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I recently read in a well known forum:

I worked for a large investment bank about 10 years ago, writing trading programs for quant traders who were market makers. The quants called guys like him "retail" investors and they gleefully picked off all those trades. It's how they made all their money. (source)

"Him" in this context is referring to a programmer who made a large sum of money (500k) on High Frequency Trading.

I was wondering whether this forum comment was true. Do quants and professional traders prey on retail investors? What does it mean to "pick off" all those trades? I thought equities markets were non-zero sum. How do professional traders 'compete' against retail traders?

  • What's a QFT? For the ignorant of us... – littleadv Jan 10 '14 at 3:24
  • sorry, I made a dumb typo: I meant HFT (high frequency trading) – Noob Coder Jan 10 '14 at 4:20
  • Oh... That's not investing, that's speculating. Of course professionals prey on amateur speculators, how else can they speculate? – littleadv Jan 10 '14 at 5:44
  • sorry I am a bit new to this. if both people speculate on say the price of a good/currency, why does one's bet affect the others? isn't it all in relation to the true value of the currency? – Noob Coder Jan 10 '14 at 6:12
  • of course not, its a speculation, gamble. Compare it to a poker game in the casino, value of the cards is not the half of the game. – littleadv Jan 10 '14 at 7:29
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I can address what it means to "pick off" all those trades... As quantycuenta & littleadv have said, it is absolutely true that professionals "prey" on less-sophisticated market participants. They aren't in the market for charity's sake.

If you're not familiar with the definition of the word "arbitrage", look it up.

One possible strategy that can be employed with HFT machinery in order to arbitrage successfully in the stock market is to 'intercept' orders that are placed on various exchanges. In order to do this, an HFT organization watches all the transactions at once to find opportunities to buy low and sell high.

A good explanation of it is described here in this NY Times article; I'll paraphrase what that article lays out.


Stocks are traded through multiple exchanges The first key point to understand is that stocks listed on one exchange (i.e. the NYSE) can be sold on multiple exchanges. That's where the actual "I would like to sell 100 shares of Ford stock" is matched with "I would like to buy 100 shares of Ford stock." There are multiple clearinghouses on the various exchanges.

Your order gets presented to one exchange at a Time An ideal market maker would like to look at the order books for a given stock, say Ford, and see that in exchange A there's a sell order for 100 shares of F at $15.85, and in exchange B there's a buy order for 100 shares of F at $15.90.

Arbitrage Market maker buys from A, sells in B, and pockets $0.05 * 100... $5. It's not much, but it was relatively risk free. Also, scale this up to the scale of the US' multiple stock exchanges, and there are lots of opportunities to make $5 every second.


Computers are (of course) faster than people To tie it in completely with your question about 'picking off trades', HFT rigs can be set up and programmed to go faster than an average retail investor's order.

Let's say you execute the trade to buy 100 shares @ $15.85 as a retail investor. The HFT rigs see your order starting to make the rounds of the different exchanges that your brokerage works through, and go out in front in a matter of milliseconds, finding the orders that are less than $15.85 and less than or equal to 100 shares. They execute a transaction, buy them up, sell to you, and pocket the difference.

You have been "picked off".

It's admittedly not the only way to use HFT equipment to make money, but it's definitely one way to do it.

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The primary advantage of HFTs is their speed to act upon opportunities that exist for only fractions of a second.

The reason why they are able to do this is because they invest heavily in hardware, custom software, and custom algorithms. Most of the fleeting advantage, as they all manage to top each other's hardware seemingly every other day, is from the hardware investment. To see the extremes that HFTs will go to invest in hardware, one might view this.

It is highly likely that the trader with the market making algorithm could have been ignorant of the "hide not slide" order and missed out on many more opportunities while still being successful. Haim Bodek, who is very much against this order type, was not so lucky.

If it was truly an investment bank then it was unlikely that they were actually front running, which is very illegal and easily possible with much more low tech means, since companies like Citadel handle most orders now, and they have not been successful in investment banking.

The reality of HFT is slowly coming to light, that while HFT can provide extremely consistent returns with enormous sharpe ratios, the capital investment is equally enormous, and the amount of capital that can be employed is also as enormously limited. After all, the richest people on the planet are not HFT owners.

Also, when it comes to time periods longer than 500ms, their results become very human.

  • not sure if it answers the question i'm asking, but I learned a lot about HFT from your post. ty for taking the time to answer – Noob Coder Jan 10 '14 at 6:17

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