A detailed exposé on how the market is rigged from a data-centric approach

You cannot defend frontrunning of a market.<p>If I ask for X at Y. Someone else shouldn&#x27;t have the facility to buy it based on my own trade signal and try sell it back to me.<p>It is mindblowingly simple theft. The arguments for liquidity do not hold. There is some fascinating cognitive dissonance when it comes to the HFT industry.

Say there are three exchanges, A, B, C, each with 1k shares of Ford on offer at $20. They are all random numbers of ms away from me, and for simplicity say A is closest and C is farthest. I send out my order for 3k shares at $20, and it hits A then B then C. People who are watching A see my request, and try to make adversarial changes on B and C. They have a low chance of success on B because it&#x27;s almost as close to me as A is, but they have a higher chance on C because it&#x27;s pretty far from me.<p>One way to fix this is to delay your orders carefully so that A, B, and C will all get your order at almost the same time. Now there&#x27;s not time for someone who sees your order on A to react and send a message to C that will beat your message to C.<p>I believe this is what IEX does: <a href="http://en.wikipedia.org/wiki/IEX" rel="nofollow">http:&#x2F;&#x2F;en.wikipedia.org&#x2F;wiki&#x2F;IEX</a>

A solution: Discrete double auctions. Instead of continuous trading, the exchange can divide up the day into a series of small windows (say 100ms). When you come to trade in the market, you have to wait for the next window to open. You submit your order and you find out what happened at the end of the window. This way nobody has any timing advantage and the delay is barely noticeable to &#x27;normal&#x27; traders (waiting 1&#x2F;5 of a second is hardly an inconvenience). It also stops all the order-book shenanigans that HFT players get up to (where they stuff the book with orders and cancel&#x2F;resubmit them at high frequency).<p>So why don&#x27;t exchanges do this? They make a ton of money in fees, it simply isn&#x27;t in their interest to prevent HFT at the moment. Change their incentives (ie. regulate differently) and they might actually do something about it.

If you offer something for sale at a certain price and someone says &quot;I&#x27;ll buy it!&quot; you have a contract at that moment.<p>I don&#x27;t fully understand the conditions under which you can cancel an order but it seems all the cancellations happened on exchanges where no orders had yet been fulfilled so I assume this means that the order had not yet arrived. This seems ethically just about OK to me but a sign that there is not one single stockmarket and that the system could be far better designed.<p>There is the single front-running trade which is suspicious but it seems plausible (unless it happens every time) that it was just a small random trade that happened to coincide with the timing of the big trade. It should be monitored though.<p>My conclusions:<p>1. There is not one single market with a number of available shares but a number of linked markets. Send your trade to a single exchange (first at least) with enough offered shares that it should execute before offers can be cancelled. Wait, repeat.<p>2. Much of the liquidity supposedly offered by HFT is illusory and disappears if you try to use it.<p>I think that the market could probably be improved if cancellation weren&#x27;t free or at least weren&#x27;t instant. If cancellations took a second (maybe 100ms or 10ms would be enough) to process and the offers could still be accepted in that period the offers made would be more serious and although the spread might be slightly larger it would more honestly reflect reality.

What is happening here is really quite simple, and doesn&#x27;t deserve an entire blog post.<p>There are two exchanges, A and B, and a market maker Jill is quoting (say) 10,000 shares on each of those two exchanges for $17.<p>Big institutional trader Jack sees the 20,000 shares and decides that he wants to buy 15,000 of them, so he sends two orders for 7,500 shares each to A and B. Because of various effects (network latencies, routing switching delays, whatever) his order arrives at exchange A first, and is immediately filled at $17.<p>Jill, who has her computer co-located at exchange A, sees that she has sold 7,500 shares for $17, and realizes that there is demand for shares. Because of this demand, she decides to raise her prices. She immediately cancels her remaining 2500 shares on exchange A and replaces them with 10,000 shares at $17.05 and sends an instruction to do the same thing at exchange B.<p>Because Jill has fast computers and low-latency connections, her cancellation arrives at exchange B before Jack&#x27;s buy order, so Jack is told that there are no longer shares available on exchange B at $17.<p>RESULT: Jack is filled for 7500 shares at $17 (half of what he requested) and the new market best offer is $17.05. Jack is welcome to submit another order for $17.05 if he wants to buy at that price. Jill is now short 7500 shares at $17, and will try to buy them back at a lower price (she may or may not succeed - until she does, she is exposed to the risk of further price rises).<p>Jill was able to use her speed advantage to detect that there was additional demand to buy this stock, and raise the price at which she was willing to sell it before Jack had finished buying all that he wanted to. This is <i>exactly</i> the way that an efficient market is supposed to work - it reacts to fluctuating demand (and other information) to set appropriate prices.<p>I think there are several things that get glossed over while people are working themselves up about this -<p>1. Jack is upset because he couldn&#x27;t buy 15,000 shares at the price he wanted to buy them. But Jack has no god-given right to be able to buy shares at the price he likes best. He is subject to the laws of the market, just like everyone else.<p>2. The <i>only</i> reason that Jill has a speed advantage over Jack is because she has paid for it! She has paid to co-locate her server at the exchange, and she has paid to use high-speed connections between exchanges. Are we going to declare that paying for a competitive advantage is suddenly immoral?<p>3. If Jack doesn&#x27;t like this state of affairs, he has several options. He can invest in high-speed infrastructure as well. He can use smarter order-routing logic (e.g. adding delays to his orders so that they arrive at the exchanges approximately simultaneously, or splitting his large order up into multiple smaller orders). Or he can use a broker who will do these things for him. If Jack doesn&#x27;t want to pay for any of these things, then he has to put up with lower quality execution. As much as he might wish it, the ability to buy as many shares as he wants at the price he wants them is not a universal human right.

This article establishes that two things often happen shortly after you place an order to buy shares: 1) Another trader places a similar order on another exchange. 2) A large number of outstanding sell orders are cancelled.<p>It&#x27;s not clear to me that either of these are Bad Things, deontologically speaking. [I don&#x27;t recall Jesus mentioning them.]<p>The key question is consequentialist: Are there regulatory changes which would improve the lot of the average investor, investing through, say, an index tracker or pension fund? For each potential change, one ought see how it fares w.r.t. this standard, considering, to the extent that it is possible, the induced second-order effects.<p>Talk of theft, rigging, fairness (you don&#x27;t owe people like me anything), stolen goods and frontrunning is only useful to the extent that it helps us converge on an answer to this question. These words are tools that we have developed for analysing more familiar situations, where they correspond to actions which are clearly harmful.<p>Most changes proposed here either lose market efficiency directly (trade buffering &#x2F; increased tick sizes) or just give us new games to play (if the market clears once a second, we will get our orders in last), potentially resulting in a less direct loss. The question remains.

I don&#x27;t see how this proves the market is rigged. What I do see is: 1) One market participant is being less than clever by trying to buy, in one order, 80% of the offered quantity, and 2) Another market participant realizes this, and reacts accordingly.<p>The post is written as if the world should freeze once the client sends an order. He was &#x27;stolen&#x27; shares. Really?

As a non-trader, my question is:<p>Were the 24k shares being offered by one seller&#x2F;broker, as in &quot;I have 24k shares to sell at 17&quot; or was the 24k just an aggregation of the availability all the smaller offers?<p>If the former, it seem to me that the seller is cheating, if it is the latter then I can see how the HFT systems would raise the price in response to a sale, but I also see how frustrating that is to the buyer.<p>I wonder why these trades are not being performed in parallel across the various exchanges, partially preventing this kind of arbitrage?

All exchanges should have synced clocks and all messages should have a timestamp up to 2 seconds in the future when they will be published by each exchange. The buffering would be internal to each exchange and not shared with anybody. You can only cancel after what you are cancelling is published. This would allow everyone to make all exchanges publish at once so people with fast cable between exchanges can&#x27;t beat out those that don&#x27;t.

Can someone explain what&#x27;s happening with the order cancellations? What causes it? Who is the party that is canceling orders?

An interesting contradiction appears here. On one hand, this increases market efficiency, or so we&#x27;re told. On the other, we are also told that if a big pension fund wants to avoid being played like this, they should spend money on their own HFT equipment.<p>It seems there is only one clear winner here - the IT people making money off developing HFT systems.

Doesn&#x27;t surprise me the least bit. Where there is something available to exploit (in this case, access to direct, fast feeds), it will be exploited.<p>Would it be possible, legally and technically, to put a special additional fee&#x2F;tax onto high-frequency trading while leaving normal high-volume traders alone?

Just in case anyone has time to help me out:<p>What&#x27;s the difference between trades and quotes here in this chart? And how are the trader&#x27;s order and purchases indicated?

what is market-pricing without arbitrage?

This is the bad part of HFT, the one that is theft and destroy value. It is paid by the big players, and &quot;solved&quot; by imperfect solution like dark pools. A better solution could be to add a hour component to the order, so all commands from an actor in all markets are executed at the exact same time.<p>This rotted apple should not hide the good part of HFT, which is to reduce spread and inconsistencies between markets and to generate profits from this (positive) action. HFT took the place of traders, who were paid a lot for doing that stupid task.