Talking stocks, trading, and investing in general



lawyerdad said:

One essential element of insider trading is that the material nonpublic information being traded upon have been obtained in violation of a fiduciary duty or other special relationship giving rise to an obligation to keep the information confidential. (Simplistic illustrative example: taxi driver who trades on basis of conversation overheard in the back of his cab is not guilty of insider trading) In some factual situations that's obvious. In others it isn't.

That requirement may or may not be meaningful in the situation you guys are discussing -- just throwing it out there in case it is.

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That's an interesting distinction about the cab driver.

Hypothetically, would there be a difference if the cab driver setup that ride with the intention of scooping information from the passengers? Meaning, is there a difference between happenstance and intent? I always understood it to be about intent.



idfnl said:

That's an interesting distinction about the cab driver.

Hypothetically, would there be a difference if the cab driver setup that ride with the intention of scooping information from the passengers? Meaning, is there a difference between happenstance and intent? I always understood it to be about intent.

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Big caveat:
These are significant gray areas, in the sense that the general principles are clear, but how they might be applied to particular factual situations is often less so. For a variety of reasons, there's often a dearth of spot-on case law.

So (going in reverse chronological order):

Difference between happenstance and intent? Well, sort of. In an effort to be succinct (and because of general laziness), my earlier definition was sloppy.

There are generally two theories of liability: (1) "traditional" insider liability, where the trader (or tipper) is a true corporate insider; or (2) the "misappropriation" theory. But even under the "misappropriation" theory, there generally must be a "special" or confidential relationship under which the information was entrusted. So, for example, an employee of a law firm or a printing firm who utilizes a client's nonpublic information to trade can be liable under this theory. They do have to know that the information is nonpublic, so in that sense intent matters.

But absent such a "special" relationship, there's no insider trading claim. (To be clear: when lawyers talk about an "insider trading" claim, they're generally talking about a claim under a specific provision of the securities laws, known as Rule 10b-5. That doesn't preclude prosecution of the same facts under some alternative legal theory. I'm only talking about that particular specie of legal claim here.)

Rule 10b-5(2) describes the sort of relationship that must exist. The cabdriver likely wouldn't qualify. (That said, lawyers often say that "bad facts make bad law". In an area where's there's some wiggle room in the legal requirements, the more of a dick you seem to be, the more likely a judge or jury is going to call the doubts against you.)

Rule 10b5-2 -- Duties of Trust or Confidence in Misappropriation Insider Trading Cases


Preliminary Note to § 240.10b5-2: This section provides a non-exclusive definition of circumstances in which a person has a duty of trust or confidence for purposes of the "misappropriation" theory of insider trading under Section 10(b) of the Act and Rule 10b-5. The law of insider trading is otherwise defined by judicial opinions construing Rule 10b-5, and Rule 10b5-2 does not modify the scope of insider trading law in any other respect.


Scope of Rule. This section shall apply to any violation of Section 10(b) of the Act and Rule 10b-5 thereunder that is based on the purchase or sale of securities on the basis of, or the communication of, material nonpublic information misappropriated in breach of a duty of trust or confidence.

Enumerated "duties of trust or confidence." For purposes of this section, a "duty of trust or confidence" exists in the following circumstances, among others:

Whenever a person agrees to maintain information in confidence;

Whenever the person communicating the material nonpublic information and the person to whom it is communicated have a history, pattern, or practice of sharing confidences, such that the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality; or

Whenever a person receives or obtains material nonpublic information from his or her spouse, parent, child, or sibling; provided, however, that the person receiving or obtaining the information may demonstrate that no duty of trust or confidence existed with respect to the information, by establishing that he or she neither knew nor reasonably should have known that the person who was the source of the information expected that the person would keep the information confidential, because of the parties' history, pattern, or practice of sharing and maintaining confidences, and because there was no agreement or understanding to maintain the confidentiality of the information.



indesertum said:

I don't think front running can only be done by brokers. The first front runners were probably CEOs and people around CEOs that made shorts ahead of large stock orders by companies.

Seems like a very small thing to nitpick. What seems unethical is the concept of taking advantage of private knowledge of a clients order in order to gain financially and in the process decreasing the clients gain by a very small amount

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Whoever is buying (selling) the stock is absolutely not a client of the HFT. The HFT holds out a price to the market in the hope of making some money off that. They don't take orders on behalf of someone else, they're dealing only for themselves.

And the knowledge they get isn't private - it's a reported trade done on a public exchange.

The issue is complicated by paid- for data feeds but I'd (again) point out that the people on the other end of this have more money than the HFTs and could pretty easily get that same access themselves.

I guess it boils down to the fact that I just can't get worked up about the fact that big investors are bad at execution. Like that's a non-trivial part of their job. To use Lewis's example, David Einhorn should be pretty embarrassed to be a tourist at a card game since he's since it's his job not to be / that's part of what he charges his investors a bajillion dollars in fees for.



Cantabrigian said:

And the knowledge they get isn't private - it's a reported trade done on a public exchange.

The issue is complicated by paid- for data feeds but I'd (again) point out that the people on the other end of this have more money than the HFTs and could pretty easily get that same access themselves.

I guess it boils down to the fact that I just can't get worked up about the fact that big investors are bad at execution.

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It's not whether the info is public vs private. Its public. The issue is that BATS is pitting exchanges against each other so that they display different pricing data at different times. This gap is where one flavor of HFT operates. And these operators pay a premium for this discrepancy. This is clearly outside the spirit of how exchanges should operate.

Your second point is simplistic. I believe there are lots of regulatory issues for funds, especially retirement funds, which would hinder their ability to get involved. Big banks could care less anyway. They have funds, brokerage and HFT, they win on all sides. And, as far as I'm aware, most non-bank funds and hedges use brokers anyway so much of the trading is out of their hands.

What's the 'spirit of how exchanges should operate?'

That sort of talk strikes me as hopelessly naive. HFT makes you mad or sad or whatever. Okay - we get it.

But trying to apply some indelible moral code to this stuff is misplaced. Regulation seems designed to encourage more participants and that doesn't seem particularly unreasonable.

Rather than pounding the pulpit about how something is unfair or resorting to ridiculous hyperbole as Lewis does, I think you can safely let the market handle this. Large investors who pay brokers gobs of fees have quite a bit of leverage. And they are always under pressure to reduce the fees they change / improve performance net of fees. So it seems like everyone has every incentive to arrive at an acceptable equilibrium.



Cantabrigian said:

What's the 'spirit of how exchanges should operate?'

That sort of talk strikes me as hopelessly naive. HFT makes you mad or sad or whatever. Okay - we get it.

But trying to apply some indelible moral code to this stuff is misplaced. Regulation seems designed to encourage more participants and that doesn't seem particularly unreasonable.

Rather than pounding the pulpit about how something is unfair or resorting to ridiculous hyperbole as Lewis does, I think you can safely let the market handle this. Large investors who pay brokers gobs of fees have quite a bit of leverage. And they are always under pressure to reduce the fees they change / improve performance net of fees. So it seems like everyone has every incentive to arrive at an acceptable equilibrium.

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The points I've made previous address everything you mention here. I'm no pollyanna, I've even looked for an HFT ETF, but I disagree fairness is misplaced and your wish to position me as some extremist is falling flat.

If an equilibrium was meant to happen, it would have by now. The incentive to eliminate the parasitic behavior is not there because the skimming is passed on to the customer. The funds take their % regardless, and since everyone is losing out about equally there is not a compelling reason for them to care.

idfnl said:

Cantabrigian said:

This is pretty much my view. Stated more clearly (and authoritatively) that I could have done it.

http://online.wsj.com/news/articles/SB10001424052702303978304579475102237652362

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Can't see the article. Would like to hear your opinion.

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Here's the article:


By CLIFFORD S. ASNESS And MICHAEL MENDELSON

April 1, 2014 7:23 p.m. ET

A few nights ago, CBS's "60 Minutes" provided a forum for author Michael Lewis to announce that Wall Street is "rigged" and for the sponsors of a new trading venue called IEX to promise to unrig it. The focus of the TV segment was high-frequency trading, or HFT, an innovation now over 20 years old.

The stock market isn't rigged and IEX hasn't yet generated a lot of interest. In our profession, what we saw on "60 Minutes" is called "talking your book"—in Mr. Lewis's case, literally.

The onslaught against high-frequency trading seems to have started about five years ago when a blogger made a wildly exaggerated claim about one firm's HFT profits. Nowadays after any notable market event, and again last Sunday for no reason other than a book launch, the world gets bombarded with arcane details and hyperbolic assertions about HFT strategies. If you find the discussion overwhelming, we have some good news: The debate can be understood without knowing how equity orders are routed, matched or canceled.

Few professionals completely understand the details of market microstructure. Rather, when someone has a strong opinion about the subject, it's likely to be what they want you to believe, not what they know.

Our firm, AQR Capital Management, is an institutional investor, primarily managing long-term investment strategies. We do not engage in high-frequency trading strategies. Here is where our interest lies: What is good for us is lower trading costs because it translates into better investment performance and happier clients, which makes our business slightly more valuable.

How do we feel about high-frequency trading? We think it helps us. It seems to have reduced our costs and may enable us to manage more investment dollars. We can't be 100% sure. Maybe something other than HFT is responsible for the reduction in costs we've seen since HFT has risen to prominence, like maybe even our own efforts to improve. But we devote a lot of effort to understanding our trading costs, and our opinion, derived through quantitative and qualitative analysis, is that on the whole high-frequency traders have lowered costs.

Much of what HFTs do is "make markets"—that is, be willing to buy or sell stock anytime for the cost of a fraction of the bid-offer spread. They make money selling at the offer and buying at the bid more often than they have to do it the other way around. That is, they do it the same way that market makers have done it since they were making markets in Pompeii before Mount Vesuvius halted trading one day. High-frequency traders tend to do it best because their computers are much cheaper than expensive Wall Street traders, and competition forces them to pass most of the savings on to us investors. That also explains why many old-school Wall Street traders hate them.

One of the biggest headline-grabbing worries about HFTs is how fast the trades are conducted. The speed sounds unnecessary, dangerous and possibly nefarious—"These guys care about the speed of light!" For the most part, though, HFTs don't need that super speed to get ahead of the little guy or even institutional traders, but to get ahead of other HFTs. Some of the loudest complaints about high-frequency trading come from the slower traders who used to win the races.

While we like HFTs on balance for reducing our clients' trading costs, some may push the envelope at times. Some of them may negotiate advantages that might be bad for markets. Worse, these arrangements tend to be little understood by the broader range of market participants. A little more transparency would be good here, and the market venues that have been offering these deals have been moving in that direction. They should move faster.

But these concerns are occupying too much attention. The biggest concern we have with modern markets is their complexity and the associated operational risks. The market structure that enables the HFTs and provides us with their benefits may also be one that risks technological calamity.

The good news has been that regulators began to focus on this potential problem last year. Unfortunately, the recent fusillade of hyperbole about HFT practices threatens to derail this effort and refocus attention where the problem isn't. Real work is necessary to improve and safeguard a complex and still reasonably new system. We shouldn't get ourselves dragged into a hyped-up war over a matter that doesn't affect investors very much—and where, to the degree that it does, we'd argue that the effect is easily a net positive.

So why are so many people so loudly certain about the problems of high-frequency trading? Again, look to interests. Making mountains out of molehills sells more books than a study of molehills. But some traditional asset managers are also HFT critics. These managers are institutional investors like us but with different investment strategies and trading methods.

Rather than embracing electronic markets, these managers have stuck with their old methods. They think HFT costs them money. Often when they try to trade large orders quickly, they find the trades more difficult to execute in a market that has gravitated toward more frequent trades in smaller sizes, and that the price moves away from them faster now.

We doubt that these old-school managers were truly better off in the pre-HFT world, but it's hard to prove either way. And if they're right, it may be only because HFTs have made the markets more efficient, eliminating some of the managers' edge.

Well, sorry, but prices responding quickly—and traders not being able to buy or sell a ton without the market moving—is what is supposed to happen in a well-functioning market. It happens to us too. It may be that in the old days these managers were able to take advantage of whomever was on the other side of their trade, and that nowadays they find it far more difficult to gain that advantage. A more efficient market shouldn't be mistaken for an unfair one.

These big, traditional investment managers represent a business opportunity to anyone who can offer them new market venues, like IEX, that might conceivably avoid the perceived ill effects of high-frequency trading. We wish them well in that effort, and if they succeed these new exchanges and their clients will benefit. But let's allow the issue to be decided by open competition, not by politics, demagoguery and rules born of crony capitalism.

Our bet is that high-frequency trading comes out on top as it offers more investors better execution. But we have zero problem being proven wrong by the marketplace.

How HFT has changed the allocation of the pie between various market professionals is hard to say. But there has been one unambiguous winner, the retail investors who trade for themselves. Their small orders are a perfect match for today's narrow bid-offer spread, small average-trade-size market. For the first time in history, Main Street might have it rigged against Wall Street.

Mr. Asness is managing and founding principal of AQR Capital Management, where Mr. Mendelson is a principal and portfolio manager. Aaron Brown, chief risk officer at the firm, also contributed to this op-ed.

Sold my Pioneer and CenturyLink... picked up some some OZM for just over $12/share -- was trading for over $15/share earlier in the year. Pays a fat dividend!



amerikajinda said:

Here's the article:

High-Frequency Hyperbole
Beware of critics who are 'talking their book' about trading that lowers costs.​

By CLIFFORD S. ASNESS And MICHAEL MENDELSON

April 1, 2014 7:23 p.m. ET

The onslaught against high-frequency trading seems to have started about five years ago when a blogger made a wildly exaggerated claim about one firm's HFT profits.

Few professionals completely understand the details of market microstructure. Rather, when someone has a strong opinion about the subject, it's likely to be what they want you to believe, not what they know.

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These authors seems to know very little about how HFT works. They are basing their assertion on the idea that it reduces cost without considering the shaving. Also, costs were going down since the market went decimal. They point to nothing that supports their arguments.

Also, they failed to substantiate that the "blogger" in question made claims that were false. My understanding is that most HFT systems have never lost money. In a market based on risk, I find this pretty incredible.

I read (skimmed, really) Flash Boys last week. It was an enjoyable read.

For whatever it's worth as perspective on my biases/opinions:

I've read most of Lewis's books and enjoyed them. I take them with a grain of salt. He (like each of us) has a specific personal mythology that he tends to project onto all of the stories he writes about: the game (whatever "the game" is in a particular context) is rigged to favor the little guy over the big guy, people who support existing institutional structures are either complicit or idiotic dupes, the speaker of truth is always cast out and ridiculed, etc. Not to say that there's not often an element of truth to it, but it's clearly the narrative he is pre-disposed to tell.

I've had a bit of personal involvement in/exposure to a couple of subjects he has written on in the past. From my perspective, while the overall gist of what he wrote on those subjects was reasonable, he got some facts wrong and sometimes presented what were really just made-up assumptions on his part as though they were universally-accepted facts. In his effort to appear knowledgeable yet accessible, he sometimes glosses over gaps -- or at least patches of superficiality -- in his own understanding. Having seen a few anecdotal examples of this in areas where I like to think I know some ****, I assume the same is true in areas where I don't know **** (which is to say, most areas).

Notwithstanding that, I think he's a smart guy, he writes well, he tells a good story, he seems to be a pretty good reporter who gets the underlying facts mostly right, and he does a pretty good job of explaining sometimes complicated concepts.

In short (pun intended), 'd say the book is a diverting airplane/poolside read. YMMV, obviously.



idfnl said:

My understanding is that most HFT systems have never lost money. In a market based on risk, I find this pretty incredible.

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Lulz.

http://www.bloombergview.com/articles/2014-03-20/why-do-high-frequency-traders-never-lose-money

You're not a regulator but still relevant--

But "high-frequency traders consistently make money trading, and that is too good to be true," is not such a sensible position. If you find yourself unable to understand how the people you regulate make money, that does not in itself mean that you need more regulation. It means you need more understanding.

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Cantabrigian said:

Lulz.

http://www.bloombergview.com/articles/2014-03-20/why-do-high-frequency-traders-never-lose-money

You're not a regulator but still relevant--

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That's hilarious. Bloomberg's "journalism" is generally complete crap, but that piece is well-done.



lawyerdad said:

That's hilarious. Bloomberg's "journalism" is generally complete crap, but that piece is well-done.

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I think that guy, Matt Levine, is generally excellent. Started reading his stuff when he was at Dealbreaker.

He worked in biglaw doing M&A or something then derivatives issuance at Goldman. But surprisingly readable despite his background.



Cantabrigian said:

I think that guy, Matt Levine, is generally excellent. Started reading his stuff when he was at Dealbreaker.

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That's why his name sounded familiar - thanks. I was sure I'd come across him at some point, but it was before he moved to Bloomberg.



Cantabrigian said:

Lulz.

http://www.bloombergview.com/articles/2014-03-20/why-do-high-frequency-traders-never-lose-money

You're not a regulator but still relevant--

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Interesting read, but I fail to see the lulz aspect. He doesn't really dispute that the HFT systems almost never lose money over the course of a trading day. In fact, anecdotally, one group laid a fiber cable at the cost of $300m to reduce the travel a few miles... so you really think this investment would happen if there weren't massive profits in this practice? Come on dude. Anyone in this game would be an absolute idiot to disclose the profits their making. But spending $300m on a cable is a pretty clear indicator of the revenue stream at hand.

If you're curious, the company that laid that cable was Spread Networks http://spreadnetworks.com/

" We trenched a new route - a direct route with microseconds in mind-to provide firms with the fastest possible speed on the shortest possible route. For firms where every microsecond counts and who want full control over their network from Chicago to New York, Spread Networks offers dedicated ultra-low latency dark fiber networks, wavelength services, and collocation on the fastest path."