(Bloomberg)–Pooling equilibria hurt the uninformed: separating equilibria help them. The opposite is true of informed traders. Market makers that can evaluate more accurately the informativeness of order flow induce more separation and less pooling.
Ultimately, then, the driver of this dynamic is the informed traders. They may well be the true predators, and the uninformed (or lesser informed) and the market makers are their prey.
The prey attempt to take measures to protect themselves, and ironically are often condemned for it: Informed traders’ anger at market makers that anticipate their orders is no different that the anger of a cat that sees the mouse flee before it can pounce. The criticisms of both dark pools and HFT (and particularly HFT strategies that attempt to uncover information about trading interest and impending order flow) are prominent examples.
Noah Smith on strategies
But a lot of HFTs simply don’t know what their strategy really is. They hunt for patterns in prices or orders, find a pattern that seems to work, and trade on it until it stops making money.
They don’t have any idea why the pattern exists. Sometimes it only exists for a few seconds. In fact, if they stop to gather enough information about the pattern to figure out why it’s there, it often disappears!
Actually, there are deep mathematical (information-theoretical) reasons to suspect that lots of HFT opportunities can only be exploited by those who are willing to remain forever ignorant about the reason those opportunities exist. It’s mind-bending (and incredibly interesting).
Matt Hurd on IEX
OK. You are lucky enough know the price is going to be always delayed and thus stale at match point. The stale pricing is guaranteed by many miles of fibre in a shoebox.
Great! Try to use all your inputs to deduce an impression of a better price in real time. Throw it at them. Send in limits or IOCs at your biased price and see if you land a trade in their time warp. Better information exists on the outside of the delayed world. Use it. It’s still a race.
Slower exchanges are always problematic as the world knows better. IEX is no different. You can be played by better information or decisions. You don’t eliminate the speed race. Also here is an interesting discussion of high-frequency- trading on Reuters Insider. And here is Zero Hedge on VWAP algorithms. And “Why not read a fun book on a fun and understudied topic?”
More thoughts about bank capital
The New York Fed is not short of interesting ideas on bank capital. Here’s another one, the “special capital account”:
A second feature is that the SCA accrues to shareholders as long as the bank is solvent, but it accrues to the regulator—rather than the bank’s creditors—in case the bank is insolvent and there isn’t an industry-wide rescue of banks. That is, in case of idiosyncratic failures, bank creditors are forced to take losses. The fact that creditors don’t benefit from the SCA in that case means that creditors have enough skin in the game to discipline banks.