Stock Market Manipulation By Millisecond Trading 624
cfa22 writes "Nice piece in the NY Times today on ultra-fast trading on the NYSE and other markets. The 'algos' that make autonomous trading decisions have to be fast, but I wonder: Is network speed ever a bottleneck? Can anyone with inside experience with millisecond trading provide some details for the curious among us regarding hardware architectures and networking used for such trading systems?" According to the article, high-frequency traders generated about $21 billion in profits last year.
Human reaction bottleneck (Score:2, Interesting)
winner-take-all competition (Score:5, Interesting)
Re:Profits, but for whom? (Score:5, Interesting)
Ultra fast trading is an interesting idea and done right it can lead to successful short term returns, but if you take a Ferrari around a hairpin at 120mph, you're still going to hit the wall and die.
Here's what happens when that particular Ferrari hits the wall:
http://tech.slashdot.org/tech/08/09/10/203233.shtml
Performance is a driving issue (Score:5, Interesting)
A firm I worked with recently tore down an arbitrage network (they were getting out of the business as it was not core) which comprised of a great deal of Layer 2 dark fiber between sites in NYC and an external data center in NJ, Force 10 fabric switches with multiple paths to server clusters, and a great many Sun X-series servers running Linux. This arbitrage network bypassed the standard corporate (i.e. Cisco-based) network as they wanted exclusivity, higher bandwidth and as much speed as possible. Still, there were issues and the whole environment was scrapped since the actual returns did not match the expectations or cover the costs.
When I looked over the shoulders of the designers (they didn't want too much support from the regular network engineering team) they were concerned with raw performance and not as much with security or other daily operational issues. I would characterize it as the difference between, say, a NASCAR Sprint Cup car and your regular transportation. The former is purpose-built solely for performance while the other has to contend with safety requirements, daily functionality, and a lower common denominator for use.
Re:Profits, but for whom? (Score:5, Interesting)
Can someone explain to me the benefit to society of this kind of activity? I get how the stock market is beneficial, generally allocating resources according to the merit of the business ventures involved, investing capital where it will produce goods/services/jobs, and so on. So despite being a social lefty, I'm not anti-capitalism or anti-stock-market; it has risks and flaws but it works. But how does this kind of stock trading benefit anyone other than the traders themselves?
Allston Trading Has Spoken At My University (Score:5, Interesting)
Allston Trading occasionally speaks at my university, and they've said that network bandwidth can be a big bottleneck. They needed to install servers across the street from the NYSE to attain the edge they needed.
As far as who the profits go to, ALlston (and I suspect many similar organizations) keeps most of their profits internal, and exercise big profit-sharing programs for their employees. It's actually quite an interesting idea, as this group of almost entirely Computer Scientists are using their expertise to make some good money as a cell in an atmosphere dominated mostly by business-types.
Some info (Score:5, Interesting)
FAZ and FAS funds (Score:3, Interesting)
This has been a common topic on the stocks news groups about FAZ [google.com] and FAS [google.com] using different methods because of inefficiency between the two funds.
They are support to inverses of each other (short and long) of the finacial markets with leverage, but a few people have noticed that during the first minute of trading they aren't exactly the same.
The basis of the what people are doing is complicated and usually involves buying both shares and dumping one in the first minute and then selling the other shortly thereafter.
But there are other methods people have talked about but I can't seem to find the newsgroups since they were buried in spam a month or so ago.
Re:meh (Score:3, Interesting)
No, the little guys still have hope, they can still make money, just maybe not quite as much as these "super-fast" traders.
(Disclaimer: I work for a financial firm. This isn't really news, as the market for these types of trades has been mature for a while now)
LOL, and now I get the "Slow down Cowboy" message. It appears slashdot does not believe in micro-second posting. ;-)
Re:Profits, but for whom? (Score:4, Interesting)
Traders make a profit on each trade. But the profit is always to the broker.
Depends on who your broker is and what kind of account you have with them.
A true blue day trader is going to have a setup for Direct Access Trading [wikipedia.org] which isn't what you see on TV for those $9 dollar trades for the average Joe.
It requires you to have more than say $20,000 in the account and you must make a lot daily trades to be eligible, but the transaction fees are very low per trade so you won't be paying as much to your broker (like pennies on the dollar sometimes if volume is high enough).
Re:Great future (Score:3, Interesting)
The corporations are owned by investment funds which in invest money for investors. Everyone from you or me and out pensions up to the big fish with their hundreds of millions.
I'm not complaining that the evil corporations are hoarding the money away from the common man (man), I'm just wondering why the average Joe has to work as hard as ever and still has a struggle to provide for his (ever retreating) retirement, when traders trade in more than enough for everyone.
I guess that makes me a socialist or something.
Re:1588v2 aka Precision Time Protocol Version 2 (Score:5, Interesting)
Anyways, back on the original question, no, network speed is not so crucial once all of your packets are properly timestamped.
RTFA:
One second after the market opened, shares of Broadcom started changing hands at $26.20.
...
While markets are supposed to ensure transparency by showing orders to everyone simultaneously, a loophole in regulations allows marketplaces like Nasdaq to show traders some orders ahead of everyone else in exchange for a fee.
...
Automatic programs began issuing and canceling tiny orders within milliseconds to determine how much the slower traders were willing to pay. The high-frequency computers quickly determined that some investors' upper limit was $26.40. The price shot to $26.39, and high-frequency programs began offering to sell hundreds of thousands of shares.
On the one hand, you can call this 'perfect price discovery'
OTOH, that specific set of behaviors fundamentally breaks the traditional way that the imperfect markets have worked.
And just as importantly, it represents an unfair trading advantage that you or I will never have.
Allowing this behavior doesn't further market activities, it just allows a few players to accumulate wealth at everyone's expense.
Seems to me that the solution is to close the loophole that allows this to happen.
Re:Great future (Score:5, Interesting)
You actually could have a life of comparative leisure relative to the past, but humanity spends huge amounts of time competing with status displays which have become vastly more important to personal happiness in the more "relaxed" world. If you're willing to live a 1950s lifestyle you should be able to have far more leisure time than the 1950s person. Remember though that you'll never leave your home country for travel, live in ~300 sq/person house, share a household immediately after college, and you would probably only own 3-4 suits of clothes.
Cancellation fees (Score:2, Interesting)
Canceling an order should be discouraged, in the form of a fee small enough to be merely annoying to someone who occasionally cancels an order, but costly enough to discourage routine cancellations.
It's frontrunning, not lag. (Score:5, Interesting)
GS sees both the buy order and the sell order.
They can sell before large sell orders. Then buy again after to avoid a loss.
They can buy before large buy orders. Then sell right after to take a gain.
It's called front running and it's illegal.
But the government is not enforcing the law.
My theory is they are letting illegal activity go on to hold up the market prices.
I could be paranoid. But I've been in this thing for 28 years now and I've never seen such goofy market behavior and repeated evidence of price manipulation at market close on thin volume-- and yet there are no investigations.
Re:Primarily Fiber Channel Networking (Score:1, Interesting)
Rubbish. These networks tend towards Infiniband. Fibrechannel is only used for storage, and is too slow for use in real time trading systems.
Re:Profits, but for whom? (Score:4, Interesting)
I get how the stock market is beneficial, generally allocating resources according to the merit of the business ventures involved.
I realise I am likely to be charged with trolling [again!] but the stock market now seems to reflect the quality and quantity of ype not products and services. The market capitalisation of dot com companies in particular (AOL is wonderful example) is ridiculous when stacked against their profitability. Nuts and Bolts companies are dull, don't generate headlines and thus don't post great dividends for their shareholders as no-one even cares if they are making a regular profit. Stock markets seem now to be so detached from the reality of the profitability/financial viability of a company that watching the rise of shares to ascertain corporate health is foolish at best.
I wonder if theses 'algos' have some built in A.I. which parses the days headlines to see if sufficient vacuous hype has been generated to make an investment worthwhile . . .
Re:winner-take-all competition (Score:5, Interesting)
The location of their server no longer matters as GS was allowed to put a peeker in line between everyone else (on the planet) and the publicly traded ETNS. They get an opportunity to front run every transaction. Every single one. Zerohedge is a financial blog that has been keeping up with this story. Their coverage is good if a little breathless.
Link is to their "high frequency trading" tag:
http://zerohedge.blogspot.com/search/label/High%20Frequency%20Trading [blogspot.com]
Re:Profits, but for whom? (Score:5, Interesting)
Chicago trading experience as a Sys Admin (Score:3, Interesting)
I was a Sys Admin for a day trading company in Chicago.
We had a 100mb serial line direct to all of the major markets that we traded in. We also traded the European markets. Trades were taking upwards of 300ms to complete. So, we spent $25mil USD to build a data center in Germany. We could then use Citrix to remote into this data center and trade, We still had traders that would scream for us when a trade took >100ms on the local markets. And we came running and scoured network logs trying to find the bottleneck.
We replicated all traffic to certain ports on the Cisco and had Wireshark running constantly, even after hours. Every millisecond counted. And seeing that the owner of the company personally made $3mil profit every quarter, it seemed to be working.
Welcome to 1992 (Score:4, Interesting)
We had a couple of mini-meltdowns of the market in the early 90s because of programmed trading that went haywire. Ever since, programmed trading and the arbitrage that comes from out-pacing the market by a few seconds (at first, and then a few tens of seconds and now milliseconds), there has been an ebb-and-flow that looks like this:
* Someone starts doing this (they think it's the next big thing)
* They run into problems, and accidentally make the news
* The news media is all shocked that this new thing is happening
* The company (or project) that started it either goes away or settles down and becomes a mature member of the programmed trading community.
The interesting story, and the one never covered is the nature of the mature community. They essentially have a shadow-stock market that hasn't fully been regulated, and which is literally invisible to most humans. Now, these companies are mostly very large and stable organizations that want to stay that way, so for the most part, they implement controls that are sane, but as we've seen over the past few years, systemic mistakes which have no obvious downside until they cause wide-spread failure are not typically regulated well from the inside (alas poor Lehman, I knew you).
However, we should be clear here: this arbitrage is very often not as valuable as you would think. It costs a lot of money to do and has fairly small margins of return. It makes money, but there are easier ways to make money in the market. On the other hand, it has the virtue of very high turn-over, which means you can throw a pretty sizable chunk of money at it. When you're a large investment firm saying "sizable chunk of money," you typically mean, "dang, they won't let me buy more than 10% of IBM in this fund."
Re:Profits, but for whom? (Score:5, Interesting)
>But how does this kind of stock trading benefit anyone other than the traders themselves?
How does any trading benefit anyone but the trader themselves? This high frequency trading issue is a moot point. There is nothing sinister about it. What bothers people is that a few are doing it and making oodles of money. I work in this industry and have worked at investment banks where you do high speed trading. But now I work at a hedge fund and we just avoid it. It is an arms race and what bothers people right now is that there is a break in technology capability.
I am not kidding here. I know for a fact a few houses have been able to get micro-second trades, whereas the rest of the industry is still dealing in milli-second trades. Thus what is happening is that some very very big houses are getting whalloped in a major way. Hence the sour grapes...
Re:Great future (Score:3, Interesting)
Re:An abuse of the free market system. (Score:2, Interesting)
This kind of activity is an abuse of the free stock market system.
This activity does not generate wealth. It doesn't create something from nothing. And it doesn't add value to society. If they generated 21 billion, then 21 billion was necessarily lost by others.
People should look down on this kind of business and method of trading.
A common and understandable misconception.
For the remainder of this comment, I choose shares in Google as an example. I have no position in Google, not an opinion on their current price.
Both arbitrage (making use of inconsistencies in the market) and speculation (trading for immediate short term profit, and not for long term investment) are activities that add value. It is important to understand that markets are not only there to facilitates exchanges (e.g. trading in securities), but they also play a vital role in information processing. The activity of trading feeds information into the world: If a person buys 1 share of Google for the price of x, this person is also saying "I am willing to put my money on the notion that 1 share of Google is at least x". The current price of Google is nothing else than the consensus opinion of all market participants.
The accuracy and efficiency of said consensus depends heavily on the tools available to the speculators and arbiters. Say I think that Google is currently overpriced. If the market rewards me for supplying this information, then I would do it. For instance, I could sell Google shares short (i.e. I would sell shares that I don't have, hoping to buy them later on at a lower price and thus make a profit). At the beginning of the financial crisis, a lot of governments disallowed trading short, naively expecting the market to stabilize. What actually happened ofcourse is that information exchange slowed down: if Google was indeed overpriced, this would be known much later to the world if short trading wasn't possible.
The bottom line: speculation and arbiters bring their information into the market and are rewarded for this by their profits. If the information is incorrect, they will be punished with a loss.
Re:Profits, but for whom? (Score:5, Interesting)
We did trading similar to this a few years ago, though we used a simple, pure-arbitrage strategy. We were trading the morning of 9/11 (pre market-open - the market never opened that day), and didn't pull the plug when the news hit. We were actually testing feasibility, and had not yet installed our server in a rack in Manhattan. My partner was trading (actually, "overseeing" is a better term) in a day-trading room about 30 miles N of NY. (Later we moved our server to the same building as the Island ECN, which at the time owned the ITCH technology mentioned in the article.). Everyone in the room stopped trading, their jaws dropped, staring at the monitor in the corner. BTW, the consensus in that room that day was that the market was not going to re-open. EVER.
My partner, though, is sitting in the back of the room, trading away (or, watching the computer trade away), wearing headphones, which already had the other guys suspicious. (The headphones didn't have soothing music, but vocalized order flow information - it was too fast to keep up with visually. My partner did have to intervene when things went awry, and the headphones told him when he needed to act or if things were humming along nicely.)
I figured later that we did about 5% of the pre-market NASDAQ trades that morning.
This gave me some consternation for some time. We made a bundle that morning, and the subsequent increased market volatility was the start of a winning streak. We did thousands of trades a day, and simply did not have losing days. Was there a purpose or value to our trading?
I eventually concluded "yes". We provided market liquidity when it was sorely lacking. The people who sold to us at, say, .50 outside of the market would have sold to somebody else at $1.00 outside of the market had we not been there as a counter-party. We stood there catching hot knives and handing them off, while providing the benefit of a quick and certain sale. This helped reduce spread and volatility.
Indeed, over the next couple of years, our typical profit/share shrunk from .10-.50 to 1-2 pennies, and competitors entered the market and the war of technological escalation started.
Now, as for the "flash orders", which apparently started last year, I don't see the benefit of that to the market. It just front-running in exchange for a fee paid for the privilege.
Re:Profits, but for whom? (Score:3, Interesting)
Re:Some figures, circa-2003 (Score:3, Interesting)
When I talk micro-seconds I am talking complete turnarounds in micro-seconds.
These days exchanges are offering inplace hosting. Thus you are connected with fibre to the exchange. Not cheap! For those exchanges that don't offer hosting the big boys lease buildings RIGHT BESIDE the exchange.
What seems to be the vogue today is probabilistic turn arounds. In other words you don't actually wait for the data or the turn around you just throw out orders and then keep a lagging system that tracks your error. This has actually sped things up quite a bit.
But like you said "this will take the biggest iron you can throw at it" and it seems right now there are many very big boys who are falling massively behind the curve. This is a game that only boys like Goldman's can support since the hardware and environment is not trivial. But then again I don't think I need to tell you that.
Re:Profits, but for whom? (Score:3, Interesting)
That's a fair point.
But why would you lay of 6,000 people and then give $100,000,000 to one person?
I'm sure $5,000,000 would have done just as well. Until the very late 1980's, $1,000,000 in today's dollars would have done just as well.
We are grossly overpaying people at the top.
---
However, I know at one company I used to work for, it made a profit every year-- it was bought and everyone was laid off.
The larger company took the customer list-- and lost over 80% of the customers since there was reason most of them were not with the larger company to begin with.
It was a waste of the larger companies money, destroyed 260 people's lives (some had been there 20 years), destroyed a profitable venture (It made about a million dollars a year profit after all expenses for whoever owned it). I don't know but I bet the larger company CEO got a big fat bonus for making such a boneheaded move (they basically pissed away 23 million dollars for a 200,000 a year in net profits).
---
But yea, inefficient companies do have to go out of business. Non-productive workers do need to be laid off.
OTH, when a corporation is providing no net benefit to a population- why allow it to stay in business?
Re:Profits, but for whom? (Score:2, Interesting)
The typical justification for this type of trading is that it "eliminates market inefficiencies." But the problem is that these kinds of short-termist hedge fund strategies work by exploiting price volatilities, so they actually thrive on, and need, volatility in the market. There are some times when it can actually magnify them, creating price bubbles, etc. When large volumes are traded through quant strategies like this it's easy to see how that could happen. Some box says 'buy' because prices rise a millionth of a click; then a million shares are bought, driving the price up further. Other traders who follow the really fast quant traders follow suit, and then you have a price bubble.
Re:Profits, but for whom? (Score:2, Interesting)
I give it no more than 2.
Basically I haven't seen anything that caused a restructuring of the way the financial industry does business, which is basically allowing them to build another bubble with the bailouts. In the next year or so we are going to find out nothings changed except more people are out of work. This time it's going to lead to a complete total lack of confidence in the government to do anything about it and absolute loss of confidence not just in the people running the financial industry, but in the industry itself.
There are a lot of people who believe that the market is based on good management and productivity of a company, when in reality a lot of these companies are propped up by marketing (product marketing, marketing of future expectations, pipe dreams
------example---
Someone buys a computer 4GB of RAM , 2 hard drives, 26" LCD, 3GHz processor. $1100
But really all they need is something to read emails. A setup for that can cost less than $300
So the actual value of that computer to a company is $300, but because of marketing they went and bought a $1100 computer.
This is a micro example. ------
Now apply this to a company who says their net is $24 billion. So are they actually producing $24 billion of worth. No because they sold $12 million of computers which really weren't needed and the actual end worth is $3million. So if you actually look at what their net worth of their end products is , it's actually only $15 million.
So now apply this industry wide. Most of you have been there and know how much is being wasted.
So a lot of the economy is still being propped up by marketing. And I'm not talking about just companies marketing, there are wall street financial interest and lobbiest, which are continuing a false economy.
But then again there is no telling how long a false economy can continue. Look at the number of tax attorney and accountants who would loose their jobs overnight if we went to a flat tax or a taxing scheme which was much less complicated.
Re:Profits, but for whom? (Score:3, Interesting)
In the US trading done by an automated computer program is illegal. Whether it should be or not I do not know. But apparently drastic market sways were once caused when computers used certain software to control sale and purchases. In order to drop the amplitude and frequency of those sways automated trading was deemed illegal.
Probably the real world effect of such a law is simply that the big firms must follow the law whereas individuals would probably never be noticed. But with this high speed trading even the little guys might stick out like a soar thumb.
Re:Profits, but for whom? (Score:3, Interesting)
I'm no fan of executive pay and bonuses, but HYPOTHETICALLY, that guy getting 100 million could be getting 90 million at the bank next door, and would jump ship if he was not adequately compensated.
These are extremes, but so is the reality of the payscales at these (huge) firms. Let's say these 2 firms, instead of being banks, are firms that deal in rocket science (to use a cliche). There are only 3 people in the entire world who know this particular rocket science.
So Bob with the 100 million bonus is legitimately necessary to that business operating. Your choices are to lose him and EVERYONE at the company loses their job, or you fire as many low-wage workers as necessary or possible to keep him.
HOWEVER, I don't agree at all that this rocket science scenario is legitimate. Nothing is really that hard.
It was a waste of the larger companies money,
Agreed - so how can companies get away with wasting so much money? The problem is massive consolidation in (most) US markets. When there are only 2 to 3 companies, or fewer, there is no competition. Prices are higher than they should be. Massive profits are raked in and handed to whoever happens to be at the top of the near-monopoly corporation. Capitalism cannot function successfully with such large companies.
If US regulators prevented such extreme consolidation, then there would be legitimate competition in both prices and wages. Bob the executive could not get a 100,000,000 bonus because the company would not have that much profit to overpay someone that much. Prices would come down on the products or services before the company would ever have that much profit.
This is exactly the problem in health care too. Would health care costs be so exorbitant if Blue Cross, Anthem, and so on were actually separate companies competing on prices and services? Of course not. That's the reason companies buy up competitors - it lets them offer worse service at a higher price, and their customers have no choice in the matter.
The only question is - why does the US government let companies do this? Of course the answer is - those businesses are the ones paying for the senators' and congressmen's campaigns. Customers and individuals have very little influence on what the US government does these days.
(sorry to go off on such a tanget :)
Re:Profits, but for whom? (Score:4, Interesting)
Computing horsepower and software yes, Bandwidth in large part, but you're forgetting the critical piece in something like this.
Lower latency.
They pay ridiculous sums of money to colocate and get gateways on high bandwidth high speed/low latency networks for market data feeds and trading.
The smaller brokerage house (if such a thing exists), let alone the day trader/personal trader is so over matched just in terms of how quickly large houses have access to the data, even before you start figuring in things like semi-automated trading algorithms, in-house matching (match sellers and buyers in-house and pocket the exchange's commission for yourself), and the ability to have multiple worldwide feeds to pick from (oh, NY is slower by 3ms today? better switch to the London feed).
I'm amazed at what is going on in some of these companies.
Re:Profits, but for whom? (Score:3, Interesting)
But unemployment went up by how much? It's a bit under 10% now... that's 4% over a normal economic period, who knows what it would've been if it wasn't for the bailout.
The money wasn't supposed to completely stop the recession, just lessen it's impact, so we can recover faster.
Re:Explanation must agree with the facts. (Score:4, Interesting)
Rapid day-trading has very little effect on long-term-held investments. One is looking at long term trends; one is exploiting intraday volatility. They're not mutually exclusive. It's very possible to make money from repeatedly shorting a stock that's still going up over the long term.
These rapid-traders are mostly playing a game against each other, not against long-term investors.
Re:Profits, but for whom? (Score:5, Interesting)
It's a bit under 10% as measured the new way created under clinton.
It's over 16% the way they measured it until then.
http://www.shadowstats.com/alternate_data [shadowstats.com]
And it's over 20% if you include people who have run out of benefits and people who used to make six figure incomes who "have a job" for a fraction of their former pay.
These are really historic times... the banks are refusing to take ownership of houses that should be foreclosed on. The banks are refusing to list houses they have foreclosed on to artificially pump prices. Cities are tearing down thousands of houses rather than let them sink to their true price (which may actually be zero anyway since without a job, you can't pay anything for a house).
Re:Profits, but for whom? (Score:3, Interesting)
That's a problem.
Because about 20% of the voters are voting to slit their own throats because of the Abortion and Gay Marriage issue. As they start to lose everything they own- some-- a few percent actually voted against more "pro elite" (aka "my base"), "pro corporate" policies continuing under more republican leadership. They do this partially because the right finally got their crap together in the 80's and 90's and have a massive propaganda engine running that has people making $40k seriously believing some tax on people making $250k+ is going to affect them-- ever.
Basically, I'd rather be unemployed and give the wealth of my entire neighborhood to one person so I can shift the court towards overturning abortion and to put politicians in who will promote religion and fight gay marriage.
And it's a principled position so I can't knock it that much. I spoke to a democratic labor lawyer a couple years ago and he said the best thing for the democratic party would be to lose on the abortion issue- and I've felt the same way for quite a while.
I think it's a dumb position personally but I don't care either way about abortion or if a gay man and a gay woman want to get married.
Re:Profits, but for whom? (Score:3, Interesting)
Entirely possible, latency becomes the big problem here, not bandwidth. Cheap DSL in the same city as the exchanges could easily outperform an Internet T3 across the country. That'ss why some brokers provision massive point to point optical circuits (think SDH/SONET) to POPs near Exchanges (or directly into them?).