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Ask me anything about hedge funds and HFT
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Ask me anything about hedge funds and HFT

  #41 (permalink)
Elite Member
Wayne, NJ USA
 
Futures Experience: Intermediate
Platform: Multicharts, Deltix DCS
Broker/Data: Interactive Brokers/IQ Feed
Favorite Futures: ETF Options
 
Posts: 41 since Oct 2012
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Yes, I donít think 2/20 is viable fee structure to survive on with a small AUM. I have interviewed with some start-up quant hedge funds where they already have over 15 person employed and have only raised a few million. With a 2/20 structure assuming they can make 20% their revenue is going to be 60k per million. That is not even going to be enough to pay the salaries. Iím just sitting there shaking my head in disbelief.

Are there any reasons why these start-ups hire many people especially quant researchers even though their AUM is relatively small. I just find it hard to believe these guys canít do simple math. They arenít doing anything fancy like high frequency trading. Their trading models are built in Matlab using daily data. Personally, I would rather spend the money on better software and data first.

I'm going start with a few number of people only 3 to 4 counting myself. It is basically going to be me doing the quant research strategy and implementing the models while the other guys are raising capital. My initial demographics will be mostly high worth individuals with a few million usd to invest. Assuming I can raise 10 to 20 million usd from friends and family and generate good returns (20% +). Where would I go from there?

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  #42 (permalink)
Elite Member
Wayne, NJ USA
 
Futures Experience: Intermediate
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Do you have any experience with researching automated option trading options? Iím trading ETFs and Iím in the process of converting my strategies to trade the options rather than the underlying. My implementation so far is very simple. I take a long position in a call option when Iím long the underlying ETF. Likewise, I take a long position in a put option if Iím short the underlying ETF. I would like to backtest how the strategy performs trading options versus the underlying.

However option data is very difficult to work since there are many strike prices and expiration date. They are also irregularly traded so there might not be a trade when my system generates the signal in the underlying. How does one back test options?

Intuition tells me that my win rate will be lower because I will be dealing with time decay. On the other hand, my average losing trade will decrease since I can only lose the option premium which is a faction of the stock. Iím going to start with a small account to trade the options to see how well the strategy does vs trading the underlying. My main concern is getting raped by the bid-ask spread in many of these options.

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  #43 (permalink)
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artemiso View Post
First, I speak for HFT:

1. It is not cheap to be in this field, and it's extremely competitive - I say this despite having a very talented team who have come from very prestigious positions and still have the credentials to go where they choose. For every 1 buy-side trader or developer who is well-paid, I know 3 kids who are making 1.3~1.5x as much in the tech industry - I have employment statistics from my college/grad school's alumni associations. If our goal was to make money by doing something brainless, we would have gone to Silicon Valley, which to be honest, is full of less sophisticated VC investors (e.g. Thiel) who have yet to be stung by a Madoff-class fraud, and even worse failure rates than hedge funds.
2. If what we're doing is speculative, brainless, and unintelligent BS, then we're buying into a bubble and we've been trained to get out of it quick.

I'm not sure this answers the heart of my question. Just because something is really hard to do and costs a lot of money to do doesnt neccessarily mean a person will feel good about the end result. Most will. I've got no doubt you have some serious computer jockeys being seriously challenged to write some crazy code that not many other people can comprehend and in that sense, who wouldnt feel good about their job if they are being challenged on a daily basis to that level and getting paid well? But I see HFT as exploiting a system, looking for weak spots in a network to take advantage of rather than actually trading. I generalized HFT there and I know thats wrong as some are actually trading. But you cant tell me the proliferation of order types (hide and slide, hide and light, hide and whatever) and quote stuffing and all the other crap some HFT do has anything to do with real trading other than gaming the system.

As for the benefits of HFT, seriously where are they? I speak for the futures markets and having watched the ES/FESX everyday for the last 11 years I have seen no benefits. Both markets were as tight as they could be 11 years ago just as today. My exchange fees have never gone down. My clearing firm has the same volume based fee system they did since I switched to them in 2006. I'm still paying the same 8.99 a trade for stocks in my fidelity account that I did years ago. What I see as different is that now bids/offers are completely useless. There was spoofing in 2003 just as today but now its certainly much higher. I don't get why the exchanges are bowing down to HFT either- a quick glance at volume suggest across the board reductions since 07. A look at their stock prices show CME, DeutscheBorse (and I won't even check NYSE) to be well less than half their 2007 hi's despite the market currently being at all time hi's now.

Sorry, I went on a rant there. But can you flesh out what I am getting at?

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  #44 (permalink)
Elite Member
Bay Area California
 
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@artemiso

I have a few questions, but I am hoping they all roll up into one answer.

Is it reasonable to assume, in markets like mini stock index futures, where there is no designated market maker, many HFT firms are attempting to act as a synthetic market maker?

What role does the probability of informed trading play in HFT?

One of the obvious differences between higher level trading (hft, institutional...) and retail trading seems to be the use of liquidity information. Mostly, I think retail traders avoid this because of how inconvenient it is to collect, organize, and properly evaluate level two data. Are we avoiding this at our own peril? Or is is largely irrelevant for high latency, low volume trading?

"If I agreed with you, we'd both be wrong."
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  #45 (permalink)
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Manchester, NH
 
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I have to head out for a meeting so I don't have time to review and edit this reply, will touch up on it later probably.


quantarb View Post
Yes, I donít think 2/20 is viable fee structure to survive on with a small AUM. I have interviewed with some start-up quant hedge funds where they already have over 15 person employed and have only raised a few million. With a 2/20 structure assuming they can make 20% their revenue is going to be 60k per million. That is not even going to be enough to pay the salaries. Iím just sitting there shaking my head in disbelief.

Are there any reasons why these start-ups hire many people especially quant researchers even though their AUM is relatively small. I just find it hard to believe these guys canít do simple math. They arenít doing anything fancy like high frequency trading. Their trading models are built in Matlab using daily data. Personally, I would rather spend the money on better software and data first.

I'm going start with a few number of people only 3 to 4 counting myself. It is basically going to be me doing the quant research strategy and implementing the models while the other guys are raising capital. My initial demographics will be mostly high worth individuals with a few million usd to invest. Assuming I can raise 10 to 20 million usd from friends and family and generate good returns (20% +). Where would I go from there?

Right, these guys are doing what most startups do and prioritizing growth rather than net profit. I don't think it's wrong to do that but they really need to last, and by that I estimate they need to have the capital to survive 3-5x the time that their business plan projects they need to become cash-positive. Chances are, they were too excited about a strategy or two, but they've grossly misestimated the strategy or business continuity.

In my experience, your fund is the log sum of the first 5 people in it. I'd definitely focus on the expansion of the team and hiring the right people foremost. Besides that, when you cross the 5-10 threshold, I'd start looking for a fund administrator, an introducing broker, or even a law firm that specializes in fund incorporation.


quantarb View Post
Do you have any experience with researching automated option trading options? Iím trading ETFs and Iím in the process of converting my strategies to trade the options rather than the underlying. My implementation so far is very simple. I take a long position in a call option when Iím long the underlying ETF. Likewise, I take a long position in a put option if Iím short the underlying ETF. I would like to backtest how the strategy performs trading options versus the underlying.

However option data is very difficult to work since there are many strike prices and expiration date. They are also irregularly traded so there might not be a trade when my system generates the signal in the underlying. How does one back test options?

Intuition tells me that my win rate will be lower because I will be dealing with time decay. On the other hand, my average losing trade will decrease since I can only lose the option premium which is a faction of the stock. Iím going to start with a small account to trade the options to see how well the strategy does vs trading the underlying. My main concern is getting raped by the bid-ask spread in many of these options.

I'm afraid it's inappropriate for me to discuss backtesting and strategy development.


Profiler View Post
But I see HFT as exploiting a system, looking for weak spots in a network to take advantage of rather than actually trading. I generalized HFT there and I know thats wrong as some are actually trading. But you cant tell me the proliferation of order types (hide and slide, hide and light, hide and whatever) and quote stuffing and all the other crap some HFT do has anything to do with real trading other than gaming the system.

As for the benefits of HFT, seriously where are they? I speak for the futures markets and having watched the ES/FESX everyday for the last 11 years I have seen no benefits. Both markets were as tight as they could be 11 years ago just as today. My exchange fees have never gone down. My clearing firm has the same volume based fee system they did since I switched to them in 2006. I'm still paying the same 8.99 a trade for stocks in my fidelity account that I did years ago. What I see as different is that now bids/offers are completely useless. There was spoofing in 2003 just as today but now its certainly much higher. I don't get why the exchanges are bowing down to HFT either- a quick glance at volume suggest across the board reductions since 07. A look at their stock prices show CME, DeutscheBorse (and I won't even check NYSE) to be well less than half their 2007 hi's despite the market currently being at all time hi's now.

Sorry, I went on a rant there. But can you flesh out what I am getting at?

I don't think exchanges are "bowing down to HFT" either. Quite the contrary, they have absolute control over their DMMs and member firms. It's difficult to monetize their business, and they've found a great way to do it because they've found a speculative following that would pay for a deluge of market access, data and colocation services.

Here are 4 predatory HFT firms that I know and I've mixed in a retail daytrader's profits. Do you recognize them?

--- Player ---|-------- Profit per side ($) -------
Player A ------- $0.40 to $2.00
Player B ------- $0.04 to $0.50
Player C ------- $0.10+
Player D ------- $0.02
Player E ------- $0.10 to $0.20


--- Player ---|-------- Risk (+/-$) as a multiple of profit per side ($) -------
Player A ------- 0
Player B ------- 0
Player C ------- 0
Player D ------- 0
Player E ------- 40 to 60

Do you recognize which one is the retail trader?
You'd probably guess Player E. That's incorrect. A retail trader usually takes a small risk, typically in the order of 1x, not 40-60x. Player E is actually your average HFT. A, B, C and D are the exchange, broker, software vendor (e.g. TT license fee) and regulator.

As far as I'm concerned, it doesn't require much intelligence to do B and C's work. Tell me that TT isn't predatory for arbing $0.10 per side from a retail trader who uses the NT DOM or whatever they call it, when REDI Baikai, Sapphire etc. are commonplace. I think it's ridiculous someone has to pay for an execution on a price ladder. If a retail speculator is losing money, I think he should really put the blame on his broker arbing $0.04 to $0.50 per side from him. It doesn't require much intelligence as far as I know.

Liquidity shouldn't be measured by the spread alone. It comes up from both sides of the argument - either Arnuk and Saluzzi will probably talk about it, or a self-proclaimed HFT expert like Aldridge will bring it up, but it's a red herring: it's only easier for people to understand a number like that. A narrow spread is a fringe benefit of liquidity, not the other way around. It doesn't mean liquidity cannot improve while the spread remains constant. If you find a spread that does not go narrower, it's almost certain that it cannot go narrower or whoever's quoting it will just be bleeding. And I welcome anyone to try. If you forced me to choose between quoting inside the market for no good reason and quitting my job to pick up aluminium cans from the trash, I would choose the latter.

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  #46 (permalink)
Trading Apprentice
San Francisco, CA
 
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lookOutBelow's Avatar
 
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Thanks artemiso for your time! I love reading intelligent threads about HFT that aren't focused on bashing it.

I'm involved in HFT as well and frankly, between Nanex, Zero Hedge, and well for that matter, almost everyone else, I'm pretty sick of the false information. It is scary how little the so called experts actually understand HFT.


Thanks again!

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  #47 (permalink)
Elite Member
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lookOutBelow View Post
Thanks artemiso for your time! I love reading intelligent threads about HFT that aren't focused on bashing it.

I'm involved in HFT as well and frankly, between Nanex, Zero Hedge, and well for that matter, almost everyone else, I'm pretty sick of the false information. It is scary how little the so called experts actually understand HFT.


Thanks again!

You're very welcome.

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  #48 (permalink)
Elite Member
Manchester, NH
 
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@addchild

I missed your question on my previous post and apologize.


addchild View Post
@artemiso
Is it reasonable to assume, in markets like mini stock index futures, where there is no designated market maker, many HFT firms are attempting to act as a synthetic market maker?

My answer is partly no, but mostly yes. No as in not all strategies are explicitly market-making strategies in the conventional sense of providing two-sided quotes. However, most of these strategies are, whether by design (two-sided quote) or comovement (pure alpha strategies, purely aggressive etc.), liquidity-providing. I have to re-emphasize the latter: you do not have to place standing limit orders to provide liquidity, a fortiori, you could be aggressive and provide liquidity.


addchild View Post
What role does the probability of informed trading play in HFT?


addchild View Post
One of the obvious differences between higher level trading (hft, institutional...) and retail trading seems to be the use of liquidity information. Mostly, I think retail traders avoid this because of how inconvenient it is to collect, organize, and properly evaluate level two data. Are we avoiding this at our own peril? Or is is largely irrelevant for high latency, low volume trading?

Great questions.

The spread is the fraction of informed trading. That way the price is risk-neutral for the market maker. This extends from my reply to your previous question.

Liquidity is notoriously difficult to model or forecast compared to return. There are people who spend their entire career modeling it with limited success. If you are managing the portfolio of an insurance company, I've mentioned that the major risk factor is the long-tail duration of your liabilities, and the liquidity of your liabilities comes a close second. If you are investing in stocks and bonds like most managers, then it's well known that your market exposure is the major risk factor, followed by value and size exposure, so you have a lot on your hands before you even get to liquidity modeling. You should think about your exposures and what drives your return, and you can do this either empirically or theoretically. I have a moderate position on this: You don't need to model liquidity to be successful in trading, and you also don't want to waste too much time on a sophisticated model. But I would not trade without at least some view of it that's better than "assume the asset is liquid".

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  #49 (permalink)
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If you are still answering questions, I have a few. If they are too revealing, feel free to ignore. (I hope I am not asking something you already answered. I read through the posts rather quickly and may of missed it).

1) What was the main reason you went out on your own? Was it purely money driven? Or perhaps the freedom of doing things your way? Or something entirely different?

2) How many people work with/for you? Do you have partners or are you the sole owner? Did you involve investors, finance it yourself, or work out some other deal with another entity?

3) Do you concentrate on one asset class or several?

4) Do you get annoyed by all the negative and untrue media coverage? (Or with those that seem to have an agenda) Or are you able to brush it off and ignore?

5) On a scale of 1-10 how concerned are you that HFT will be regulated away in the US? I know strategies can adjust to rule changes. I guess I mean, HFT as we currently know it?


Thanks

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  #50 (permalink)
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What sort of hardware are HFT funds using? Is it anything special?

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