Comments on Rick Bookstaber: Goldman and High Frequency Trading

Regarding the previous comment on IT bonuses and H...

2009-08-06T08:37:07.552-04:00

Regarding the previous comment on IT bonuses and HFT, people sometimes are getting confused between high frequency trading as a money making strategy versus algorithmic trading, which is intended to efficiently execute trades. The forner decides what is mispriced and buys or sells accordingly, the latter takes existing trading decisions and executes them to reduce transaction costs.

Many firms provide their clients with algorithms for trading which are mechanistic, rule-based approaches. They might be useful for reducing transaction costs, but cannot be unleashed on their own to make money. They simply facilitate trades that would be done one way or another.

In my previous comment I said, "I've ofte...

2009-08-06T07:36:23.460-04:00

In my previous comment I said, "I've often wondered to myself 'is it the IT guys/companies that make the big bonuses'"

After reading this article

http://arstechnica.com/tech-policy/news/2009/08/nyse-builds-computer-trading-mothership-worries-abound.ars

if they aren't they certainly should be. It appears we are getting close to 90% of trades being done between computers. (Which is a bit worrying because it's pretty clear that finance does not know how it works. How confident is anyone that the right data is going to the right place at the right time?)

Anyway, can anyone direct me to an "idiot's guide" so I can try and understand precisely what human traders do that requires they are paid huge bonuses?

Hi Rick, What you say in your article, that you d...

2009-08-03T05:34:56.410-04:00

Hi Rick,

What you say in your article, that you do not believe Goldman are making their money from High Frequency trading, is correct.

Goldman have no high frequency trading teams in London (they had a medium frequency team, but they all left in 2008) and they have no high frequency trading teams in New York. They do have a team in Asia, but the PnL they generate is nothing relative to GS's results for the last quarter.

Few of the investment banks really have a big presence in HFT as of 2008, when the the banks were unable to pay bonusses to these profitable teams, and most of these teams relocated to hedge funds, started their own hedge funds, or moved to dedicated high-frequency trading firms such as GETCO, Optiver, Kyte Group etc.

Again this is GS conspiracy theorists getting over-excited and making a load of unsubstantiated conjecture.

The banks who have big high frequency prop trading teams are BNP Paribas, Societe Generale and Barclays Capital.

From William Cohan's House of Cards (pp...

2009-07-27T22:57:31.447-04:00

From William Cohan's House of Cards (pp. 336-7): "'... the marks are 99, 98, 97. A week later ... Goldman Sachs sent, by e-mail its April marks on our securities...'. As a counterparty to trades in the funds, Goldman was obligated to report its thinking.... 'Now there's a funny little procedure that the SEC imposes on you, which is that even if you get a late mark, you have to consider it,' [one Bear Stearns executive] said. 'Suddenly we get these marks. ... They give us these 50 60 prices. What we got from the other counterparties is 98. ... We have to repost our NAV. And now we go from minus 6 to minus 19 ... and that is game fucking over. by the way, the firm that sent us the 50 made a shit pot of money in 2007 shorting the fucking market.'"

Truth, according to the Bear Stearns executive, is indeed stranger than fiction -- or at least on a parallel track with Rick's forthcoming fiction.

Rick, What you described in your novel is a commo...

2009-07-22T23:40:43.701-04:00

Rick,

What you described in your novel is a common occurrence in OTC derivatives. However, usually if you call up the outlier counter-party and kindly ask for a tradeable two sided market, they'll wise up. If not, get a couple more marks from other counter parties and threaten legal action...they will back down. Unless the majority of your counter-parties are marking at the same level (which implies your position is truly seriously submerged), the scenario you painted is not plausible.

I suggest that you use the VIX future settlement in Nov or Dec 2008 (I forgot which one) to bring your point about market manipulation across. Someone was long many thousand contracts of 50 call options on the VIX future. On settlement date, the person manipulated the VIX by quoting pre-open on settlement day 1 cent bids and ridiculous asks on far out of the money SPX options that no one even bothers to make a market on, thereby boosting the VIX from the 40s to just above 50. The trader then pockets a princely sum from his 50 calls. Real life is indeed stranger than fiction ;)

Hi Rick, I thought A Demon of Our Own Design was ...

2009-07-22T08:29:07.404-04:00

Hi Rick,

I thought A Demon of Our Own Design was one of best books I've ever read. As a close market watcher, one thing that stood out last fall was the 'lack of a crash' --- it was a crash but it was kind of a controlled ooooze more than a break. In your book or elsewhere, I would love to hear your take on the nature of what happened in Sep-Nov 2008 in your book --- from a mechanics/system perspective.

Very timely article. You are right that the barri...

2009-07-20T18:32:54.020-04:00

Very timely article. You are right that the barriers to entry in the HFT game are not that high.

You don't need Goldman's connections to do millisecond level trading. With very small amount of capital, someone with intermediate or high programming skills, moderate knowledge of finance and financial systems can build a basic trading system (I know from personal experience).

I don't quite understand the charge that Goldman was intercepting trades and trading ahead of them. As far as I know, Goldman is a market maker and could use client order flow to front-run -- very illegal.

I'll be surprised if they were stupid enough to place their programs between exchanges and their customers...assuming that it is even possible (very, VERY, unlikely). If they did intercept such orders, how could they then generate their orders and transmit them to the exchange before the order they intercepted hit the exchange.

There are just a whole set of things that don't make any sense.

Hi Rick, Please excuse my ignorance as I know lit...

2009-07-18T20:09:15.030-04:00

Hi Rick,

Please excuse my ignorance as I know little about finance/trading, or IT for that matter, but perhaps you can answer a question for me.

As I understand it, today many financial institutions seem to be little more than data refineries. Over 90% of money exists in the form of data and trillions get 'pumped' around the the globe every year. Some companies pump the data faster and/or can 'read' it more quickly, so they steal a march on competitors (with inferior infrastructure/software) by trading automatically - technology enables them to be 'faster' and more 'precise' and take the best price.

I've often wondered to myself 'is it the IT guys/companies that make the big bonuses'....for example, if programs are automatically trading to maximise value, or low latency enables trading ahead of rivals, what skills do traditional traders have that require huge bonuses? Isn't much of Goldman Sachs profitability coming from tech capability as opposed to any financial 'skill'?

If a firm is front running, that is not part of wh...

2009-07-17T15:05:10.796-04:00

If a firm is front running, that is not part of what I would call HFT, that is something that comes out of their franchise. The franchise is giving them the information to be able to front run. They might use high frequency methods to execute based on it, but that is a different matter.

And granted two guys in a garage can't do it, but the infrastructure investment for HFT is one many firms can readily make. A lot of what is necessary in terms of infrastructure is available from vendors.

"For another, why bother with high frequency ...

2009-07-17T14:59:23.259-04:00

"For another, why bother with high frequency trading, an area where there are relatively low barriers to entry and where you have no particular comparative advantage,"

First, there are not low barriers to entry with HFT when you are talking about trading huge lots every 50ms. This requires a cutting-edge server colocated with the exchange's server running advanced code. Second, they do have a competitive advantage, as it's pretty clear they're frontrunning. (Take a look at their massive volume HF SPY trades immediately before the S&P spikes, and tell me that's not frontrunning.)