I am writing this post in response to the CBS "60 Minutes" on
10/10/2010 on the subject of high frequency trading. If you think that
achieving profit every single day for years and years is impossible,
think again! In fact, the opposite is true: not making a profit
EVERYDAY (or even every hour) is nearly impossible.
I don't remember whether Thorp, Shannon, or Kelly proposed the problem
of rebalancing on the stock that either goes up or down 50% each
day. In reality, no stock goes up or down 50% everyday. In one of my
previous posts, I have addressed the problem of this random jump vs
random walk:
http://www.elitetrader.com/vb/showthread.php?s=&postid=2796098#post2796098
Rigorous proof of how a trader who can enter bid and ask at sub-penny
prices will have mathematically guaranteed upper hand over a trader
who can only enter bid and ask at penny-level prices is simple. But
here is a common sense way to think about it:
For retail traders, they can only play at penny-level. For them,
prices move up or down by multiples of one-penny each time. In other
words, the smallest step of retail traders in their price random walk
if one penny. Institutional traders, however, can play at 0.01 penny
level (basis point), and will win nearly every time they trade against
retail traders.
Consider a random walk for retail traders. The price starts at 0 and
goes up or down one penny with equal probability. The retail trader
sets profit target at +2 pennies and stop loss at -1 penny. To trade
against the retail trader, the institutional trader sets profit target
at +1 penny and stop loss at -0.01 penny. Note that each step of the
random walk of the retail trader is a random jump for the
institutional trader whose steps are 100 times smaller. Now the walk
begins. If the price goes to +1, the retail trader has not reaches his
profit target, but the institutional trader has already made one
penny; if the price goes to -1, the retail trader is stopped out, but
the institutional trader loses only 0.01. Now at either +1 or -1, the
institutional trader can again enter a profit target at one penny
higher or a stop loss 0.01 lower, while the retail trader can only
languish. One successful trade for institutional trader will cover 99
losing trades, and yet winning and losing trades occur with equal
probability for institutional traders. If an institutional trader does
a multitude of trades, how can he ever have a losing day, or a losing
minute!?!
Sub-pennying allows institutional traders or high-frequency traders
unfair mathematical advantage. SEC must regulate to level the playing
field to protect the public. To curb high frequency trading, financial
transaction tax is unnecessary if sub-pennying is prohibited. We
should write to our senetors and congressmen to outlaw
sub-pennying. Dark pools, quote stuffing, front running are still
conventional weapons, but sub-pennying is a nuclear weapon and must be
stopped!!!
Comments welcome!
Please write to your senators and congressmen, write to Mary Schapiro,
write to Sen. Ted Kaufman of Delaware.
10/10/2010 on the subject of high frequency trading. If you think that
achieving profit every single day for years and years is impossible,
think again! In fact, the opposite is true: not making a profit
EVERYDAY (or even every hour) is nearly impossible.
I don't remember whether Thorp, Shannon, or Kelly proposed the problem
of rebalancing on the stock that either goes up or down 50% each
day. In reality, no stock goes up or down 50% everyday. In one of my
previous posts, I have addressed the problem of this random jump vs
random walk:
http://www.elitetrader.com/vb/showthread.php?s=&postid=2796098#post2796098
Rigorous proof of how a trader who can enter bid and ask at sub-penny
prices will have mathematically guaranteed upper hand over a trader
who can only enter bid and ask at penny-level prices is simple. But
here is a common sense way to think about it:
For retail traders, they can only play at penny-level. For them,
prices move up or down by multiples of one-penny each time. In other
words, the smallest step of retail traders in their price random walk
if one penny. Institutional traders, however, can play at 0.01 penny
level (basis point), and will win nearly every time they trade against
retail traders.
Consider a random walk for retail traders. The price starts at 0 and
goes up or down one penny with equal probability. The retail trader
sets profit target at +2 pennies and stop loss at -1 penny. To trade
against the retail trader, the institutional trader sets profit target
at +1 penny and stop loss at -0.01 penny. Note that each step of the
random walk of the retail trader is a random jump for the
institutional trader whose steps are 100 times smaller. Now the walk
begins. If the price goes to +1, the retail trader has not reaches his
profit target, but the institutional trader has already made one
penny; if the price goes to -1, the retail trader is stopped out, but
the institutional trader loses only 0.01. Now at either +1 or -1, the
institutional trader can again enter a profit target at one penny
higher or a stop loss 0.01 lower, while the retail trader can only
languish. One successful trade for institutional trader will cover 99
losing trades, and yet winning and losing trades occur with equal
probability for institutional traders. If an institutional trader does
a multitude of trades, how can he ever have a losing day, or a losing
minute!?!
Sub-pennying allows institutional traders or high-frequency traders
unfair mathematical advantage. SEC must regulate to level the playing
field to protect the public. To curb high frequency trading, financial
transaction tax is unnecessary if sub-pennying is prohibited. We
should write to our senetors and congressmen to outlaw
sub-pennying. Dark pools, quote stuffing, front running are still
conventional weapons, but sub-pennying is a nuclear weapon and must be
stopped!!!
Comments welcome!
Please write to your senators and congressmen, write to Mary Schapiro,
write to Sen. Ted Kaufman of Delaware.
