Tuesday, June 18, 2013

Two seconds

The weekend wall street journal had an interesting article about high speed trading, Traders Pay for an Early Peek at Key Data. Through Thompson-Reuters, traders can get the University of Michigan consumer confidence survey results two seconds ahead of everyone else. They then trade S&P500 ETFs on the information.

Source: Wall Street Journal

Naturally, the article was about whether this is fair and ethical, with a pretty strong sense of no (and surely pressure on the University of Michigan not to offer the service.)
It didn't ask the obvious question: Traders need willing counterparties. Knowing that this is going on, who in their right mind is leaving limit orders on the books in the two seconds before the confidence surveys come out?

OK, you say, mom and pop are too unsophisticated to know what's going on. But even mom and pop place their orders through institutions which use trading algorithms to minimize price impact. It takes one line of code to add "do not leave limit orders in place during the two seconds before the consumer confidence surveys come out."

In short, the article leaves this impression that investors are getting taken. But it's so easy to avoid being taken, so it seems a bit of a puzzle that anyone can make money at this game. 

I hope readers with more market experience than I can answer the puzzle: Who is it out there that is dumb enough to leave limit orders for S&P500 ETFs outstanding in the 2 seconds before the consumer confidence surveys come out?


  1. One line of code!!?!?

    First you need a DB with these early notice events are flagged. Then you need that data present in the code at the point where you are deciding to pull limit orders or not. Then your change has to be tested and deployed without breaking anything else (see: knight capital).

    All for a small pre-market trading event.

  2. Sure, once everyone knows the rules of the game, it is hard to make money. But until this article came out, many investors did not know of the two second advantage. The traders that did know tried to keep a low profile about it.

    This type of information time arbitrage is little different from insider trading.

    1. everyone who cares about speed knew about it - reuters is selling it to everyone - that's how Reuters makes money

  3. Customer limit orders are left in the book. if you submit a good till cancel order, it will be there, number or no number

    The article misses the point - since all the traders that do this high speed trade have access to the 2 second feed - they derive no benefit from it because all of their competitors also have it - all the benefit accrues to University of Michigan and Reuters.

  4. I said this exactly -- after considering Dealbreaker's "traders provide funding for crucial information" and Krugman's "this is unproductive finance." If I ask what a perfect and efficient market looks like, I doubt anyone would include pockets of illiquidity due to information discrimination (which occurs if we let our imaginations run with the "who in their right mind" idea). Then again, you probably would want the information provided to the market to be accurate, timely, etc.

  5. I don't know enough about how financial markets work to know if this is an issue. Suppose the survey shows that confidence is up and as a result stock prices will rise. If I know this before anyone else, even if no one is willing to trade until the information is completely public, I can still put in a buy order before anyone else. If the price is quickly bid up, but not instantaneously bid up (someone sells at $50, then someone sells at $50.01, etc.), then I will get the lowest price since my order will be filled first.

  6. Someone made the point that the early exclusive data access schemes theoretically should only be profitable so long as no one knows you have the information. Perhaps prior to the revelation about Thompson-Reuters and University of Michigan, most traders were genuinely unaware of this possibility?

    Seems like now that we know about the scheme, Thompson-Reuters should experience a decline in demand. As you say, who on earth would be selling these stocks, now knowing that the buyer probably has information you don't?

  7. There are traders (not me) who are very strictly technical traders: traders who do not care about what is happening with the company, but only care about what the price chart says. These people thus don't know when the next earnings report will be released (or consumer confidence survey), and they don't care.

  8. I'm intrigued by this suggestion:


    Get rid of day trading. Just allow trading once per day, so the minimum holding period is one day.

  9. The consumer confidence numbers move many markets, not just the SPY ETF. All the equity index and treasury futures move off those numbers, as do many individual equities that are correlated to the broader market.

    Also, retail investors placing orders through Ameritrade, WellsFargo or the like are not using execution algorithms. They are holding still and getting run over.

  10. I guess the answer is the same as the answer to the question "who leaves limit orders on the book at ANY time?" People provide limit orders because they get compensated (via the b/a spread) for providing liquidity and taking risk. What I would expect to see with these data releases is an equilibrium being reached where spreads widen to compensate for the increase risk during this time.

    I think WSJ would have to show that spreads weren't widening appropriately to show that people were "being had". The mere existence of the advance release isn't enough.

  11. I traded my own account for 25 years. I traded through numbers every month. Who leaves limit orders on ahead of economic numbers? Retail and customers that just want out or in at that particular price.

    Really, we shouldn't care why people are trading, what trading style they use, if they are fast or slow...speculating or not.

    I am not too concerned with spreads widening just before a number, or what they look like immediately after. Prior to electronic trading taking over, people could get out of bad positions. Now, no time to react. It's increased trading ranges. But, we aren't going back to an entire open outcry system.

    We should be on the side of everyone getting public information at the same exact time-and having similar access to the market so they can act upon it.

    That's why co-location, payment for order flow, dark pools, internalization and other bits and pieces of the market detract from transparency and public trust.

    what we need to concentrate on is market structure. make the playing field flat=horizontal. no preferences, no preferencial treatment.

    this is a much deeper issue than one blogpost can cover-or one academic study.

    let's side with the premise that markets are effficient and all public information is priced into them. then lets structure the marketplace so its transparent and all information is released at the same time.

    The winners will be the ones that interpret that information correctly to take action on it.

  12. I've said this many times. I did see the ES move more than 8 points in day for five years. And that happened maybe twice a year. I know some of it lower liquidity due lack of public partic and maybe the fed, but I agree with jeff that the computers are causing stuff to have crazy moves. Why is ES near its highs and moving 40pts? And underneath the surface the cash market has no real volume at all? HFT may be better when there is enough other kinds of participants, buts its makings crazy now

  13. John - to answer your question, Hirshliefier, Subra, and Sheridan would be dumb enough to. But only if they were risk averse and exiting positions they already had on, adverse selection is less of a concern when exiting a position.

    Security Analysis and Trading Patterns when Some Investors Receive Information BeforeOthersAuthor(s): David Hirshleifer, Avanidhar Subrahmanyam and Sheridan TitmanSource: The Journal of Finance, Vol. 49, No. 5 (Dec., 1994), pp. 1665-1698

  14. Everyone reading this blog is on the other side of the trade. If everyone knew about this effect, the WSJ article, and your blogpost would be boring and redundant. Just by posting this blog, you've answered your question.

  15. "Who is it out there that is dumb enough to leave limit orders for S&P500 ETFs outstanding in the 2 seconds before the consumer confidence surveys come out?"

    Better question, who is dumb enough to rely on a consumer confidence survey to determine the forward earnings of the S&P500 companies?

    1. Maybe there is a strong enough positive correlation between consumer confidence surveys and subsequent S&P500 earnings.

      -- Pavel Filip

  16. "Who is it out there that is dumb enough to leave limit orders for S&P500 ETFs outstanding in the 2 seconds before the consumer confidence surveys come out?"

    The uninformed and the unsophisticated, i.e., the vast majority.

    --Pavel Filip

  17. Re: "Who is it out there that is dumb enough to leave limit orders for S&P500 ETFs outstanding in the 2 seconds before the consumer confidence surveys come out?"
    If there weren't parties "dumb enough" then there would be no benefit in buying the data 2 seconds ahead of time. Therefore there must be parties "dumb enough".
    Reductio ad absurdum

    By definition if all parties removed their limit orders during this period there would be no limit orders for this two seconds. This would constitute a regular disruption to market trading. Why would it be useful to create such a regular disruption? How would this be good for capital markets and the wider economy.

    Also, I put "dumb enough" in quotes because this stands in for people who are too busy to know the very finest details of the underlying mechanisms of stock trading and information flow. In other words, most retail investors.


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