A few weird things stand out to me: (1) Renaissance is super secretive. If they want to use this strategy to make money, a patent reveals to competitors what they're doing and creates more issues than it seems to resolve. (2) Renaissance is an HFT firm. Why are they interested in thwarting HFT? (3) This really isn't that fancy an idea. It's fairly general: send orders ahead to co-located servers to be executed at specific times.
I wonder if what they're really trying to do is prevent banks or others from creating anti-HFT infrastructure, and then providing it as a service to market participants that want to place large orders. The patent would perhaps provide some protection in that case.
Think about it this way. They are publicly advertising to their investors that they have a weapon to defeat HFT. Because of this, they will get better returns.
When an investor decides to put their money in a fund, are they going to choose the one that has a patented defense against HFT or will that investor put their money into a fund that has a known vulnerability?
>It's fairly general: send orders ahead to co-located servers to be executed at specific times.
This is harder than it sounds. Coordinating a number of servers in different locations to send a trade at a specific time is not that straightforward when you're dealing with microsecond or nanosecond transactions.
Forget the trade, just trying to synchronize the time on all of the different servers in different locations is a large challenge. NTP has an accuracy of 10ms on the open internet [1]. The state of art in HFT is sub-microseconds [2]. This is at least 2 orders of magnitude faster than the NTP margin of error.
A hedge fund with track record of Reinessance Technologies does not have to advertise to investors in any way. They just choose not to raise more capital because in some ways they are unable to push it to such returns (when you are too big, you can't move as quickly without moving the market against you).
You have to keep in mind that the mentioned sub-microseconds are the _reaction time_.
HFT can't beat the speed of light either.
Therefore if your orders are synchronized to better than the speed of light distance to the next exchange, HFT traders won't be able to profit off them (-> you have milliseconds).
With GPS receivers or very good network connectivity to your ntp server (ie. not home dsl) you can easily get down to below 1ms.
I disagree that the problem the patent purports to solve is particularly difficult, given the technology that is already readily available (PTP, an OS with a high resolution clock, machines located in exchange data centers).
Renaissance is not that type of hft firm. Renaissance uses algorithms to predict price movements before they happen. The type of hft this system is designed to prevent is front-running. Which is me seeing your order on exchange A and buying ahead of you on exchange B before your order arrives.
Those types of hft firms are surely eating into Renaissance's profits in a big way.
Well, it is not illegal, that is correct. Whether or not it is 'front running' is a matter of debate.
It certainly seems to me that they are running out in front of the order. I'm not sure how exactly you might be contorting the meaning of 'front running' for this not to apply.
Front running is trading in front of an unexecuted order, which you have because of your fiduciary responsibility to a client.
You're discussing trading in response to an executed order, which you have as a member of the general public.
If that's front running, then what isn't? Is my purchasing wheat futures in response to news of an predicted drought "front running" the orders that bakeries will be making?
'Front running' has specific legal definition (which has existed for a long time) which definitely doesn't apply to these cases. The contortion is in fact on your side.
It's worth nothing that eating into Renaissance's profits in this way is good for everyone else because it means that accurate prices are reaching the market faster.
If a firm is able to consistently get to all the other exchanges first, they can shave pennies off of a large percent of orders. That's a pretty big downside for everyone that trades.
They get accurate prices to the market faster, but only by a millisecond or so. That's a miniscule upside.
If market makers (i.e. most HTF firms) weren't able react to large market moving trades very quickly, they would have to keep spreads wider to manage the risk of adverse selection. This increases the cost for everybody for the benefit of a few large investors.
You could say the same thing about insider trading. So, the argument that accurate prices reach the market faster is not, in and of itself, an argument that something is good.
I am on the fence myself, not having thought about the matter too much. Instinctively, I'd say insider trading should be handled as a breach of contract (ie if I trade on something that I signed an NDA for), not as a criminal matter.
What you are describing is an acausal (i.e. physically impossible, since cause effect happens before cause) version of demand anticipation - changing prices in response to market demand.
It's impossible because the HFT will only know your order has reached exchange A after exchange A has told him about it. Obviously A can't tell him about it until after your order has arrived.
Front running is a strategy where your broker sees your order, trades ahead of it, and then routes your order to the market. It's highly illegal.
Perhaps the parent comment was edited after you posted, but while what is described is not "front running", it's not acausal. The observation is happening at Exchange A, the reaction at Exchange B.
If he sees an order on exchange A (which is completely anonymized and disconnected from anything on exchange B), he cannot know if you are making an order on exchange B.
"Buying ahead of you" requires some kind of advance knowledge, and in the scenario described you simply don't have it.
If there's a pattern of sloppy traders trying to fill large orders by splitting them across exchanges and firing them off at roughly the same time, then having seen a trade at one exchange and not yet at another, it might be a good guess that a trade was incoming, if I'm faster enough to make those decisions.
I don't really know if that is the case (or ever was).
Suppose there is a pattern of 10% of traders being sloppy, and 90% being not sloppy. If you run this strategy, you lose 90% of the time.
Additionally, whenever a small trader comes along, you are again overreacting. I.e., I make quite a few (automated) trades. I never cross exchanges or blow up more than 1 level. Whenever I trade you are again buying all the shares and probably losing money.
What I described as acausal is responding to an order at BATS before it gets there. Guessing that maybe an order might go to BATS because you saw one at ARCA isn't acausal.
Did you not read my example? We are talking here about multiple, physically separated exchanges.
Example:
Vanguard sends a buy order of 1000 shares of AAPL to exchange A. Some HFT firm sees that order on exchange A and knows that it will also be placed on exchange B, and was surely broadcast from Vanguard's trading floor at the exact same moment as the order to exchange A.
However, the HFT firm also knows that Vanguard is physically closer to exchange A then B, and the HFT firm has invested a lot of money to ensure that they have the physically shortest possible route from themselves to exchange B.
This allows them to broadcast their order to exchange B and have it arrive there before the order broadcast by Vanguard, even though they broadcast their order later.
It is somewhat difficult to wrap your head around, but it is a physical reality, and people are making millions of dollars from it as I write this.
A) 'yummyfajitas has worked in hft and written several blog posts on the subject.
B) he is reacting specifically to the term front-running which has a known technical definition in trading and cannot happen the way you describe (I've said elsewhere I believe the term has been appropriated and redefined and am not willing to fight that anymore, maybe he is).
C) it's funny that you mention Vanguard as they have been pretty adamant that HFT market makers of the form that use latency are save them money.
He does not see "Vanguard" - the trade confirmation is anonymous. It could even be him! (Yes, you are subscribed to a multicast trade confirmation feed and even your own trade confirmations are anonymized.) He does not see Vanguard's physical location - for all he knows Vanguard is closer than he is.
So actually, all the HFT knows is that someone bought some AAPL.
Now what? Whenever someone buys AAPL he goes out and buys a bunch more? That doesn't sound like a moneymaking strategy to me.
What evidence do you have that people are making millions of dollars from this as you write this? Michael Lewis?
Actual front running requires your broker to violate the fiduciary responsibility they have to you, and violating fiduciary responsibilities is both immoral and illegal.
The behaviour your discussing does not involve any fiduciary responsibilities.
> This behavior, however, is identical to it in spirit and moral character.
That seems self-evidently false, but okay, I'll bite: What moral precept is being violated here, and why is it "identical" to the fairly serious sin of someone with a fiduciary responsibility to you violating your trust?
Let's play fill in the blanks: "Goldman Sachs wants to buy $400m stock in Apple, but after they buy $20m, a member of the public sees the strange pattern of executed orders, guesses that someone is buying a lot of Apple stock, and starts buying up stock too. This is highly immoral, because members of the public have a ______ duty to ______, and not allowing Goldman Sachs to manipulate the market in peace violates it."
What phrases can we put in the blanks that makes that not nonsense? I'm pretty sure it's not a fiduciary duty, and it seems quite clear it's not to Goldman. What duty is it, and to whom is it owed?
With that definition of "front running" people are doing the same interception as 'true' front runners, but they happen to be third parties. People are using the best available term, and making it slightly more general. What would you rather have them call it? They can't call it nothing.
Just like people will call things "insider trading" when there is trading based on insider information, whether or not it happened to be legal.
That argument is a bit like calling all sex rape, because someone having sex is doing the same thing as a rapist does, they just happen to have consent.
The reason front running is illegal is because it is a violation of a fiduciary duty. Third parties do not have a fiduciary duty, therefore it's not illegal. "It's front running, but without the violation of the fiduciary duty" is like "murder, but without the killing someone", or "fraud, but without the deception".
> What would you rather have them call it? They can't call it nothing.
Not everything needs a name. Since what you seem to be describing is "reacting to the public actions of other market participants", does it need a name?
Alternatively, if you think something serious is going on, why don't you define it, and then we can name it?
> The reason front running is illegal is because it is a violation of a fiduciary duty.
And nobody is calling this kind of "front running" illegal.
> like "murder, but without the killing someone", or "fraud, but without the deception".
In a murder analogy, you'd keep the killing but change something else, maybe it's properly manslaughter but people will still call you a murderer.
For "fraud without deception", let's look at what that entails. You lie. The victim knows you're lying, no deception involved, but they rely on your word. The victim is harmed. I think that's close enough to allow people to call it fraud, even if legally it's slightly different.
> "reacting to the public actions of other market participants"
The reason people dislike it is because it's not just 'reacting'. They're getting in their own action before the thing they're reacting to has finished.
> why don't you define it
Darawk defined this version for us. "front-running. Which is me seeing your order on exchange A and buying ahead of you on exchange B before your order arrives."
> The reason people dislike it is because it's not just 'reacting'. [...] Darawk defined this version for us. "front-running. Which is me seeing your order on exchange A and buying ahead of you on exchange B before your order arrives."
Seeing a completed order on exchange A, and speculatively purchasing stock on B in the hopes that the buyer might later buy stock on B sure sound reactive to me.
> also interrupting. People dislike the interrupting.
So your argument is...what?
Hypothetically: Let's say I have an inventory of stock A, which I think is worth X, and which try and sell whenever the market price climbs above X. Now there's some new public knowledge that materially impacts my estimation of the value of that stock (eg, a large hedge fund has started buying large blocks of this stock): I no longer think it's worth X, but actually Y, and I'd like to stop selling it whenever the price climbs above X, and instead wait until the price climbs above Y.
So you're saying that's okay, and I can price my inventory however I want, but only if I give the hedge fund a chance to buy a bunch of underpriced stock first? This raises some questions such as:
1) Why on earth is that a good rule?
2) How much time do I need to give the hedge fund? Do they only need a few seconds? Should they get a day? A week? At what point am I allowed to change the price I'm selling stock A for without it "interrupting" the hedge fund? Do they need to announce that they're done, or is their a timeout period after which I can just assume? Can I change the price I charge other people if I still let the hedge fund buy at the old price, or does everyone get the discount?
3) Or is it not about time, but about amount? Does the hedge fund have some divine right to buy as much stock as they want without it driving the price up? Why? And how come nobody else has that right? Do you have to be a hedge fund to get the right to name your own price, or do normal people get to do that too?
4) Or is it somehow okay if I'm selling, but not buying? Is it's okay for me to raise the price I'm willing to sell stock A for if I find out a hedge fund is investing, but not okay for me to raise the price I'm willing to buy stock A for? What happens if I find out a hedge fund is liquidating their position instead? Do I get to lower the price I'm willing to buy and sell it for, or just one of them? There's no laws or SEC regs about this; is there a list of rules somewhere? Is it in the bible?
5) Does this only count market actions? If the hedge fund gives a Bill Ackman style press release about how some company is terrible and should be prosecuted, can I change my prices immediately, or do I need to wait in case I'm interrupting some hedge fund strategy? I mean, maybe they were planning on giving the press conference and then buying a bunch of stock; if I think their arguments are bollocks and I buy a bunch first, is that interrupting them?
And so on. The entire argument seem awfully focused on why large hedge funds and investment banks should be able to ignore basic market rules. I'm sure they'd like to; I'm still waiting to hear why they should. (One of my favourite scenes for Lewis's Flash Boys was when a trader expresses outrage that his very large order in a thinly traded stock caused the price to move against him. How terrible; if only there was a law that required people to trade with him at the price he chose...)
For this particular case I can make the answer very simple. How about waiting half a second.
Can you not see how it's bad in the specific case where they already issued the order to all exchanges but your order gets processed first because you used a different cable? Ignore the more ambiguous cases for the moment.
Why is protecting the interests of hedge funds and investment banks important enough it needs a special rule? This isn't a rule that will benefit the little guy; it strictly benefits the biggest fish.
> Can you not see how it's bad in the specific case where they already issued the order to all exchanges but your order gets processed first because you used a different cable?
To be clear, your concern is strictly that if a hedge fund is buying a very large amount of stock, this will cause the price to move against them as people react to it, and you think they should get a full half second (an eternity at the speed of the modern market) to buy as much as they want before people are legally allowed to react?
That sounds like a terrible idea, and in the specific case you list: No, I don't see why that's bad. I don't see why anyone except a large hedge fund or investment bank would.
Further: Once the order hits the market, you're saying there should be a half second window during which no one can do anything except the hedge fund. But as soon as that half second window closes, there will be a race to (finally) react. Which will be won by...the HFT firms, right? Won't they be able to, hypothetically, get their rSo even if we accept your premise, isn't this just shifting the victims around without fixing anything?
"Half a second" was not meant to mean "enforce a delay of precisely 500000 microseconds". The point is that the problem would be solved if traders would chill out for the blink of an eye. The fact that it's hard to force people to chill out is a completely separate issue.
> To be clear, your concern is strictly that if a hedge fund is buying a very large amount of stock, this will cause the price to move against them as people react to it,
> in the specific case you list: No, I don't see why that's bad.
The original scenario has nothing to do with order size. The scenario is that X sends a simultaneous order to multiple exchanges, but while it's still in transit to most of the exchanges Y reacts to the order and submits their own on a faster cable, getting there before the order they're reacting to. I think such an outcome is clearly bad. I won't suggest a fix to avoid distraction. Do you disagree with it being bad? Picture it happening to an old lady if you have no sympathy for hedge funds.
Are you saying front-running is not an HFT strategy? Because that is incorrect.
In equities markets, for trades of a sufficient size it's not possible to place the order all at once. You'll hammer the order book, and take very suboptimal pricing for the latest marginal shares you buy/sell. Therefore you have to split up the order into chunks.
HFT firms will try to detect when equities traders are doing this. e.g. If they see a pattern indicating that chunks of shares are being bought, they will try to buy, too. When the rest of the order comes through, the price will rise and that firm will make money. That's why "front-running" is just a special-case of an algorithm to predict price movements.
I seriously doubt that a HFT fund as large as Rennaissance uses a single strategy, be it satellite images, or front-running or what-have-you.
HFT firms will try to detect when equities traders are doing this. e.g. If they see a pattern indicating that chunks of shares are being bought, they will try to buy, too.
Price discrimination against large traders - grandma gets a better price than Bill Ackman - is a valid and real HFT strategy. They do it in the manner you describe.
But it's not front running. It's only front running when your agent (usually your broker) does it based on private information.
Front running is just a term Michael Lewis misused in his misleading advertisement for IEX.
>Are you saying front-running is not an HFT strategy? Because that is incorrect.
I think dsl is quite familiar with the sort of HFT strategy you describe. I think s/he is just trying to correct your use of the term front-running, which was redefined by Michael Lewis et al. from its previous definition as the objectively illegal activity by a broker-dealer. Based on comments like yours, it's a losing battle.
I wonder if what they're really trying to do is prevent banks or others from creating anti-HFT infrastructure, and then providing it as a service to market participants that want to place large orders. The patent would perhaps provide some protection in that case.