Lavabit is still in court over this. You can contribute to their legal defense fund here.

Score 3? I have to wonder who actually modded up a post which, in two sentences:

(a) attributes malicious intentions to its opponents,
(b) calls them names, demonstrating the level of maturity of a small child,
(c) asserts opponents' spitefulness while simultaneously engaging in spite itself,
(d) fails to present even a single shred of evidence for any of the above.

Oh, wait. This is the internet. Carry on.

No he can't. He doesn't have JavaScript enabled.

They cannot see your incoming market order before it actually executes. They can see your incoming limit order when you put it up, just like anyone else with access to level 2 market data. But your limit order is just an offer, not a demand to buy/sell at the currently available prices.

With a limit order, all they can do is outbid you. That's completely legal; it is not front-running. It is no different than someone outbidding you in an auction.

Front-running is when you, as a stock investor, want to buy a stock, and your broker buys some of the stock first, then buys some for you. Buying the stock increases the price as the lowest offers are removed. Since your broker bought first, you're getting a worse price on your stuff. Then the broker turns around and sells the stuff he bought at the new, higher price. This is fraudulent and illegal.

It's illegal for anyone to do this, robot or human.

I completely agree.

If you pay a higher commission for market taking than for market making, it's either the exchange charging you, or your broker. If it's the exchange, then the market makers can afford to give you better bids/offers in compensation for the smaller fee they have to pay. If it's your broker, get a better broker. They shouldn't be doing that.

As for the slightly worse price, you're absolutely right. Many are willing to pay that spread because it is so small these days. The enhanced competition forces those prices to not be much worse than making your own offer, but there's only so much risk the other market participants are willing to take on at any one time.

This is highly misleading. Level 2 market data is real-time offers to transact, not actual incoming transactions. GP was talking about knowing about what transactions are going to happen before they actually happen.

If you're worried about people adjusting their selling prices in response to your buy offer, you can always just buy at their prices immediately, rather than putting up an offer for a bit less.

True, but any electronic securities exchange won't tell anyone you've put in an order to buy or sell at an available market price until it actually executes your order. Doing otherwise would be highly fraudulent. Therefore, a bot can't tell unless it has some predictive capabilities... more likely probability and statistics than ESP, realistically speaking, but using probability carries with it the risk that it'll be wrong.

Just from that, huh? So we should just take everything "a researcher at the University of Miami" says as gospel? If the researcher had said trading robots are cute, pink, fluffy creatures that play nicely with the unicorns, you'd be arguing we should be throwing money at them.

That's nonsense. You should always make an effort to hear the other side before coming to a conclusion. Why was this modded up?

I guess you stopped there, not deigning to read the very next sentence, which was intended to address your concerns. For reference:

The point being, if such claimants could win, it wouldn't be profitable for corporations to engage in that kind of behavior.

That said, the objective of my post was to explain in very general terms the argument made by the other side, not to provide excruciating detail, defend it against all counterarguments (and you do hint at one I think is good, namely Big Security), nor even to persuade anyone. Why? Because without informed responses that address points people are actually making, we're left with only political potshots like this:

... which, while I understand is satisfying, add nothing of value to the debate. Just look at how many comments in this thread amount to "libertarians are stupid" or "liberals are stupid". And they're modded up, too! It's silly.

Nonsense. Nobody, whether Republican, Democrat, Libertarian, Green, Socialist, whatever, wants individuals to be able to freely harm others.

Libertarians and Republicans frequently call for less regulation. I'm neither, but I still believe I can explain the argument they're making: they don't want complete deregulation, they just want less of a monopoly on regulation. Government regulation is a monopoly on regulation, and regulatory monopolies lead to regulatory capture (basically, corruption), as we've seen all over the US. Private regulation, on the other hand, means something like having insurance companies "internalize the externalities". If you just now took "private regulation" to mean companies voluntarily regulating themselves without any monetary incentive to do so, I agree, it sounds absurd. But that's not what it means.

The canonical example is pollution. The argument against free markets goes something like this: without regulation, companies will pollute the skies and dump toxic waste into rivers, since it is less costly than handling the waste. In other words, the market won't price in the externalities.

The counterargument: if companies did so, they would actually be hurting people--people who breathe pollution are more likely to get cancer, fishing businesses cannot catch uncontaminated fish, etc. These individuals would then have legal standing to sue in court, and have a really good case to boot. If you also had some tort reform such as loser pays + claimants can receive third-party funding for their cases, such claimants could actually win judgments in court, rather than settling out of court for a measly $2k or simply being out-funded into oblivion.

Under this system, companies would buy liability insurance to protect themselves against such large judgments, or else risk destroying their business entirely. (And who is going to invest in that?) As a condition for continued coverage, they would be required by their insurers to submit to regular audits and comply with certain safety and waste handling procedures, etc. If the company won't submit to these regulations, insurers just jack up the rates--it's riskier to insure them, after all. The audits and other compliance are cheaper by design, so companies will go that route.

This system provides a balance between the interests of the companies affected by the regulation, and the people who would be affected without it. Insurers don't want to impose onerous regulations lest the company choose a different, better insurer. But insurers don't want to do too little, else they're liable to be mispricing their insurance and end up losing a bunch of money. And corruption is gone, because there's no sense in letting a company you're insuring change your auditing procedures when you believe that's going to cost you money. Better yet, the regulations put in place are preventative rather than reactionary. While a monopolistic regulator motivated primarily by politics may simply react to events that have already occurred and put in place regulations to ensure they don't happen again, insurers actually have an incentive to imagine the worst-case scenarios and design policy to prevent them in the first place.

Would this work? You decide. But at least get your opponents' arguments straight, first. Otherwise we're never going to get anywhere.

I don't know about you, but where I live, there are constitutional laws imposing limits on government power, and so it cannot be said the government owns the entire country, and certainly not the lives of everyone in it.

There's a difference between doing it on your forum or blog, which you own, and doing it for your whole country and everyone in it, which you don't.

The term frontrunning can be used to refer to the illegal practice of a broker placing his own order ahead of that of his customers', but it can also be used to refer to any practice which attempts to trade before another known trade, such as watching the trades in the market and determining, statistically speaking, when an index fund is re-weighting its positions, and buy/sell ahead of them on the stocks they haven't yet traded. The former is illegal, the latter (relying only on public information) is legal.

True arbitrage, say of the same asset between exchanges, does increase liquidity; I was unclear. I meant trading with non-equivalent (but similar) stocks; buying Coke when Pepsi goes up a fraction of a cent, and vice versa. Such a strategy can spread volatility from stock to stock. Alone, I would say it usually decreases volatility, but that it can also increase volatility as well, depending of course on what the other parts of the market (what it is arbitraging with or against) are doing. I believe the detractors primarily focus on the volatility increases, and the supporters primarily focus on the volatility decreases. *shrug*

Thanks for the informed reply. I'm aware that the crash you mentioned and the crash I mentioned are not one and the same. The link you gave provided little insight into its cause. Do you have any more information about it? The crash I mentioned wasn't due to a fat-finger trade either, just a really large trade placed as a hedge, but done in a time of low liquidity.

As for what I would consider HFT: it is a bit of a grey area and hard to draw a precise line, for which I'm sure you'll forgive me, but as I see it, it is entirely independent of the "why" the trades are being made, just the timing, and is a bit of a relative thing: how fast a trade is turned around, how new the information must be to act on it, and so on, somewhat relative to what everybody else is or had been doing. Things like holding a stock for 10 seconds before selling it, getting your orders in before anybody else, and so on, and doing this regularly and as part of a business model--these things I'd call HFT.

My focus is on the underlying mechanisms the trader/algorithm uses, not any kind of official designation or requirements. Automated market making would therefore in my opinion fall under this category, for most liquid assets. (For less liquid assets, trades are likely slower, so it'd be something I wouldn't consider high-frequency.) Officially designated market makers, under this perspective, are simply HFTers employed with a specific algorithm (make trades at the quoted prices) and specific requirements (always stay in the market / provide a minimum amount of liquidity at all times). In exchange for these requirements, they may get certain benefits such as liquidity rebates or better information.

I would like to point out that much of the debate as to whether HFT increases or decreases volatility hinges upon what exactly you consider to be HFT. If you take market makers and arbitratrageurs out of your definition, if you even can (you pointed out the difficulty here), I believe most of what is left is going to be those increasing volatility. And then you could say HFT increases volatility, or removes liquidity. But doing that seems a bit arbitrary to me. If you look at it from this perspective, I think you can understand why people make the claim that HFT reduces volatility or adds liquidity. How would you define the line and why would you put it there?