Like how twenty years ago you could buy a stock you believed in for like $4 by using a computer system, paying a fraction-of-a-penny spread on average, to have a trade executed in milliseconds to seconds, but now you have to talk to a human on the phone and pay a $400 commission to pay a fraction-of-an-eighth spread and have the trade execute in minutes or hours? That fact pattern would make this critique make sense.

No, it is fantastically easier to trade the stocks of companies you believe in. If there is a problem with the market, the "problem", and one uses that term loosely, is that people are talking about macroeconomic trends more than individual companies because the observable evidence is overwhelmingly in favor of a conclusion we've pretty much known for decades: seeking alpha is a sucker's bet.

You're interpreting that sentence literally. His point is that investing in a company used to largely be based on how successful you though that company would be. The market has changed in a way that an overwhelming number of external factors can have a negative (or positive) impact on that company's share price, making the evaluation of risk far more difficult. At the same time, the barriers to getting into the market have been lowered making it far-easier for anyone to participate. That sentence has nothing to do with how your initial trade was executed.

From the point of view of a value investor, the numbers that you care about are the current price, and how successful you think that company will be. If the current price is below that benchmark, you buy and hold. If the current price is above that benchmark then maybe you want to sell short. (The reason for the maybe is that, the market can stay irrational longer than you can stay solvent.) Either way you're aiming to make a profit off of the difference between long-term returns and the price you bought it at.

Therefore from the point of view of a value investor, everything that helps people lose track of a company's long-term prospects is good for you.

When high frequency trading is allowed, the price of a stock becomes influenced by the simple act of trading itself, and while it is true (as @btilly mentioned) that this enables other methods of trading like benchmarking, it discourages investing purely for the sake of supporting the company's growth. THAT was Mark's point. Wall Street's purpose is to INVEST in companies, not to microtrade the crap out of their shares until the stock price is so volatile you'd think the CEO was schizophrenic.

Investing is about knowing the difference between value and the price.

When you can do that-- and when I say "knowing" I mean it, and I have a spreadsheet to calculate it-- then you can buy low and sell high.

The problem is wall street is in the business of managing other people's money and most people are ignorant of money, so you have a lot of people who just turn their money over to others to "manage"... and many of those that use other people's money end up gambling with it rather than investing it... this problem is compounded by the moral hazard created by the government bailing these companies out when the gambles turn south (or underwriting the gambling by buying bad securities as helicopter ben is doing right now to the tune of $40B a month.)

The problem with wall street is government regulation which is idiotically designed, and intervention-- in the form of bailouts-- that perverts the entire system incentivizing gambling.

And the people voting for all this, generally don't even know what money is, let alone how to invest it. (If you think the dollars in your pocket are money, then you're one of those people, and I suggest you read http://mises.org/money.asp )

Never ignore Keynes' rule - the markets can stay irrational longer than you can stay solvent.

Where Keynes' rule applies in spades is when you are doing things like shorting an overpriced stock. Now as the price goes up you keep on having to put more money in, and should you run out of money you lose your shirt.

And about poker, there are a lot of variants of poker out there. Texas Hold 'em is what everyone is playing because it has the combination of more strategy and thinner edges. So good players have a real challenge figuring it out, and weaker players have a better chance of walking away lucky on any given night.

Just wondering

Deregulation. http://dealbook.nytimes.com/2009/11/12/10-years-later-lookin...

“Without the...repeal of Glass-Steagall...Washington might not have felt a need to rescue the institutional victims.”

Really? In what way has it changed?

External factors have always had a huge impact on businesses. I'm sure there were lots of super well run businesses that went under durring the Great Depression (which was, you know, the mother of "external factors").

Two examples:

1. High-frequency algorithmic trading.

http://blogs.reuters.com/felix-salmon/2012/08/06/chart-of-th...

3. Repeal of the Glass–Steagall Act, giving government-protected 'too-big-to-fail' commercial banks the ability to incur risks traditionally reserved for investment banks.

And all of that assumes the algorithms behave in a way that they're expected to. I like this example from Amazon's pricing algorithms: http://www.pcmag.com/article2/0,2817,2384102,00.asp but you could apply the same concerns to pricing matters of the stock market where the unintended consequences of poorly-conceived strategies have a destabilizing effect on pricing.

HFT allows all of this happen so much faster than could have ever been done manually. And when high frequency trading is being done by entities with enormous balance sheets, and an increased tolerance for risk due to assurances by the government that they'll be bailed out should they make a bad bet, it's got the potential to destabilize the entire market.

No, it really doesn't. There's not a boogey man hiding under your bed just waiting to get you.

You know what would happen if a bunch of computer algorithms went crazy and mispriced a bunch of stocks? The guys running that code would get taken for a bath(1). If a bunch of computers went crazy today and started selling shares of GOOG for $20 then the humans would start buying like crazy and the share price would correct.

1. http://en.wikipedia.org/wiki/Knight_Capital_Group#2012_stock...

We would see a lot less of these disruptions if exchanges would make everyone live with the stupid exchanges their computers made.

"The market has changed in a way that an overwhelming number of external factors can have a negative (or positive) impact on that company's share price"

Knight Capital loosing a ton of money was not due to an external factor. It was due to an internal factor. The fact that they (apparently?) accidentally deployed a bunch of test code to production. Oops!

So yes - in this case, the internal factor of Knight running a flawed algorithm turned into a very real external factor for those 148 companies, as well as anybody else whose trading was impacted along the way.

That said, I do question the overall premise that HFT affects stock values over the long term.

I also don't think that "government decisions can have a big impact on the economy" is a new phenomenon.

"In the short run the market is a voting machine. In the long run it's a weighing machine." - Warren Buffet, quoting Benjamin Graham

Also, with interest rates low, return expectations might have gotten low enough that the significant vig of Wall Street is a bigger problem for some strategies.

Your comment would be more interesting if it confronted his main point: "There is absolutely NO VALUE to High Frequency Trading. None. We need to bring our markets back to their original goals of creating capital for business. "

That's how market makers make money. They match up investors who want to buy and sell the amount they want to sell at the time they want to sell it.

Contrast to the private corporation that I own shares in, where it's taken me weeks to broker a deal to buy some more shares from another shareholder -- including face to face meetings with many of the officers of the company. We had to have an accountant do the valuation and I ended up buying exactly the number of shares the other owner wanted to sell because this would mean more financing complexity and paperwork for the hardworking officers who should be spending their time building the business.

Maybe your broker gets $10 and the market maker gets $15 but this is a bargain when you consider how much it would cost without them. Imagine trading on the New York Stock exchange when you were in San Francisco in 1860!

Many low latency (high frequency) traders are market makers. Since the first successful offer gets the trade, you've got to be the fastest to survive at this game.

One reason it's hard to make money as a trader is that as people find discover deviations from ideality and exploit them, the deviations go away. "Market neutral" strategies we quite successful through the 90's but are no longer profitable. Today I'm worried about the options market because trading in volatility may alter the relationship between implied and realized volatility and ruin another family of simple strategies that have performed well lately.

But the benefits of market making tail off with frequency - would you mind waiting another hour for a deal at 518 or even a whole day? To a trader its unacceptable, to an investor, its a coffee break.

But what drives HF trading is trading - as markets become more efficient trading opportunities, as you point out, vanish. So smaller amounts of arbitrage need to be leveraged with larger amounts of cash to get the same return.

We want nice safe retail banks who make a tiny fraction on the movement of wages from company to employee to shops each year, and bundle it all up into mortgages and ATMs. They keep society oiled

By the same token we (society) wants nice safe boring market makers. Who efficiently take a tiny fraction of each trade and keep liquidity in the markets for investors.

I cannot prove it but the amount of margin gained for investors who hold for >1 year through the existence of HF trading is probably small - you can now get 515 offered quickly. 5 Years ago? 520? If that would have prevented you investing, maybe it was the wrong company.

secondly I also dislike the justification that HFT is ok be ause it is Market making. I see it as a form of Market making trying to capture the equivalent of the consumer surplus - I was quite happy to sell my shares at 505 and old boring mRket maker would turn and sell them at 510 tomorrow - but HFT nips in buys from me at 504 and old Market maker has to take them at 506

no real liquidity has been added to the Market in that situation - a deal was ready and raring to be done and another just reduced margins. Not bad, ethically fine but not actually adding much to the system

thirdly I dislike broccolli

If you want to sell at 505, an HFT can't change that. Place a limit sell at 505.

If you're not willing to hold out for 505 and want to sell at the market price, you're a liquidity buyer paying a premium (of some sort) for getting out of the market right now.

People love to point out this scenario where the HFT buys something at $9 that a human would have paid $10 for. They never acknowledge the fact that by doing that, the HFT assumed the downside risk; the HFT is now to some extent illiquid and exposed to the market. If the price goes to $11, the HFT wins, sure. But if the price goes to $8 --- which should be equally likely, else why sell --- the HFT is fucked.

Broccoli is delicious. Here's what you do: blanch it in boiling water, just like 20-30 sec, shock it in ice water, and then dry it off. Put it in a bowl, douse it in olive oil, shake some fish sauce into it, cumin, chili flakes, maybe a little sriracha or maybe some lemon juice. Shake the bowl up. Now grill it. Yum. Eat it with sriracha mayonnaise, which is the highest calling of mayonnaise.

in the comics, when Superman is protecting Metropolis and Supergirl turns up, she cannot do anything the Man of Steel could not do - she just looks better in tight blue Lycra.

Kudos for your recipie.

Edit removed my dumb, knee jerk, unappetising broccolli recipie/comment on state of English cooking in my childhood. Nevermind.

Anyway makers have specialisms and get advantages from the exchange - they are not supposed to just bugger off home cos it's Tuesday

Most markets are not specialist markets. Specialists at the NYSE were accused of skimming hundreds of millions of dollars from customers. They're an anachronism and a much more disquieting idea than robots competing to provide the best price --- which is pretty much what most HFT systems do.

If a particular market maker can't work for some reason with some particular symbol [there are thousands of symbols], at some particular time, he would just pause. And they often do.

Some HFT firms have agreements with the exchanges that require them to be in the market providing liquidity no matter what. This is not true of all HFT practitioners, but major key players are required to do so.

This is contradictory. If there is only one offer of 100 shares at an arbitrage price you take it and the arbitrage is gone. You can't leverage more money to get higher returns, you're done. Market=efficient wipe hands and walk away.

http://www.chrisstucchio.com/blog/2012/hft_whats_broken.html

http://www.chrisstucchio.com/blog/2012/subpenny_rule_respons...

http://www.chrisstucchio.com/blog/2012/bigger_ticks_more_ren...

Its about what the bulk of the trading is: robots trading with robots without any regard to the stocks they are trading. The big whales are the mutual funds and they have to execute their buy/sells using special techniques of spacing trades out to try to not show what they are up to. Otherwise the HFT spots it (and they usually do) and then front runs all of the trades, just skimming pennies off. What use are they ?

The majority of the trades are not making markets at all, they are just zipping back and forth to collect pennies. If they were market makers then they would hold inventory, but they never do.

NOBODY believes the "liquidity" story. and what about flooding the market with fake bids to cause opponents to get overloaded ? or running tracer LFOs spitting out strange bid patterns just to see if they can detect another hidden program ? what does that have to with market making ? its just robot games.

I developed HFT algorithms in a previous life at a very large, well known bank. The majority of trades out there are in fact market making related. The ones that are market taking are usually at the expense of OTHER HFT algorithms, the ones that are slow and showing out dated prices.

And yes, HFT algorithms most DEFINITELY hold inventory. Some don't, but most do. It's too expensive to get hit on a bid and then try to get rid of it right away. They often hold inventory for days, weeks, even months. I know this for a fact. I can't tell you know much time is spent on worrying about and managing the inventory HFT systems accumulate.

HFT is immensely useful for large mutual funds. They replaced a broken system of high school dropouts who worked on the floor of the NYSE. Mutual funds HATED calling the floor, waiting an hour for execution, not knowing what was happening, and inevitably being taken for a ride. This is all public...go ahead and read a lot of the articles after Thain took over as president of the NYSE and gave tours of the floor to the large mutual fund managers...they were not impressed, to put it mildly.

With HFT, you have transparency and immediacy. You put in an order, and you get that price. In the old days, mutual funds called in an order, and had no idea what they would get, it would be whatever fill the NYSE trader gave them. Executing orders throughout the day makes perfect sense, and is cheaper execution in the long term. You simply get a bad price if you try to sell a billion shares of MSFT in an instant, so instead you spread it over time.

HFT does not front run in any way that is different than trading since the beginning of time. They are trying to understand if their is future demand, and adjusting their prices accordingly. You don't think that after being hit on a bid, the old NYSE floor traders didn't change their prices? They're doing the same exact thing as HFT does.

There's a ton more to say about it, but these are just to counter some of your points.

I wonder how much of the dislike for HFT comes from applying intuition about 2 party trades to a many party market. Mostly, I think people ignore that the HFT systems are competing with each other, not just arbitrarily stepping into the middle of transactions. The latter really violates intuition about fairness.

One of the greatest examples of how nothing nefarious is going on is from a large multi billion dollar hedge fund I used to work at. They have both an equity investment group, as well as a HFT equity liquidity providing platform. I worked on HFT, and knew the equity guys. They always wanted to execute with us in the open market. It was so much better than what they used to have to do.

Why would one of the most sophisticated equity investors in the world want to run an operation that "skims" from the other? Because that's not what HFT does, and of course they know that. They use their own product (their HFT system) to execute their own buy orders. If that's not a testimonial, I don't know what is.

This is precisely the point about HFT. If you are a seller, there isn't always a buyer. HFT is there when there ISN'T the other side. The scenario you described is absurd. How often do a buyer / seller want to interact within the same millisecond?

They can of course. HFT does nothing to stop that. Two people can trade in the open market with each other whenever they want. The reason most of the time HFT is involved is HFT gives the best price. That's why it's become so big. They provide the best price to their customer, not attacking some "flaw" in the exchange.

Here's an exciting company with a spread of $0.01 (at the moment anyway):

http://finance.yahoo.com/q/ecn?s=WEC+Order+Book

My selection criteria was to try to find a S&P 500 component that I wouldn't expect to be among the most highly traded S&P 500 components.

Isn't that exactly the point the GP was making?

If it's bad that one firm capitalizing on the situation of another firm making a mistake is the point, then I think he should really rethink his participation in capitalism.

The problem with the competition between HFTs is that it's turned into a ridiculous arms race to shave microseconds off the response time - how is that in any way productive?

It turns out to price an asset, like a stock, a wide variety of skills is needed. Some people focus on macro trends, like analyzing political events, oil prices, etc. Some people talk to management of the company, count cars at Wal Mart, etc. These are the micro trends.

And some people try to estimate the current supply and demand for a certain stock. That is what HFT does. So yes, it has "regards to the stocks they are trading." Just different regards. That's why specialization works so well. HFT worries about current supply/demand issues, and tries to estimate a fair price to set the market so that when the average investor comes in, and looks at a stock with a 1 cent spread, he is going to get a fair price. Over the long term, people who analyze micro and macro factors will trade with HFT, which will then force the algorithms to change the stock price to reflect their views.

Is an arms race to shave milliseconds off of trading times the most important thing in the world? Absolutely not. But is gaming the Apple app store to get your mobile app higher in the rankings any different? At least with HFT, milliseconds do matter in more situations than you can imagine. If one day you buy a stock that had bad news announced just milliseconds before, and HFT did not update that quickly so you paid a price way, way too high, you would be upset. Again, not the most important thing in the world but it does help.

The millisecond thing is highly overrated. Anyone in the industry knows that it only matters to a small degree…understanding supply demand and adjusting accordingly is the most important skill. That's why the most profitable high frequency firms don't care about what millisecond they execute in…that is one of the great ironies of this--you guys are concerned about something that not many other people who actually do this for a living are concerned about. But you guys latch on this minor point as the major one, and that is a mistake. Do developers worry about how quickly their apps load? Yes. Does it mean their product will be a success? Not necessarily. That is the same thing here. HFT shops work to make sure they aren't too behind, but focusing on that aspect is just trivial compared to the actual work they do.

So when BigMutualFund decides they want to buy 50 Million Shares of MegaCorp they try to disguise their order so that the share price of MegaCorp doesn't go up to much as they make their buy. That's absolutely right.

You're also absolutely right that HFTs have made it harder to disguise this action. The HFTs "see" what's going on and start buying shares of MegaCorp at a higher price and then selling them to BigMutualFund. So BigMutualFund makes a bit less money.

So where does BigMutualFund's go? To the HFTs? NO! The HFTs aren't changing the spread width, so they aren't making more money.

You know who makes more money? The current shareholders of MegaCorp who decide that they want to sell! And that's great! Whatever information it was that made BigMutualFund think that now was the time to buy gets communicated to the market faster (in terms of the share price) because of the great work the HFTs are doing.

More efficiency for all!

They can do the trade slightly faster, and according to the rules of the market, if you place an order to sell with a limit of $50 then someone willing to buy now for $50 beats someone willing to buy a second later for $51. If that's not what you wanted, you should have made the limit $51.

Maybe we need new order types, but that would set off a slew of complaints about additional complexity. And note that eliminating the sub-penny rule would put a lot of the front-runners out of business, since they'd only be making $.001 per share rather than $.01.

We have misinvested countless millions on a system which produces the wrong answer, optimizing for millisecond latencies which benefit neither companies needing capital not investors providing it.

It has always been in the interest of high volume traders to hide their intentions just as it has been in the interest of all other market participants (including other high volume traders) to attempt to discover those intentions. In this sense, trading now is exactly as it has always been, although it occurs at a more rapid pace.

"Otherwise the HFT spots it (and they usually do) and then front runs all of the trades, just skimming pennies off. What use are they?"

Please explain why it is bad/wrong/unlawful/unethical that other traders may act when a large trader does a bad job of hiding his intentions.

"The majority of the trades are not making markets at all, they are just zipping back and forth to collect pennies."

I don't understand. What do you mean by this?

"If they were market makers then they would hold inventory, but they never do."

I assume this to mean that you believe that the definition of "market maker" should include a reference to the length of time one holds a position. If you demand that to be called a "market maker," one has to hold a position for a minimum amount of time, then you will exclude some market participants from being so designated. I don't understand how the definition of this term is relevant to the discussion; please explain.

"NOBODY believes the "liquidity" story."

I assume that by ""liquidity" story" you mean the idea that HFT firms increase liquidity (more size with which to trade, at a better price) and that this is to be valued. Is this not the case?

"and what about flooding the market with fake bids to cause opponents to get overloaded ?"

Deliberately entering unbalanced (one-sided) orders without the intention of trading so as to manipulate the market is illegal. This vague idea is a serious infraction of SEC rules that carries significant fines and penalties. See: http://www.finra.org/Newsroom/NewsReleases/2010/P121951

"or running tracer LFOs spitting out strange bid patterns just to see if they can detect another hidden program ?"

I'm not familiar with "tracer LFOs," please explain what these are. If they are orders or order submission strategies intended to gauge market interest, do you think that they are bad/wrong/unlawful/unethical? If so, why?

Historically, not all market makers were designated market makers.

Some HFTs (e.g. some branches of Goldman) do act as designated market makers, receive these privileges, and are obliged to continue trading. Others do not. Same as always, just with machines replacing people.

High Frequency Trading makes trading stocks cheaper. There have always been market makers. They used to be expensive humans. Now they are cheap computers. This means that it now costs less for you to trade a stock.

His main point: Wall Street doesn’t know what business it is in. Wall Street has nothing to do with creating capital for businesses, its original goal.

He's saying wall street should have an incentive to create/raise capital for businesses, not invest in marginally profitable trading strategies like HFT.

The opportunity cost of wall street investing in trading is that other pursuits like capital raising get less or no attention.

So it's not that HFT is necessarily good or bad, it's that it's a distraction that's not going away, to the detriment of other potentially more value-creating pursuits, like raising capital for new companies.

Wall street knows what business it's in...lots of them. It does bond research, equity research, investment management, sales and trading, and yes, investment banking (to raise capital to all these poor companies that can't find anyone to pay millions of dollars in fees to do)

Do people really think that there are no investment bankers who raise capital anymore? That because of HFT, a job that pays 1mm a year when you're 30 has no more interest to anybody? That there are so many humanities majors graduating from princeton and harvard that normally do client relationship investment banking but because of HFT, they are going to write algorithms and optimize OS code for latency instead?

Have people seen how many layoffs are happening in investment banking division on wall street? (where they raise the capital for companies) It is NOT A ZERO SUM GAME. HFT doing well is NOT AT THE EXPENSE OF CAPITAL RAISING.

What kind of point is this? Is it even informed by any facts?

Personally, I'm not irritated at the nerds (after all, I'm one of them) so much as I am at places like Zero Hedge and Rolling Stone which prey on the ignorance of nerds to drive up pageviews.

And Matt Taibbi was responsible for the legendary characterization of Goldman Sachs as a "great vampire squid wrapped around the face of humanity."

I get it: people like reading this stuff. That's why they write it that way. But I'm saying, like reading it or don't like reading it, a lot of the underlying facts being reported are laughable.

So instead of being able to compete on price, market-makers compete on latency in order to be the one making all the monies, resulting in the current arms race.

Cf. this blog: http://www.chrisstucchio.com/blog/2012/subpenny_rule_respons...

That is yummifajita's blog, btw.

It does mean the market demands more knowledge; it's more sensitive now, so you can no longer do a buy or sell "at market" and expect a good price. But even if you don't know how to play the market you can go through a broker and still pay far less than you would've in the "good old days".

Divide the market into three categories of participants:

A. Holding period less than one minute (high frequency traders)

B. Holding period greater than one month (entrepreneurs, companies, value investors)

C. Everyone else (noise)

Question: Does category A really create any useful liquidity for category B? Category B is the economic purpose and intent of the stock market. He's saying: that the HFT guys are like trolls living under a bridge stealing a shoelace from each person who crosses the bridge. He's saying that doesn't fulfill an economic purpose.

I'd love to hear a counterargument. I don't know enough to have a firm position.

it is unimportant if the Market maker holds for 1 pixo second or one month - what matters is that someone is there to trade. Now HFT is at a disadvantage as they have less scope to make their spread (essentially the other side must already be in the Market) but that's where if all other Market makers disappeared (and the stock slowed down) HFTs must become LFTs and hey presto are indistinguishable from the old style Market maker

yes there is a price point issue but most buyers really have a range they will buy at so more precisely I am conjecturing that there are minimal benefits to an exchange to having more than one Market maker at a given stock within a given price range.

How to provethat - not sure

Could you perhaps explain the downside of having multiple market makers per stock? It seems trivial to state that competition in providing liquidity alters the cost of said liquidity and disprove your contention - but why bother to make that argument when there can't really be additional costs by multiple parties competing to offer a service?

With one Market maker the exchange can do so and so it benefits from being a effective place to trade - this is a huge advantage over any other exchange With a second Market maker, the exchnage gain is I believe orders of magnitude lower. Almost any Market maker is forced to maintain sensible spreads (else it is worth trading without them) so just one Market maker will offer expensive but not outrageous spreads. A second one brings only the benefit of slightly cheaper, which coma red to the benefits from the first are negligible

Surely this can't be right. If for the only reason that, if it were a sucker's bet, then most people wouldn't take it. Especially most 'informed/rational' actors. The vast majority of the players on Wall Street, we can assume, are informed and relatively rational. Yes, they may follow the herd - but that too is a rational exercise. If you are in a building and everybody is running for the exits, it is irrational to stand still and risk being trampled.

So, the mere fact that there are countless informed/rational actors seeking alpha and - quite frankly, many do capture it - would seem to me that statement is inaccurate.

If your argument is that the odds are long, well that is more nuanced view.

There are many traders that seek a small amount of alpha, with no leverage, and make a reasonable return annually - enough to support say 1 - 2 employees. But, there are many others that do the same with a larger capital base and capture enough to support larger organizations.

Seeking bets with long odds is, quite frequently, not a sucker's bet - because the mainstream view of that bet is that it is a sucker's bet. Mainstream adoption of that view, actually - non-intuitively - turns the bet into a prudent bet. The whole be greedy when everybody is fearful bit.

The same can be said of founders wanting to build the next Facebook - you might argue it is a sucker's bet, but the outcomes aren't as rare as it may seem.

When I started writing I thought if I proved X was a stupid thing to do that people would stop doing X. I was wrong. - Bill James

For some measure of 'sucker-value', seeking alpha is a sucker's bet, or timing the market is a sucker's bet, or blackjack is a sucker's bet, or poker is a sucker's bet. But there are the few who can find an edge, and don't play when they don't.

A more nuanced point of view is that the market is efficient enough and perverse enough that it takes an unusual ability to find alpha, or time the market, or to pursue any strategy. So if you don't have those, then it's a sucker's bet.

As a thought experiment, consider what would happen if (nearly) everyone indexed. Anything outside the index would be super-cheap and illiquid, and the index would be expensive in comparison. In that case, non-indexers would outperform. (Efficient market theorists would of course argue it was an illiquidity and risk premium and the market is still efficient.)

In the real world, the market finds an equilibrium between indexers and non-indexers where some can generate alpha, enough to persuade a lot of people that they're alpha generating when they are just fooling themselves. It's really people's ability to rationalize and fool themselves that explains the persistence of alpha-seeking strategies, not their success.

Paradoxically, when dumb money acknowledges its limitations, it ceases to be dumb. - Warren Buffett

I agree with you that it's possible, but hard to outperform, but mostly for a different reason. Partly because the market is somewhat efficient and rational, but mostly because where and when it's irrational, it inherently mirrors the irrationality of the human participant in ways which almost everyone will struggle in vain to overcome.

The market can remain irrational for longer you can remain solvent.

Yes, but can it remain solvent for as long as everybody can remain solvent? i.e. everyone that makes these "sucker" bets? No. Liquidity will dry up, because there is a big chunk of the market that takes these bets.

But by "invest" he is not talking about the friction out there (paraphrase as "having to spend $400 and talk to a human") to purchase a stock but rather the price of the stock in relation to the value being manipulated by, as one example, high frequency trading and macro economic conditions.

Let's say someone decides to invest in Bingo Card Creator because they think there will be a market in China and that Patrick and BCC are the ones to be able to take advantage of that opportunity. So they invest in BCC because as a small operation, and after doing due diligence, they believe the "new chinese sales manager" that you hired can crack that market. Regardless of what else is going on in the world or in China.

But the truth is even though the stock market is less like that analogy today, I don't believe it was ever like that. (Look at 1929 as one example). Of course in the past I do believe people did make more long term investments. There were places to put "widow and orphans" money. Not sure that is the case today anymore (is it?) And that could also be just because of friction in distribution of investment information - there were less places to read things about companies and that actually helped create more long term investments (my thoughts strictly).

The game now is that people attempt to predict by all means possible what will happen in the future by triangulating any info available to determine how a company will do. And then those companies become bellwether's of the market and people make decisions in advance of those decisions. While this always happened to some extent (I'm sure before people could fly airplanes over shopping centers or before there were even shopping centers there were people who attempted to find out how a particular company was doing by evaluating any information they could. I just think the amount of people doing that was in the minority and now the majority of people are making decisions for non-fundamental reasons.)

Please explain or expand on how the above occurs.

As far as macro economic conditions same thing. A report comes out that Fedex has shipped less packages or ADP reports that there are less people using their payroll service (bellwethers). So stocks start to drop and the market goes down because people anticipate it will effect earnings of all companies. Even though it has nothing to do with what is going on specifically with BCC or with a company whose business it is is to create the washers that are used in pumps in sewer systems.

What is bad/wrong/unlawful/unethical about: >"And when the market is having a down day other stocks that have nothing to do with the stocks being traded are changed as well. So if the market is down someone's investment in Patrick's BCC will have a large chance of dropping as well."

And just to check: do you think it would NOT be bad/wrong/unlawful/unethical if one substituted "up day" for "down day" in your sentence?

It seems like you take issue with that fact that stock price changes have become more correlated. Is it bad/wrong/unlawful/unethical that traders may want to sell(buy) stock A when the price of stock B decreases(increases)?

It suggests the market is no longer performing its intended function of allocating capital to those companies that will use it most efficiently.

Please explain how the trading of a company's stock changes that company's capital allocation.

I think you can find them if you look for them. Though generally I'd say stick your money in a low-fee S&P 500 tracker; if that's too volatile for you, you probably should be keeping it in cash rather than investing.

http://www.tweedy.com/resources/library_docs/papers/WhatHasW...

[1] http://blogmaverick.com/2012/09/04/facebook-handled-their-ip...

Can he explain exactly how this is supposed to happen? Let's think it through. You see a stock priced at B, and you decide you want to buy it. Cuban is saying that a high frequency trader will see that you want to buy the stock, and he'll buy it for B and then sell it back to you at B+X, making X in the process (any you pay more for the stock). To do that, he'd have to know that you were about to submit an order. But he only finds out about your order after you've submitted the order to the exchange, and the exchange has relayed it to him. He doesn't get the opportunity to "jump in front of you", and I have no idea why Cuban thinks he does.

In actuality, what happens is this. The high frequency trader sees that the stock is priced at B if you want to buy it, and S if you want to tell it (with B > S). He then expresses his willingness to sell you the stock at B-X (by sending a limit order to the exchange). When you come along to buy it, you get it at B-X instead of B, which saves you money. The trader gets a rebate from the exchange for supplying liqudity (which he did, since you got the stock for less than you would have otherwise) and hopefully he is able to buy it back for some price around S (with another limit order), thereby making the difference between B-X and S.

There are dangers with high frequency trading [1] but they are not of the kind that Cuban is describing.

[1] http://en.wikipedia.org/wiki/Knight_capital#2012_stock_tradi...

They send in tens of thousands of requests a second, many of which they have no interest in ever being forfilled, in the hope of partly fooling other people, who are sending around similar numbers of requests.

Stock exchanges have turned into a high-frequency war-ground, which fortunately doesn't appear to spill out and effect the rest of us too often, at least as far as I understand.

In any case, to the 'end user' (a regular stock investor like you or me) the continual jockeying for position among HFTs doesn't matter - all we notice is that we pay smaller spreads and get our orders filled more quickly.

Sometimes the trading games spill out into the 'real world' with unpleasant consequences, but those instances appear (so far) to be rare. I think there needs to be tight regulation on HFTs to limit behaviour like quote stuffing, spoofing and other forms of gaming, but I don't agree with the argument that they are a net bad thing.

Besides, most retail orders go through brokers, not directly to the exchange, and the brokers can provide their own layer of algorithmic sophistication to help the clients get a better price than if they were to place the orders on the exchange on their own directly. This can be done by internally matching orders on both sides, as well as placing orders at strategic times and prices, also using algorithms.

So, this isn't really about "poor retail investor" against "evil predatory high-frequency trader".

That's called gaming, and is illegal.

The reality is that the vast majority of the damage Wall Street inflicted on the US economy had nothing to do with electronic trading. Until someone invents High Frequency Lawyering, the bulk of the work involved in trancheing collateralized debt instruments is going to be paperwork. Those instruments are traded OTC. While there are electronic markets for some of them, like swaps for blue chip companies, those markets have nothing resembling the volume of the NASDAQ. The '07-'08 crash was caused by evil phone calls more than evil computers.

The other thing you'd want to understand is that prior to electronic trading, Wall Street was crooked as a bucket of fish hooks. Before retail electronic trading, if you (you meaning anyone who didn't work for a trading firm) wanted to buy or sell a stock, you had to find an agent to execute the trade for you. As you can imagine, most people have call to engage an agent very few times a year, but agents work with each other all the time. You got worse prices because your orders would quietly be routed through the channels that secured the most grift for your broker.

There are bad things about HFT; for instance, they create an incentive to route very strong CS talent to Wall Street instead of Google. But before you decide that HFT must clearly be evil because it allows the Goldman Sachs of the world to get better deals than mom and pop stock traders (which, note to mom and pop: don't trade stocks), you should probably have a very good idea what a continuous double auction is, and what a market maker does, and have a good idea of who the "big fish" in HFT are actually preying on. It probably isn't your pension fund.

-High frequency traders provide liquidity enabling me to transact with slightly lower spreads. While narrow spreads may only provide a marginal benefit to the markets, how is it harming you or I?

-High frequency traders hardly impact my investing decisions. Has anyone here been burned by a high frequency trader? If so, please share your experience.

-I am unaware of any academic research concluding high frequency trading has caused harm to individual investors.

-The flash crashes that have occured, appear to have been temporary in nature, and therefore have had zero impact on real investors.

-Don't use market orders if you are afraid of getting a trade executed at an irrational price.

-if PG, KO, or similar crashes for a few milliseconds as a result of high frequency trading (which may be a dubious claim) how does that hurt you? You may have the opportunity to temporarily exploit a mispriced security and buy shares of a company at a lower price.

There's a decent chunk of jealousy involved; I think it's mostly the way they seem to be making a large amount of money while not doing any "real work". Compare the general attitude towards lawyers.

Wall Street has a lot of problems. Computers making markets instead of humans isn't one of them.

His argument is like saying that someone that buys and sells used cars has a big advantage over me the consumer, therefore buying a car is rigged. I know that implicitly, it's the friction of low transacting.

I'm not saying that high frequency trading isn't shady, but it also serves a purpose. And I don't think the objective is to crash a market, it's to make money. These traders don't want scrutiny, so they are personally motivated to maintain order.

I still think that everyone is missing a key point. There is huge value in programatic trading. The frequency of a crash with impact to retail investors (not traders willingly risking money speculatively) relative to the volume of spread tightening trading approaches zero.

That said, I agree that rejecting algorithmic trading just because it's new, different, and scary doesn't seem like the best approach. Computers have disrupted most industries, and the financial industry is just one of them.

It is my understanding that program trading and HFT account for 99+ percent of the trade volume at this point; how shall we even distinguish Wall Street from automated trading then?

Think how much bacteria is in our body, take it all out and we don't run as efficiently. program trading is the same.

So, let's say that Mark's right and the combination of HFT and emphasis on macro trends has caused some securities to be mis-priced compared to his analysis of their long-term prognoses. As a long-term investor, shouldn't he be delighted for the opportunity to bargain shop? If anyone can stay solvent longer than markets stay irrational, it's him.

http://archive.nyu.edu/bitstream/2451/26930/3/CFE-04-04.pdf....

If you are going to hold a stock for weeks it will probably not affect you at all. Even if your holding period is several hours you are not really competing with HFT.

An analogy (weak but serviceable) is that a home town bank is for "saving money", you save your money, you deposit, you write drafts against your deposits that other people can use to make value limited withdrawals. Oh and the people in the bank? They also have a business where they take your deposits and they loan that to people who need money now and can repay it in the future. But to do that they have to do 'magic math' and figure out how likely it is that this borrower will pay it back and they do that with an interest rate. Now the bank, like it has from the beginning of time, is "making money using your money and dealing with people who will pay to borrow it."

Interestingly this exact same works on Wall street and with 'investment banks'. You "invest" (equivlaent to making a deposit) and instead of a chit that says you have $1000 on deposit you get one that says you have ownership of 50 shares of stock in AT&T. Guess what, the bank doesn't just sit on a bunch of stock certificates, they have another business where they let other people use those shares on the agreement they can always get back 50 shares to give to you if you decide you want the certificates to put in a safe deposit box or something. One customer is 'investing' and one (possibly different) customer is 'trading'.

Guess what you can do this with anything of value, and if its something someone consumes you call it "commodities", if its currency you call it "banking", if its stocks and bonds you call it "investing", and if its gossip you call it "journalism."

Mark is smart enough to know this, so why the blog post?

My guess is that a lot of people don't like high-frequency-trading because they can't afford to play. What has happened is that a large holding company, fund, or bank with programmers and computers and data center space near the exchange can easily out trade someone trying to do this through the e-trade Web API. I get how that could be annoying to someone who used to make money that way, tell it to all the folks who used to be able to make a class A game title with a couple of programmers and an artistically inclined person or two.

I wonder what his motivation is. Is he upset by poor performance in his personal account and wants to blame someone? Does he buy the shockingly confused media hype? Is he threatened by something he incompletely understands? Is he doing it to get even more attention? Is he trying to seem intelligent or gain even more status by jumping on a bandwagon to criticize a popular scapegoat?

A complex tax structure ignores the bottom (who pay very little tax on income) and only harms the middle. The top earners in any system with a complex tax structure have the capital and the assets to make it worthwhile to design vehicles that shield them by exploiting these complex tax rules.

"A hacker wants to jump in front of your shopping cart and grab your credit card and then sell it."

On the other hand, looks like we've already lost this fight.

Before computers, Wall St. was still largely about trading and standing between people who have money and people are willing to trade ownership for money. That's it.

The problem is that HFT is about profiting on even the smallest trades, but cranking up the volume to 11. It's kind of like what Wal-Mart did to retail, they make less money per item, but they literally make it up in volume.

Algorithmic trading can be slow or fast, but it plays off the fact that machines can compute the data and make a decision faster than humans can, especially on a digital marketplace.

It is unfair to human traders, sure. But, you have a digital trading platform, so at some point it's impossible to stop algorithmic trading.

If you want a market where the purpose is to create capital for businesses without dealing with machine trading, you need to start a new market that is not run by machines and is only operated by human, person to person trades.

Whether its through a use of taxes on trades(hit every trade on a stock held less than 1 hour with a 10c tax and all these problems go away), or changing the capital gains tax structure so that there is no capital gains tax on any shares of stock (private or public company) held for 1 year or more, and no tax on dividends paid to shareholders who have held stock in the company for more than 5 years.

There are probably some edge cases where a time based tax would be a problem but for the most part I think it would drastically reduce the HFT skimming. Then again, if you are making money on the market you are probably doing the skimming.

A big problem for markets is weak or too many short term investors, they can create a snowball effect. HFT trading algorithms are very short and can create flash crash windfalls. Luckily they can also buy up when those things happen and the whole thing is over in a blink but that seems too risky. What happens when all the trades are by HFT algorithms? Eventually if those make all the money then everyone will use them all the time. Where are the long suckers then?

Maybe it's because of my background in machine learning, but I view computers as a way to reduce the amounts of arbitrage opportunities and insider knowledge that can be exploited by traders to enrich themselves on the back of others.

Well programmed computers are able to use NLP techniques to read thousands of news articles, reports, financial statements, government data, demographic data , analyse millions of data points, sort which ones are important, build predictive models, and do it all in a few seconds of time.

A few computers can do the job of thousands of traders, do it with less bias and with better mathematically proven decisions.

Nowadays every time a human trader tries to beat the market by predicting short terms swings in prices, there is a computer on the other side of his internet connection that is relying on much more information and even models of the human's own personality and biases to trade against him. This means that unless the human has inside information that is not accessible to the computer, (and I'm sure those who operate these computers try to feed them or make them infer the greatest amount of direct or indirect insider knowledge as possible ) it will tend to be impossible to beat the market.

With the greater amount of information, the computers will keep the prices closer to real world fundamentals, bust bubbles before they inflate and reduce all the price swings that traders used to be able to exploit to make a profit on the back of less sophisticated investors.

By making obsolete the jobs of all these traders, they are making the market much more efficient. They are automating a kind of job that didn't produced any real goods. Hopefully, pushing these people into jobs that make something real instead of skimming the top of everybody's retirement savings (I can see why those who want to be traders would be upset about this).

Ah but you say, all we have done is replace humans from skimming our retirement savings by machines that do the same. This would be true if there was only one computer system competing against the human traders but there is a whole industry and they also compete against each other. Two sophisticated machines that trade against each other, will not only beat the human trader and put him out of business but reduce the arbitrage opportunity and margin each of these computer systems can exploit.

Contrary to what the article states, computers that compete against each other will tend to eliminate all short term unjustified price swings and leave only accessible prices based on real company fundamentals. Only long term traders that bet on fundamentals will be able to make money and they will make more money than when they were subject to be exploited through market distortions and bubbles.

This can all be proven by something called the efficient market hypothesis:

There is a great explanation by Glen Whitman of Agoraphilia, that uses grocery line wait time predictions as a metaphor: http://agoraphilia.blogspot.com/2005/03/doing-lines.html

See also:

http://lesswrong.com/lw/yv/markets_are_antiinductive/

http://en.wikipedia.org/wiki/Efficient-market_hypothesis

There are two main kinds of retirement savings, those where the retiree is in control of where their money goes - in which case they can choose to invest it as they wish. In an index, a company or anything else, and those where a company is investing on their behalf but with a legal obligation to pay out.

Now, if the company goes bust then that is not the fault of HFTs or managers skimming. Either they failed to make adequate contributions or they simply went bust because the business failed.

If you invest your money in ACTIVE MANAGERS then you'd best know who they are, what they do, and why they think they can win in a negative sum game. By definition very few actually can.

HFT is not the cause of pensioners going without - that is a combination of lack of contributions (based on unrealistic expectations) and poor investment decisions. They don't prevent you from spending all your money on Apple shares and making a killing, and nor are they to blame if you invested in Northern Rock and lost everything.

It is a fact that more money is spent on portfolio transaction costs for large pension schemes than any other cost. It is also true that much of it is unnecessary. But these are functions of investment choices based on active management, along with poor implementation and usually high management turnover.

HFT is the perfect example of this as they don't chase growth. There goal is to tax cash flows and market inefficiency. So, they leave low churn stocks like Berkshire Hathaway alone in favor of cheap stocks with a lot of turnover. If you keep your stock for an average of 10 years then HFT is meaningless to you. But, with hedge-funds often doing quite a bit of trading they can extract money without you realizing your trading.

In the end it's yet another reason 401k's are growing a lot slower than many people predict. Sort of like how people expect the economy to 'recover' when it was what there remembering is an unsustainable bubble.

PS: And of course Dividends are something of a special case in the above analysis.

Compound interest is an exponential equation. Even 1% growth means doubling every 70 years and 1,000x growth every 700 years and 1 million x growth in 1400 years etc. Let's say US GDP is X$ and stocks are 'worth' a 100,000 X. At some point the market get's so far from the 'fundamentals' you get a crash, but it's more like a return to rational behavior.

PS: That's not to say tax breaks like 401k's cant shift things for decades. But, there is only so far you can inflate any bubble before it pops.

Of course, the efficient market hypothesis is basically an unproven assumption.

The general gist of it is obviously somewhat reasonable, but you have to be extremely careful what kind of statements you really believe.

Just to make two obvious examples: the strongest form of EMH claims that asset prices reflect even hidden information. That cannot possibly be true, because the circle of people with access to that hidden information most likely does not have enough money / market power to affect a shift of sufficient size.

The other example: slightly weaker forms of EMH still claim that prices adjust immediately to new information. That cannot possibly be true either, because traders simply aren't that fast. HFTs typically cannot afford to put so much money into affecting big price shifts, and other traders are slower. Besides, it's clearly falsified empirically: if this form of the EMH were true, stock prices would look like step functions, and they don't.

Another argument against EMH is complexity theoretic: one can most likely show that if EMH were true, the market would solve NP-hard problems efficiently (I remember seeing a line of work that attempted to show such a thing, though obviously the modeling is very messy).

Now you might argue that EMH still somehow approximates the real world. Maybe. But small errors can add up, so you have to be really careful in your thinking.

Forget traders...our universe has a speed limit.

This is assuming that computers only try to extract money by going long on every stock they purchase, an incredibly ignorant view of finance.

Instead what you would probably arrive at is an arms-race of retail investor-accessible HFT systems competing for investor dollars. That arms-race would just lead to a market even more arbitrary than the one we have now where the HFT systems are using fundamentals and at the same time learning about the trading patterns of the other systems indirectly to exploit them. Investors would be investing in the trading system instead of the real market, it would be reduced to gambling on the race instead of investing in the market.

My personal opinion is the HFT systems of today add zero value, as argued in the article. The liquidity provided by them is an illusion as they skim a cut off between the original seller and their buyer on the two ends of the trades they perform.

http://en.wikipedia.org/wiki/2010_Flash_Crash

Otherwise it would be easy to make a very profitable algorithm on the back of the machines that create flash crashes by detecting those crashes and buying tons of shares when they are discounted in order to sell them back when prices returns to rational levels. By buying on the crash this algorithm would push the price up thus reducing the price swing.

"This can all be proven by something called the efficient market hypothesis" really? This is even worse.

Front running is a betrayal of the fundamental behavioural "assumptions" underpinning economic theory. By definition, without these assumptions, there is no EMH. So this whole thing falls apart.

That's why this is such a problem. If you really believe in markets, the first thing you do is make sure their underpinnings are not corrupted.

Its not clear that OWS believes in markets. The critique I'm outlining above is a seperate position alltogether.

This isn't accurate. Computational trading uses models and algorithms. Even if the computer has all the information necessary, sometimes the models themselves have flaws. We're not at the point yet where the computers are making these perfect, predictive models. The humans who make them will make incorrect assumptions. We saw this issue big time in 2007, and we'll see it again.

Given that the rejection of HFT has to be overbroad. If they liquidity they provide is the sort of that supports the functions we like, who cares what their holding periods are?

It certainly seems true that Cuban is right about "hacking" the market insofar as yeah, a good deal of HFT sounds like exploitation of rules and procedures to avoid creating the fair market intended. But that means there is "bad" liquidity, which doesn't serve our purposes. Okay, so let's write rules that better serve our purposes for liquidity. (And if we're worried about market distortions from bad trading liquidity, what about the market distortions from Fed provision of currency liquidity? The wash of cash has lifted all asset prices, it's hard to see economic signals when price correlations are moving to one.)

Cuban seems to think we can do just that by manipulating investor incentives -- give them tax breaks for holding periods, tax transactions, etc. But all of these just make the market more complex, and increase the differential between investment categories -- all of which creates more incentive for financial hacking and further detaches pursuit of financial return from realization of economic return. It makes the rules less comprehensible. And it gives the politicians and regulators more to do in the markets, which makes them more attractive targets for lobbyists. He's increasing the incentives for soft corruption while making it harder to spot, the consequences are easily predicted.

Cuban is a smart and pragmatic guy with billions of reasons to think himself smarter than the average bear. Part of his smarts are an ability to keep it simple, and an instinct when things are out of whack. But here that instinct have lead him through simple on to simplistic.

The argument was that in a normal industry, companies in competition with each other benefit when a competitor goes out of business. Other firms step in and snap up the opportunities. But with Wall Street, the whole network of companies needs a government bail out to stop their wholesale collapse when one company gets into trouble (eg. Bear Stearns, Lehman Brothers). Thus they are not really an industry of competing companies, but should be seen as a single monopolistic entity.

(of course they are filled with competitive people, but think of how departments and employees within the same company compete with each other)

I think part of the point (maybe Cuban's point) is that gambling isn't helping anyone, either. Financial markets were designed in theory to get capital to the right companies. HFT is a lot like a Native American casino...there was something much more profitable to do with the real estate than it's intended use.

I disagree with this. How many people believe in Apple as a company and invested in it's growth over the last 8 years. Or Target over the last 3 and there are many others.

The challenge as I see it is that it is very difficult for the companies to actually leverage the growth in their stock prices. The companies need to buy and sell their own stocks in order to use the money as investment. Unless I am missing something huge here. Most of the time it seems it is only an incentive to management that the stock price increases. But really, the capital isn't invested in the company, it is gambled on the company.

   However we need to do it, we need to get the smart money
   on Wall Street back to thinking about ways to use their  
   capital to help start and grow companies. 

I still look at Prof. Sadoway and think how will he get the investment he wants from US markets. Its either VCs, Green Funds or soverign funds making all the running - the business of creating new businesses seems to have fallen out of favour.

Proof - none that you can speak of, except for my bones.

Also, Wall Street != algo/program/high frequency trading. That area of the capital markets, which requires sophisticated market infrastructure to exist in the first place, is exceedingly small by headcount and profit share.

>"The best analogy for traders? They are hackers."

Traders are hackers, and so are entrepreneurs. The kind that likes to tinker with data, play with mathematical models, and find nuances previously un-noticed or empirical anomalies irrational. The dream is to, in the process, find a way of modelling phenomena presently deemed unpredictable, i.e. to discover something new.

>"Discussion in the market place is not about the performance of specific companies and their returns. Discussion is about macro issues that impact all stocks."

Adam Smith didn't write about economics, he wrote about the political economy. The post-War trend of having a secular divide between politics and markets is historically unprecedented. Discussion has shifted because the salient points have shifted; beta is dominating alpha. A visual could be a slick of oil on top of an ocean - the oil is company-specific factors and the ocean the general market. In calm seas just watching the oil is fine. If you're in a Hellenic thunderstorm, however, the dominating factor is the rolling waves. Don't blame someone else because your model is obsolete.

>"I would be curious if anyone out there knows what percentage of transactions actually return money to a company for any reason"

I'm not sure what this means, so I'll take it as what percent of revenues came directly from capital raises (IPOs and debt offerings). This supposes that all other functions at the bank, e.g. asset management, making markets in stocks, providing brokerage and execution services, etc. are useless. From their latest GS 10-Q [1] we see that they earned $1.4 billion in underwriting for the first half of 2012. Not including net interest income their revenues for the same period were $14.5 billion; thus, underwriting represented 10% of Goldman Sachs's revenues for the first half of 2012. As a percentage of transactions I'm not sure how you'd work this out (is an IPO one transaction? Multiple?) nor what use it would be. For reference, underwriting represents nothing of Blackrock's or Bridgewater Capital's revenues.

>"Wall Street as a whole needs to be in the business of creating capital for companies and selling shares to investors who believe they are shareholders."

A healthy primary market cannot exist without a healthy secondary market, i.e. the success of an IPO, and whether it happens in the first place, is strongly related to how investors feel about being able to sell at some point down the road without incurring losses.

Let's examine the connection between holding term and governance mentality. The FT recently had a piece documenting that institutional investors, who own roughly 70 percent of U.S. stocks, despite having long-term positions and near total voting control, tend to by default vote with management and not participate in corporate governance [2]. Resolving our public capital markets is more complicated than fuck the facilitators; ape-handedly throwing taxes around before thinking through the consequences, intended and otherwise, isn't smart (though it will evidently get your article views).

--

High frequency traders, in a race to the bottom, are in the short-term being run into the red by firms that trade time-consuming safety checks for speed. In the end the bad drives out the good and the market de-stabilises. The solution to this is having a series of pre, inter, and post trade checks that have to be run, e.g. monitoring the total dollar volume of trading over a time interval or the total dollar amount lost mark-to-market (yes, there are firms that took these functions out of pre-trade verification to save a few milliseconds). This puts a natural and non-arbitrary speed limit on the markets which accomplishing something meaningful in that time beyond feeling good about having conducted a witch-hunt.

[1] http://www.sec.gov/Archives/edgar/data/886982/00011931251234...

[2] http://www.ft.com/intl/cms/s/0/e19b6a54-fbf8-11e1-aef9-00144...

Technology is the last thing Wall Street sells.

A talk by the founder at Stanford: http://www.youtube.com/watch?v=jH-wyaS2Rn0

That's why we live in a free society.

There is no valid reason or excuse for putting a gun to someone's head and telling them, "stop trading or else," which is what you keep insisting on.

Now, if everyone chose to do those things, that would have a huge negative effect on society, massively greater than anything Wall Street has ever inflicted. But that doesn't imply we should regulate how much people are allowed to buy gold or stuff their mattresses.

"Individual investors and the funds that just invest in stocks and bonds are not going to crash the market."

So what happened in 1929 then?

http://imgur.com/DxWer

http://www.economist.com/node/21547988

So say you trade against an HFT algorithm. If you are talking about the narrow context of the trade, it is zero sum. But that is not how the world works. Bill Gates can sell a share of Microsoft to a market maker trader/HFT. Say he does this for $26.00. Tomorrow, it goes to $30.00. In the context of the trade, Bill Gates "loses" $4 to the HFT algorithm. But that is not the whole story. He took that $26 and did something with it. Maybe he helped fund a startup which has created value and doubled his money. So now the HFT trader is up $4, and Bill Gates is up $26. Zero sum, huh? Or maybe he invested it in a Malaria vaccination program that has no easy dollar valuation but is clearly positive to the world. This is why in the context of the system, everyone can win, and it can be a positive sum game.

If you invested your savings 18 years ago for your kid to go to college, at some point you will sell that stock to raise cash and pay for college. You are investing in your child's education, so that he can have a good life, invent things, cure cancer, solve P vs NP, improve Shor's algorithm, and more. That seems like a good return, even if 4 years later the HFT algorithm you sold your stock to made money because the stock went up.


When the world changes, prices change as well. As an HFT firm, you are always sending prices that are competitive for customers. HFT being fast is the effort to improve prices as quickly as possible, or admittedly, pull prices if they are no longer fair. Often, this is a typical scenario for an HFT firm…news comes out on a stock that is positive. The old bid for the stock was 20.00. That means if you are sending an order to sell your shares in the stock, to say, raise money to send your kids to a good college, you will hit the bid at 20.00. If HFT is not fast, you will get $20 for your share, even though the news hit 2 seconds ago. HFT algorithms compete for your business in the sense that they try to be fastest to improve that bid price to 20.05. If they are not fast, you get $20. If they are fast, then you get $20.05. What is the problem here?


The bottom line of all this misunderstanding is, I believe, a distrust of where all this money is coming from that they make. It's simple--it's from them cannibalizing the old human, specialist trader business (do you know how many billions they made from retail before HFT?). It's no different from a startup upending an old industry veteran by undercutting their prices by 90% and taking away all their business.

All of Wall Street exists to do one thing: connect those with capital to those who want it.

The primary market exists to do what Wall Street is meant to do: a company or other entity wants money, an investment bank connects that company with investors, and investors hand over the money. Wall Street acts as a classic broker, executing the function it was meant to perform (match those with capital to those who want capital). For its services, it takes a cut.[1]

This part of Wall Street - the primary market - works reasonably well and there aren't many complaints about it.[2] In fact, people sometimes complain about the IPO market getting too hot, which really just means that more companies in the real economy are getting money. The biggest ongoing complaints about the primary market are that the big banks charge too much for the capital raises and that they hype up the securities. Neither is a particularly cutting complaint though, nor is either issue crippling in any way to the capital markets.[3]

This brings us to the secondary market - the stock market as most people know it. Most people never participate in the primary market (i.e. in the first sale of securities), but rather in the secondary market. Here's the core question: WHY DOES THE SECONDARY MARKET EXIST?

The secondary market serves a support function to the primary markets. It provides "liquidity" to the primary investors - that is, it gives them a reasonably easy and cheap way to offload their shares should they choose to do so. The idea is that if there's a ready secondary market for the shares, primary market investors will be more willing to participate in deals because they know they can get out quickly and cheaply if they want to, and they'll be willing to pay a higher price for the shares for the same reason. In more technical terms, the secondary market serves to increase the flow of capital to companies and lower the cost of capital for companies.

And this is where all the problems Mark Cuban is citing come in, plus all the problems that financial regulators were trying to deal with in the last regulatory push (Volcker rule, Glass-Steagall, etc.).

The main issue here is that you can't really draw much of a line between "market-making" and short-term trading. Market-making is something most people agree is a good thing - you want a healthy number of market makers competing transaction costs down and providing sufficient liquidity (again, all to serve the health of the primary markets). And short-term trading is something that most people feel is a bad thing - it creates short-term thinking in the markets, which usually flows over into the companies, so you have everybody thinking about the next quarter, which leads people to ignore longer-term and deeper issues. But both market-makers and short-term traders are just buying and selling securities - it looks exactly the same. This is why the Volcker rule is so ineffective. The rule stated that a financial firm could only have a few percent of its capital in "proprietary trading," but every trader at any financial firm knows that most of the trading (and most of the lucrative trading) happens on the market-making desks. Buy a portfolio of illiquid emerging market bonds at 70 cents on the dollar from an investor looking to offload quickly, warehouse it for a few days, and offload at 85 cents. That's market making. And it's also short-term trading. There is no difference. The trader had to make a judgment about whether he would profit on the trade - whether the price of the bonds would hold up until he could offload it, or whether he got it at enough of a discount that even a move against him wouldn't hurt him. He probably thought about whether he could hedge it while he held it or if he could somehow line up a buyer before he even bought it. A high frequency trader is technically doing the exact same thing - just buying and selling; they just get very fancy about figuring out whether they'll profit on the trade: fractional penny arbitrage opportunities, information about where the price is headed in the next half-second, etc.

The best idea I've heard in terms of tackling this specific issue is to alter the tax structure. Mark Cuban advocates this in the form of a 10 cent tax on trades held under 1 hour. Another version I've heard is to levy a similar penalty tax on any capital gains reaped on a trade held less than 3 months (i.e. taxed as income plus a penalty; right now it's just taxed as income), and to move the lowered long-term capital gains tax rate to gains on investments held for more than 2 years (right now, long-term is 1 year). This would certainly discourage short-term trading, but that would mean that it would also make trading slightly more expensive for everybody, which some people think would be a good thing in that it would make people think twice before they traded something, while others argue that it would be a terrible thing because it would hurt the smallest players (individual investors) the hardest - after all, they're the ones who feel trading costs the most in percentage terms (trading costs as a percentage of the amount they're investing).

As a final thought, while all this trading and short-term thinking seems like it hurts us in the long-term, I don't think this is where our energies should be focused in terms of regulation. Trying to get people to stop short-term trading in the market would be like trying to get people to stop going to see movies for all the violence. Sure, it'd be nice if everybody thought like Warren Buffett in the market, and it'd be great if everybody just wanted to watch Stanley Kubrick films. But the important thing is not to get people to be "better," but to ensure they can't cause much damage as they're acting on their impulses. People like violence, but we keep guns away from them. People like short-term trading, so we need to keep LEVERAGE away from them. If you limit leverage, you limit bubbles and busts. It's that simple and that difficult. Bubbles and busts will still happen because people will chase up prices of some securities and then run for the hills once prices falter, but you need to make sure they're just running and not rocketing. Leverage is that rocket - limit it, and you've got the most elegant solution to the major problems of the financial markets. Don't try to enforce good behavior; just limit the power of bad behavior.

[1] Some people complain about the size of the cut that Wall Street takes for these services. The cut is stable and large for 3 reasons: 1. There's an oligopoly at the top. 2. The risks to a failed capital raise are huge, financially and reputationally for the company raising capital, so they usually opt to go for one of the few top players (protecting the oligopoly). 3. Like most large negotiated transactions, there are higher costs of doing business (think cars and houses).

[2] In the primary markets, the area that probably poses the biggest danger to the economy and society as a whole is when it gets into non-plain-vanilla securities, i.e. stocks & bonds work just fine, but derivatives and other instruments (like some asset-backed securities in the last crisis) get a bit more tricky. But I'm going to leave those aside for now since Mark Cuban is mostly addressing trading in the stock market and plain vanilla capital raising.

[3] The costs have been pretty stable for long stretches of time without seemingly barring companies from raising capital or making the capital raise so prohibitively expensive that people don't participate. And on hyping the securities, investors know that there's a financial relationship between the company and the bank, and they're for the most part pretty aware of this and therefore do much of their own research. All the major mutual funds and hedge funds do their own research and know not to rely on bankers (to the point that many portfolio managers ask that the bankers remain silent during meetings with companies that are raising capital until the discussion gets to specific deal terms, and if the company is not raising capital but just meeting with portfolio managers or analysts, the PMs or analysts often don't even allow bankers in the meeting room but ask them to wait out in the lobby or waiting area).

so, i believe information asymmetry is possible. i believe that many good ideas are in such a relationship with the world that the people who have them have an asymmetric advantage over those who don't: that possession of the idea equals wealth, as long as you are attempting to execute. (wealth in the net-present-value sense, not liquidity sense.)

this gives you the interesting situation that you can be walking along the road and, if you are the right person and respond properly, you can immediately in a bolt out of the blue become richer by the net-present-value of the idea you are just struck with: provided it is one of those asymmetric ones and you proceed to execute on it.

now. now, for the larger ideas (like Google), the net-present-value was in the millions. but if the people doing it had actually had millions of liquidity, they would not have been coding: they would have hired a coder.

so please assume p, where p is "a person with a net-present-value of $n million is currently coding something which will make money and then allow him to hire coders. assume that with probability 1 he will succeed."

as he is coding, before he actually has succeeded, what business is he in under p?

i would say he is in the information-arbitrage business. he is coding at $0/hour against the net-present-value of the idea he has. it seems to me kind of an arbitrage thing.

this is assuming p, which means that this is an assymetric condition where with probability 1 he pays off. obviously it becomes more complex as we get into probabilities other than 1 - but is this a fair conclusion about the startup hacker?

that he is arbitraging information asymmetry?

as i mentioned at the start of this comment, this is a technical argument and i'm not sure of its validity. any feedback is appreciated.

if you hate my assumptions (specifically, p) i still would appreciate to go with them as well as any other thoughts you may have, which you can address separately.

Enron was famous for booking predicted lifetime profits based on the ideas that they had and look how that turned out. It isn't logically wrong but it probably is too hard to do realistically, not just predicting the profits in the first place but updating them with circumstances.

If your person had his bolt in the blue and became richer the moment he/she heard about a competitor launching before them with a similar idea would instantly become poorer (as they wouldn't have the market to themselves) and they should remark their book value.

BTW without capitalised sentences and in stream of thought style I found this really hare to read. I suggest you work on the presentation before explaining it to anyone else.

you are completely right that it's hard to peg the shift in present-wealth without a crystal ball, which nobody possesses - moreover, the future isn't even written.

so let's give you the crystal ball - it jumps wildly between valuation your net-present at a few million and hundreds of millions and sometimes billions and sometimes tens of billions and then millions again. it's useless.

but suppose that it is quite consistent that the idea is worth at least $20 million in net-present.

so, in this case - what is going on here when you, an only "competent" coder, are coding the idea yourself? Why would a millionaire code at a quality he could barely sell in the market (not being a coder), and which is just enough to show a prototype which gets funding, which gets the ball rolling, which... (all the things that lead to the net-present jumping between $20 million and billions, but never lower than the former).

So, what is going on here? Why is the person working at $0/hr producing work that's worth maybe $3-$4/hr? (buggy poor-quality spaghetti code php with no source control, for example.)

He is also directly losing a wage he could be earning elsewhere.

what is this behavior? What is going on here?

one answer could be, couldn't it, that he's producing low-quality, poor labor, because he has the chance to buy a chunk of a high-quality idea with it?

i mean, i personally know of a lot of stories of hundred-million dollar exits that started with an idea that the founder started following up on by-

- doing poor-quality accounting and business founding,

- poor quality legal research

- poor quality coding that had to be thrown away after his company was bigger

- poor quality biz dev that was mostly spinning company's wheels

a lot of other things of very low quality...

... but of quality just high enough that the idea pulls the company through, and his preconceptions can be changed by high-quality lawyers, his code is thrown away and rebuilt by real engineers, his b2b attempts are repeated by someone who can actually push deals through, his logo is replaced by a real logo that doesn't make you laugh, and so forht.

so, what just happened in this whole last example? what was the beahvior that led to it? (in abstract, theoretical, technical terms).

i want to know why he's buying his own low-price, low-quality labor, and why this works.

Freedom from responsibilities to others (employees, investors) could allow creativity.

Singular vision for the product without compromise.

No need to describe requirements to others.

Get a basic understanding of all areas while it is fairly simple before scale up (accounting etc.).

Also the pure logical case only really works when you have enough cash to invest yourself in building the business or you would have to put the effort into finding and managing investors.

The low quality version might actually be a good investment in the shift it makes in the external perception of value is sufficient.