Zerohedge’s high frequency primer and bitcoin
I’m against HFT, and when I saw that bitcoin was gonna get HFT that was gonna be bad. Naturally the real problem is the federal reserve, and HFT while a terrible thing, serves to distract from the real issues of central banks and the real people pulling the strings. I suppose after running into Forex, they are again trying to run into bitcoin, with the now increased added regulator scrutiny as goldman prepares to throw hft under the bus and use it as a scapegoat for impending collapse (they sold their $20b hft for $30m?)
It is this inextricable link between the venue and the algos that dominate the venue, that has led many to suggest – correctly – that one of the key culprits for HFT proliferation is the dominant exchange business model, known as the Maker-Taker model, in which the liquidity provider is paid (in practical terms it means paying those who provide liquidity with limit orders even it the limit orders are merely “flashed” subpenny orders frontrunning a major order block), while charging liquidity takers (those who take away liquidity with market orders). This is summarized in the panel below.
KNIGHT CAPITAL LOSS – OVER $450 MILLION + WAVES OF ACCIDENTAL TRADES
A software malfunction from Knight caused waves of accidental trades to NYSE-listed companies. The incident caused losses of over $450 million for Knight. The SEC later launched a formal investigation.
GOLDMAN SACHS – $10S OF MM + TECHNICAL GLITCH IMPACTS OPTIONS
An internal system upgrade resulting in technical glitches impacted options on stocks and ETFs, leading to erroneous trades that were vastly out of line with market prices. Articles suggest that the erroneous options trades could have resulted in losses of $ 10’s of millions. Goldman Sachs stated that it did not face material loss or risk from this problem.
NASDAQ – 3 HOUR TRADING HALT DUE TO CONNECTION ISSUE
Due to a connection issue NASDAQ called a trading halt for more than three hours in order to prevent unfair trading conditions. A software bug erroneously increased data messaging between NASDAQ’s Securities Information Processor and NYSE Arca to beyond double the connection’s capacity. The software flaw also prevented NASDAQ’s internal backup system from functioning properly.
NASDAQ – DATA TRANSFER PROBLEMS FREEZE INDEX FOR 1 HOUR
An error during the transferring of data caused the NASDAQ Composite Index to be frozen for approximately one hour. Some options contracts linked to the indexes were halted, though no stock trading was impacted. NASDAQ officials state that the problem was caused by human error. Although the market suffered no losses, this technical malfunction – the third in two months – raises considerable concerns.
This new environment puts brokers in a difficult position. They have a fiduciary responsibility to provide best execution to their clients. This requires them to invest in new technology to source liquidity and defend against HFT strategies. And because many of these venues now pay rebates for liquidity, which is quickly provided by HFTs, brokers are usually left having to pay active take fees to the venue. And at the same time that brokers are incurring these costs, investors are pressuring them to reduce commissions.
These pressures on brokers’ margins are creating conflicts of interest with their clients. By accessing venues with lower trading fees, or attempting passive order routes of their own, brokers can reduce their operating costs. However, these trade routes are not necessarily best for the investors.
Sophisticated investors now demand granular execution information detailing how their order flow was managed by their broker so they can ensure they are receiving the best execution. While brokers provide aggregate performance reports, investors can build a more complete analysis, including broker performance comparison by using more granular information.
Summarized visually – Before:
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