At the point of IPO the capital for a company has already typically been allocated. The financial markets allow the owners of a company to sell their shares to the public and realize profits on their prior investments. After that markets are about betting whether the price of the company will go up or down and people trade accordingly.
The need to trade instantly is very important for risk mitigation. If unexpected news comes out today that a company is the target of an adverse event like a DOJ lawsuit many market participants will want to react as fast as possible to the news. Say it takes 30 seconds for the price to fall by $10. If you could trade at the 15 second mark you would only lose $5. To an investment firm (non Market Maker or other HFT) this can be crucially important and many firms have automated systems of their own to trade.
A key point of the article that most people miss is that someone has always fulfilled the role that HFTs currently occupy. In the old days floor traders occupied this role as pointed out by the article. Floor trading was a club where you had to buy a seat to be allowed in. Depending on the market the cost of the seat might be hundreds of thousands of dollars. The traders controlled access to the markets and for some markets like Oil the only way to trade was through these floor traders. Now these floor traders took full advantage of this and kept the spreads on the instruments they traded much wider than they are today. In the early 90s you could easily pay $.20 per share to the market maker to get a fill on a liquid stock.
The realization (as pointed out by the article) that computers could do this better and faster is just like any other industry. The people most hurt by this development were the floor traders themselves. There is a movie called The Pit that explores the effect that computerized trading had on floor traders in Chicago. Today if I want to trade MSFT the spread on BATS's BZX exchange was just $0.01. To me, another market participant I consider it to be much better to pay a penny to Getco rather than $.20 to a floor trader.
The colocation business as it has evolved has made market access more equal, not less. Today anyone can pay to colocate a server at NASDAQ, NYSE, BATS, etc... I know longer have to buy a floor seat to be able to trade there. Now there are real market barriers to entry but they are not structural. Just as you can't go build a Google competitor given that you don't have all the historical search traffic data and the infrastructure to compete with them, HFT firms have made significant investments in infrastructure of their own. If you had sufficient capital for technology development you could compete with any other HFT firm.
Yes there are people hurt by HFT, just like anything else when new players with greater efficiency emerge. However the average investor who is not competing with these firms is not harmed. The floor traders were, just like telephone operators before them.
The need to trade instantly is very important for risk mitigation. If unexpected news comes out today that a company is the target of an adverse event like a DOJ lawsuit many market participants will want to react as fast as possible to the news. Say it takes 30 seconds for the price to fall by $10. If you could trade at the 15 second mark you would only lose $5.
This type of risk mitigation is important to whom, exactly? When the type of unexpected news you mention comes in, somebody is going to take a hit, yes. Who should take that hit? What are the criteria according to which you make that decision in the first place?
In the scenario you outline, say the price falls by $10, somebody is going to take that loss no matter what. Without rapid trade, the original holder of the paper is probably going to take the full loss. In your scenario with rapid trade, they found some "fool" who was prepared to buy the paper at an intermediate price, and so the original owner lost less. So from the perspective of the original owner that is certainly a benefit. But is it a benefit for society? That is an entirely different question.
One could argue that the only reason they lost less is that they were faster in reacting to a certain piece of news, on a timescale of minutes, which is entirely irrelevant to the real economy.
Your point about HFT replacing floor trading is a valid point, but all it really proves is that barriers to entry into the market must be low. There is nothing inherent requiring high frequency trading. The job could just as well be done by lower frequency algorithmic trading, with a matching algorithm that runs on e.g. a 5 minute heartbeat.
Yes, the spreads are going to be bigger. Then again, intraday movements dominate spreads by orders of magnitude anyway, so from the perspective of the real economy, why should I care about how small the spreads are?
What you are really proposing here is to take away competition from the market. This would mean that you need another way of assigning the winner(buyer or seller, in case there are multiple ones wanting to buy the same stock); Some ways of doing it: randomly, alphabetically, shoe size, networth etc. You get the drift... The question is, will it be fair?
In capitalist systems winners are assigned based on open and fair competition, but then again there are other political views and systems.
I think this is the important point and one that seems to be lost on a lot of traders: Yes, what you are talking about is logical, but we as a society have the right to say: No, this is not beneficial to everybody.
The way many traders argue, they seem to have little shame saying that they want the system to give them a hand when they have made a bad decision.
> If unexpected news comes out today that a company is the target of an adverse event like a DOJ lawsuit many market participants will want to react as fast as possible to the news.
No, I think the first thing you want to do is kick yourself in the butt for investing in a company that went down like this. If you invest in an oil company and it has a huge spill, the stock will go down and you will lose money. Don't like that? Don't invest in oil companies with a lousy safety record. Or invest yourself in making sure that the company that you gave your precious liquidity doesn't mess it up.
I would further claim that there are very few truly "unexpected" news. Traders are just a little too much in love with not really caring about what they invest in. At least not as much as they are in love with the money they make or the image that they are the "market makers" who provide the liquidity that we all need.
A DOJ lawsuit happens for a reason. Oil spills happen for a reason. If you have made a bet, you are the one who has to provide reasons for your bet. I cannot believe there are that many people who argue they should be able to rip off as many people as possible once their bet has gone sour. That the one thing they really need is to be able to rip others off as fast as possible. And that all this is somehow reasonable and useful.
I understand nobody really likes being the loser, but that's how capitalism works - filtering out the bad apples by having them go down in flames. Well, that's what it's supposed to be like, anyways.
Capitalist competition is inherently wasteful - advertising, lawsuits etc. - but overall it allocates resources more efficiently than any alternative that's been tried.
Speaking as a software developer at one of the exchanges, I thought these comments were accurate and insightful. A lot of people think that colocation is inherently unfair, but they don't realize what a huge improvement this is over the old system of a limited number of floor traders.
One slight correction: I think the movie about floor traders in Chicago is called "Floored". There is another another movie about floor traders in NY called "The Pit".
The need to trade instantly is very important for risk mitigation. If unexpected news comes out today that a company is the target of an adverse event like a DOJ lawsuit many market participants will want to react as fast as possible to the news. Say it takes 30 seconds for the price to fall by $10. If you could trade at the 15 second mark you would only lose $5. To an investment firm (non Market Maker or other HFT) this can be crucially important and many firms have automated systems of their own to trade.
A key point of the article that most people miss is that someone has always fulfilled the role that HFTs currently occupy. In the old days floor traders occupied this role as pointed out by the article. Floor trading was a club where you had to buy a seat to be allowed in. Depending on the market the cost of the seat might be hundreds of thousands of dollars. The traders controlled access to the markets and for some markets like Oil the only way to trade was through these floor traders. Now these floor traders took full advantage of this and kept the spreads on the instruments they traded much wider than they are today. In the early 90s you could easily pay $.20 per share to the market maker to get a fill on a liquid stock.
The realization (as pointed out by the article) that computers could do this better and faster is just like any other industry. The people most hurt by this development were the floor traders themselves. There is a movie called The Pit that explores the effect that computerized trading had on floor traders in Chicago. Today if I want to trade MSFT the spread on BATS's BZX exchange was just $0.01. To me, another market participant I consider it to be much better to pay a penny to Getco rather than $.20 to a floor trader.
The colocation business as it has evolved has made market access more equal, not less. Today anyone can pay to colocate a server at NASDAQ, NYSE, BATS, etc... I know longer have to buy a floor seat to be able to trade there. Now there are real market barriers to entry but they are not structural. Just as you can't go build a Google competitor given that you don't have all the historical search traffic data and the infrastructure to compete with them, HFT firms have made significant investments in infrastructure of their own. If you had sufficient capital for technology development you could compete with any other HFT firm.
Yes there are people hurt by HFT, just like anything else when new players with greater efficiency emerge. However the average investor who is not competing with these firms is not harmed. The floor traders were, just like telephone operators before them.