That assumes there is no bias to their signal returns over time, which is extremely unlikely. 90% of the moves that go their way could happen in the first second, for example.
Many HFTs hold positions for seconds or minutes, and predict prices out over similar time horizons, but they'll lose their best winners to competitors if they aren't fast and adept at executing.
A simple signal would be more shares bid than offered at the inside market. Imagine a market with 1000000 shares bid at $4 and 100 shares offered at $4.01, it's more likely to tick up than down in the very near-term. This isn't tradable though since the predictions aren't large enough to overcome the spread and you can't expect to join the 1000000 share bid and trade when it's good (the 1000000 shares that made you think it was going to move up all have to trade or cancel for you to trade, not looking so great anymore).
Real HFTs use other features of the order book, movements in related products (maybe a move in oil futures in the last minute impacts the price of an airline stock in the next 10 seconds, etc.), and so on. The signals are not really that complicated, but competitors eventually converge on knowing the same signals and compete them out of existence/profitability. Also, how you execute around your prediction matters just as much if not more.
I see no mention of the spread, costs or even ability to put on a short position, exchange lag variability (huge issue when simulating even on modern exchanges, let alone fly-by-night bitcoin markets). Additionally, it is very easy to find trend-following signals that "work" but break down when conditions change very quickly. That seems to make up most of the prediction, along with an order book imbalance signal that might be more stable.
I think a better approach would be looking at order book features and lags vs. other markets. The costs are high on BTC markets so it would be pretty tough to overcome those though. Anyone with experience to do this is probably doing it somewhere more lucrative. I think BTC markets only trade a few million USD a day.
About 35 million USD in trades on the public bitcoin-paired markets today. About 40 million USD today in total volume for all pairs on these exchanges.
Public spot FX markets and OTC trading do huge volumes too.
Some BTC exchanges charge like 60 bps per trade. Finding a signal to overcome that cost and do enough trading to make it worthwhile would be quite difficult.
I don't believe they were trading with themselves. They were accumulating stock in the opposite direction to hedge their imbalance-only order. However, the way they accumulated that stock was done in a way that would impact the price received on the closing order.
So imagine they sold 10000 shares imbalance-only in the auction at 3:50. They would then buy 2500 immediately, slowly pick up another 2500 in the next 9 minutes, then do the last 2500 in the last second. The initial trades would get them into their hedge at a low average price, and the last-second ones would push the price of the closing auction up, maximizing their return on their imbalance-only order.
If you read the case, it seems like this didn't always work if they had slippage on the close or they got so aggressive that they would "flip" the imbalance and not get filled on their closing order at all, instead being stuck with a bunch of shares from crappy prices. The people trading with them in the last two seconds could also keep replenishing their orders and prevent them from spiking the price. Sounds like a dangerous game of high-stakes chicken.
They were wrong and got punished, but the market would have punished them eventually anyway, and it sounds like it was already doing so. The SEC filing states that this scheme lost them $3mm on an index rebalance day when activity in the closing auction peaks. That should be a great opportunity for anyone intermediating between the continuous and auction books, so it is very surprising that they'd lose. Someone probably caught on that they were manipulating the close and waited for a big day to take advantage of them, or there was so much activity that they didn't have enough ammo to goose the price like on slower days.
Also, to be clear, there is nothing illegal about HFTs intermediating between the continuous and auction books or the majority of HFT activity. These guys were charged because they committed fraud, the use of a computer was ancillary.
It is stuffy, but I wouldn't call it backward-thinking, unless mindless hedonism is what passes for forward-thinking these days. Raising children without marriage would be akin to starting a business without incorporation or contracts. Strong bonds, group loyalty, and long-term planning/character are what let man build something larger than himself.
The claim that market makers pass costs on to end users is only true if they have pricing power. In reality, on-exchange liquidity provision is basically the kind of perfect competition that only exists in economics textbooks. Market makers are selling a commodity product (you don't care or control who you trade stocks with) in a market where buyers are purely sensitive to price (tightest market always wins and is enforced by exchange matching rules).
So what actually ends up happening in a market with multiple competitive market makers? To make money, a market maker needs to trade a lot of volume. The only way to trade a lot of volume is to put up the most aggressive (worse for the market maker, better for end users) prices at any time. Market makers can only do this by charging a smaller spread than their competitors. They can only charge a smaller spread by either reducing their margins or getting smarter at deciding when to be in or out of the market, usually a combination of both. The end result is extremely tight markets that react to information very quickly (i.e. cheap to trade and very efficient).
Competition keeps markets honest. If you had one very fast guy, he would clean up, but when you have a dozen guys who are roughly equally fast, they all compete one another down to barely making profit above their cost of doing business. Only the most efficient can survive. If anything, we want more HFT by removing barriers to entry rather than creating a lot of regulations that would ironically help incumbents by killing off weaker competitors.
That's not what's happening here. Traders are arbitraging and reacting to public trades and orders on multiple markets.
If you walk through a physical market where 8 apple carts are lined up, all selling apples for $1, buy every apple at cart #1, then buy every apple at cart #2, and so on, would you be surprised to find the price moving up or sellers stepping away as you approached carts #7 and #8?
The same thing happens when trading. Securities trade on multiple markets and multiple exchanges cannot match cross-market trades atomically. It's absurd to suggest that one side of the trade should be expected to close his eyes to what's happening in the world around him and sit tight while a huge trader runs his quote over. Why is one party more deserving of a good price than the other?
If you route to one exchange only there is no way for anyone to see or react to your marketable order before it executes, ever. If you route your orders intelligently, it can be very difficult or impossible for anyone to pull away before you get your fills. That's the executing broker's job. Instead of getting better at his job, this broker would rather complain to a very vocal conspiracy theorist who has been proven wrong many times in the past by people with actual experience and data: http://zacharydavid.com/bad-research/the-hunsader-follies/
"If you walk through a physical market where 8 apple carts are lined up, all selling apples for $1, buy every apple at cart #1, then buy every apple at cart #2, and so on, would you be surprised to find the price moving up or sellers stepping away as you approached carts #7 and #8?"
If some guy had a business where his sole service was to sit in the apple cart market waiting to front run me and then immediately sell the apples right back to me, I'd be surprised and super pissed.
If buyers were to time divide their order and time it so the request ended up at each exchange at the exact same millisecond, would this prevent others from reacting to the big trader?
If you read "Flash Boys" by Michael Lewis, he describes the creation of the IEX, which attempts to do exactly this. RBC created a tool to try and synchronize order flow, which worked for a time. Part of the solution that IEX uses is to put large spools of fiber-optic line in between the servers to delay order flow long enough to negate the HFT systems.
Also if you read "Flash Boys" you will realize that the guys that started IEX previously worked for brokers whose central job is making sure orders get executed well and they were terrible at it. They literally did not understand basic market fundamentals that they were getting paid millions of dollars to understand. I'm not convinced I want these same guys routing my orders.
As anyone with a lick of understanding in technology has to ask, why the hell do they need big spools of fiber to negate HFT systems? Can't they implement low latency time stamping much cheaper? I suppose that a box full of computer chips won't impress big named "journalists" nearly as much as a spool of fiber though...
>As anyone with a lick of understanding in technology has to ask, why the hell do they need big spools of fiber to negate HFT systems? Can't they implement low latency time stamping much cheaper?
It's actually a quite elegant solution, and most likely cheapest: it gives you very precise, reliable, repeatable, order-preserving delay for one-time installation cost and you don't have to pay to developers, wait for software to be written and debugged and don't have to buy additional hardware!
Except that what's happening is that the order is against a "cart" with sufficient inventory to completely fulfill the initial order, and other actors are interrupting the transaction to add carts 2-n. Is that not the case?
I'd say its worse than that. As you reach for each apple in the cart you've chosen, someone with an empty cart runs over and grabs it just before your hand can close around it, takes it back to his own cart and marks it up a few cents.
Not for each apple. At the very worst case you get the first apple you tried to reach for. After that all further apple prices may change. Then you can reach and take another one and all further apple prices may change, etc.
You'll notice that there was a quote at exchange A and exchange B. You reached for, and got, an apple at exchange A. Now you're trying to reach for an apple at exchange B and you're surprised that it's a different price.
People are mostly pissed because the time between reaching for the apple at A and B is so fractionally small that they feel there shouldn't be a difference in price. That's really the only issue they have.
If you stood in front of all of those carts simultaneously and said "I'll take all of your stock at the advertised price", I'm guessing you'd be a bit peeves if someone else pushed in front of you and started buying some of the stock (the equivalent of the 1,570 shared bought by some random buyer at the exact point this order was put in).
You would be peeved. Doubly so, because in the context of finance, that's actually illegal.
But the key word in your example is "simultaneously", and it's the thing that did not happen in this example. This is more like "I bought all the apples at the first cart, and by the time I got to the second card, half the carts had raised their prices, and most of the apples at the remaining parts had been bought by enterprising traders who decided there must be something special about apples all of a sudden".
The first solution is to forbid multiple marketplaces for a single virtual asset. Honestly, the service provided by these marketplaces is very simple, and could be provided by a non-profit organization that is bound by law to ensure low barriers to entry. This would be a win for everybody, really.
The second solution is to enforce that markets operate on a synchronized heartbeat with sealed bid changes. It would work somewhat like this:
T=0: Bids from the last heartbeat are published; market starts accepting bids for the next heartbeat, but those bids remain sealed
T=1: Market stops accepting bids
T=2: Trading engine matches bids, executes orders, and publishes all bids; market starts accepting bids for the next heartbeat, but those bids remain sealed (that is, the market is now in the same state as it was at T=0)
Have one time unit be something like a minute, and force markets trading the same asset to be sufficiently synchronized.
Well, yes, those are potential solutions. But are they solutions to the problem we actually have? Indeed, what problem do we have?
Do we, in point of fact, even have a problem that needs solving? The core complaint is some unnamed institutional trader really wanted to buy a very large number of shares in one go at a very low price, while other institutional traders wanted to sell the shares at a higher price. Why are we meant to care who wins that fight?
Yes. We have the problem that the 'financial industry' is running some kind of insane MMORPG which excludes and abuses most of the population to make a fast buck.
What markets should do to be efficient is invest in clever, talented people doing clever, talented things.
Every step back from that is economically inefficient, because it makes it harder to create a population with deep reserves of wealth and opportunity.
Games like this one are the equivalent of having someone cut in front of you on the freeway in a semi.
It's not efficient, it's just banal abuse of a system that is supposed to reward good ideas and filter out bad ones.
Your second solution already exists and is called an auction. Most exchange have an auction before market open and one after market close. Some even have auctions during the day.
I think part of the problem is a disconnect between what the customer conceptually thinks is going on (a single buy request, as far as I can tell) and what is going on behind the scenes - a bunch of individual purchases being made by the broker.
If it wasn't possible for people not directly involved in those individual purchases to listen in and react to them quicker than the broker can fulfil the remaining purchases, it wouldn't be a problem. What is going on may well not actually be illegal, but as an individual trader it's not something you'd expect to be able to happen so it's definitely worth knowing about.
That is very true, but nobody is pushing through here. The trader clearly didn't send his orders to all exchanges at the same time since other traders had time to update their prices. The article talks about milliseconds when arbitraging happens in microseconds.
What you are describing isn't what happened. What happened was you stand in front of the carts and yell "I'll take all of your stock at the advertised price" but all the sellers hear you say that too so they say, "man, if you want to buy out everything we're going to raise the price on you a bit."
This isn't a perfect analogy, but it's close.
You're making the mistake of thinking that HFTers are inserting themselves between the buyers and the people offering to sell. That's not right. The HFTers ARE the ones offering to sell.
Do you provide any access to raw tick-by-tick event data or just bars?
How do you secure your users' scripts so they don't worry about you stealing their ideas or front-running them?
It might be useful to provide FX rates as a feed so users could come up with a synthetic price for non-USD pairs.
For guys who want to work passive orders, an API where they can pass a dictionary of prices/sizes they're willing to buy/sell at into a goal seeking algorithm that handles canceling/placing individual orders might be a better match and more convenient.
> Do you provide any access to raw tick-by-tick event data or just bars?
The minimum granularity is 1-minute candles, where the latest candle becomes available at the close of each clock minute (e.g. 02:00:01 if we're fast enough).
> How do you secure your users' scripts so they don't worry about you stealing their ideas or front-running them?
There's certainly an element of trust here. There's a clause in our license agreement stating that we'll never access user strategies unless you ask us to, or it's needed for some kind of maintenance.
We don't trade on user strategies. That's not the model here.
>It might be useful to provide FX rates as a feed so users could come up with a synthetic price for non-USD pairs.
More generally I'll be adding a way to load in arbitrary data via HTTP requests within a strategy.
> For guys who want to work passive orders, an API where they can pass a dictionary of prices/sizes they're willing to buy/sell at into a goal seeking algorithm that handles canceling/placing individual orders might be a better match and more convenient.
These kinds of features (e.g. VWAP orders) are in the pipeline. There's certainly a need for tools like that.
http://techcrunch.com/2013/05/23/lyft-a16z/
http://www.cnbc.com/id/102008782