquidity? And are these benefits worth the massive amount of wealth extraction from the rest of us that HFTers are engaged in?
> And are these benefits worth the massive amount of wealth extraction from the rest of us that HFTers are engaged in?
Unless you were a specialist market maker or pit trader on an exchange there hasn't been any "wealth extraction". Quite the opposite, HFT has taken a system built on being tall, having good connections, and understanding an arcane set of hand signals (not to mention very high fees) and replaced it with a ruthlessly efficient automated system based on being good at writing software and planning network setups (and brought the fees down with it).
For the vast majority of market participants HFT has been a massive upgrade over the old system and dramatically lowered the cost of trading.
That's pretty simple to answer. The smaller the spread, the less going into the pocket of middlemen. Which is where we are now. Less going into the pockets of middlemen than ever before.
>And are these benefits worth the massive amount of wealth extraction
What "massive amount of wealth extraction"? Are you just making shit up?
Middlemen have always existed in markets. The middlemen have changed, but as you rightly point out, they now take SIGNIFICANTLY LESS than they used to because competition has forced spreads down to next to nothing. You pick: pay a 0.30 spread on a NYSE listed stock or a 0.01. It's sort of a no-brainer.
The thing that most people seem to be upset about is that now market makers generally have few to no obligations to provide liquidity and they are drastically smarter than they used to be.
Ultimately, unless you are slinging enormous blocks, if you send a marketable order through a retail broker these days you are almost always going to get a better fill than the displayed market. Likewise, if you are a large trader you have to be more sophisticated about how you fill your orders, you can't just lift 100k shares even when 300k are displayed unless you do so with a semi-intelligent execution algo (note: these are everywhere these days, and not using one brings into question the trader/brokers abilities and whether they are even qualified to be in the market).
If HFT lets Vanguard lower their costs, the savings of which are passed on to their customers, that's more money in the retirement accounts of regular people.
I just got an email that the expense ratio of my Vanguard target date fund is going down, so costs were reduced somewhere.
The total peak profit of HFT companies is usually estimated a bit north of 5 billion Dollar in 2009. After that it fell to about 1 billion Dollar per year as far as I can tell. For me 5 billion Dollar or even only 1 billion Dollar per year seems quite a lot for not producing a single salable good and service. The 2009 profit was the equivalent of 175,000 average yearly US incomes, i.e. 175,000 people worked somewhere on factory floors to produce the profits for HFT companies.
The comment I replied to questioned that any significant amount of wealth gets redistributed by HFT. For that it does not really matter whether it is an improvement over the previous situation or not. It is still a non-negligible amount of money for a service with questionable value.
You can't buy or sell stocks without trading with someone else. HFTs give you a lower price when you do that (otherwise people wouldn't trade with them). To the extent that they're redistributing wealth, they're redistributing what would have previously gone to a traditional market-maker, partly to themselves and partly to the person making the order.
I mean, if a supermarket sells strawberries for cheaper than your local greengrocer, is that "a non-negligible amount of money for a service with questionable value"? It seems to me that the onus there isn't on the supermarket to show that strawberries are worth the price.
What "wealth" HFT has transferred flowed from a specialist system that was crooked as a garden hose full of fish hooks, through the big investment bank system that consolidated them, all of it taken out of the hides of retail and value investors.
Because automated market making is intensely competitive, the vast majority of that "wealth" was transferred... wait for it... to retail and value investors.
The initial comment asked for the benefits of HFT. All that comes up is that it improves the performance of markets. If you need economic growth it is a good thing to have efficient markets, incentives to invest and be rewarded with a share of the growth you enabled with your investment. But without the need for economic growth it just becomes transferring wealth from the workers to the usually already well-off investors increasing wealth inequality.
I would not say that capitalism is bad per se. It is pretty good at what it does and I find it hard to imagine that we could have made the economic growth and reached today's level of wealth without capitalism. But it has its flaws and I see no way it is sustainable for much longer. And instead of recognizing that we can not grow forever and seek for a transformation to something more sustainable it seems to me we are pushing capitalism to its ultimate limits. Not stopping until hitting a brick wall. HFT seems an iconic example of that to me.
You might also google stories about market makers not answering their phones during times of high volatility. There is this strange obsession over "how it used to be", as if it was better having people in the mix matching orders and providing that liquidity. The fact of the matter is, those people were as deeply flawed as any algorithm. The major difference today is that there is significant competition to provide liquidity in US equities markets and that liquidity can be extracted ON DEMAND by any trader.
Did you know, in the past it was NOT POSSIBLE for you to post a limit order and have it displayed in the order book unless you were an anointed market maker on an exchange?
[edit: this was meant as a reply to gdl not tptacek]
Does anyone big not do that, in practice? Are there big time-insensitive fundamentals traders who will rest an order outside the spread for hours or days until it gets hit? (in practice if you wanted to do that maybe you'd just only trade in the day-open auction, where there's no maker-taker?) I understand that it's theoretically an option, just interested to know whether people do that in practice.
Not very much. If you are big, you want big fills. You need market makers for that - i.e., you need what HFT's are selling and would be worse off without them.
Of course if you are time insensitive, you can certainly play games. This basically means running your own HFT strategy, but biased in the direction of the trade you want. You'll also opportunistically take liquidity if the fill you want is in the book.
Standard PSA about "Flash Boys". If you are interested in HFT you are better off quite literally not reading that book than reading it. It is very biased and largely inaccurate.
If you want to read narrative non-fiction about HFT, "Dark Pools" by Patterson, which also has its mistakes, is much better.
There are several books which speak about HFT at a high level. If you are curious about the actual mechanics of stock exchanges and (a bit about) how various parties make their money, I wrote a bit about it at http://falconair.github.io/2015/01/05/financial-exchange.htm...
