What the heck is "liquidity," exactly... providing, purchase, exactly

jcfa2011

Yes, I know more-or-less what liquidity means. But the problem is that it’s only “more-or-less.” I hear people talking about “adding liquidity” or “providing liquidity” or “liquidity driven” things like it’s the most obvious thing in the world.
In my mind, I think of liquidity as “the ability to convert an asset to cash quickly at close to the last quoted price.”
A corollary from the purchase side is “the ability to purchase an asset quickly at close to the last quoted price.”
There are several dimensions:
A: The quantity of an asset that gets converted. Converting larger quantities of an asset tends to have a larger impact on price at all levels of liquidity.
B: The speed at which the asset can be converted. The ability to distribute transactions over time reduces the price impact, but it also opens up risk to price changes from other factors in the interim.
C: The discount to the last price. The greater the price impact, the lesser the liquidity.
One version of this view (consistent with practitioners) is that the bid-ask spread is an indicator of liquidity, because if you buy something and immediately want to sell it, the BA spread tells you how much of a hit you must take on the price to turn around instantaneously.
But there are plenty of other times when people talk about providing liquidity that doesn’t really seem to fit into this view, and I wonder what I’m missing. HFT firms, for example, talk about “providing liquidity,” but in fact, that liquidity can disappear instantaneously, so are they really providing it? How are they making money, other than, perhaps, from each other.

atate2007

I’ve pointed out repeatedly that market fragmentation, in the short run, is not a good thing for the retail investor. In the long run, it is beneficial, and we’ve seen dramatic technical advances in this space due to competition.
PS No, I don’t have a “soul”. I’m a complex bag of meat and water. Keep your sanctimonious, passive-aggressive bullshit to yourself, please. Thanks!

towardsutopia21

justin88 Wrote:
——————————————————-
spierce Wrote:
————————————————–
—–
  […]

I don’t know why I’m trying to explain things to
you, since you seem to have an axe to grind.
Hopefully others will benefit from a more rational
discussion.

There are obviously still imperfections with the
markets; in particular I’ve noted the
fragmentation of equity liquidity is a problem.
The markets will never be perfect; nonetheless the
markets are fairer and more liquid than they were
ten years ago, particularly for the retail
investor.

For instance, as a retail investor in my Fidelity
account, I can trade the S&P500 index in
real-time, commission free via an ETF. Should I
choose to invest in it, I pay a ~9bp expense
ratio. Should I choose to trade it, the spread is
usually $0.01. The top of book is usually liquid
enough to support $1,000,000 trades at market.
This is effectively infinite liquidity for a
retail investor trading this asset.

HFT plays a major role, not only in liquidity, but
also in the efficient aka fair pricing of all
kinds of cross-market assets. This cross-market
liquidity allows retail investors to trade markets
at very fair prices when they were previously
inaccessible. Two examples: GLD and LQD are ETFs
that enable the retail investor to take
previously-difficult-to-assume risks (gold and
diversified IG corporate bonds), due to market
structure and minimum price. (Front month gold on
the CME is more than $100,000 per contract, and a
diversified bond portfolio would require even more
capital.)

One could argue the rapid pace of financial
innovation is contributing to the bubble pricing
of gold and bonds, but I digress.
Obviously somebody believes everything the Lords of Finance has said is good for society. Just as much as you wonder why you bother to edumacate my poor soul, I wonder if you even have one. Keep on believing in your (and their) greatness while the systemic risk inherent in such systems increases.
I am sure the SEC investigation will result in bupkis, that’s what happens in a “free market” (aka, purchased regulators) situation anyway.

AndyNZ

spierce Wrote:
——————————————————-
[…]
I don’t know why I’m trying to explain things to you, since you seem to have an axe to grind. Hopefully others will benefit from a more rational discussion.
There are obviously still imperfections with the markets; in particular I’ve noted the fragmentation of equity liquidity is a problem. The markets will never be perfect; nonetheless the markets are fairer and more liquid than they were ten years ago, particularly for the retail investor.
For instance, as a retail investor in my Fidelity account, I can trade the S&P500 index in real-time, commission free via an ETF. Should I choose to invest in it, I pay a ~9bp expense ratio. Should I choose to trade it, the spread is usually $0.01. The top of book is usually liquid enough to support $1,000,000 trades at market. This is effectively infinite liquidity for a retail investor trading this asset.
HFT plays a major role, not only in liquidity, but also in the efficient aka fair pricing of all kinds of cross-market assets. This cross-market liquidity allows retail investors to trade markets at very fair prices when they were previously inaccessible. Two examples: GLD and LQD are ETFs that enable the retail investor to take previously-difficult-to-assume risks (gold and diversified IG corporate bonds), due to market structure and minimum price. (Front month gold on the CME is more than $100,000 per contract, and a diversified bond portfolio would require even more capital.)
One could argue the rapid pace of financial innovation is contributing to the bubble pricing of gold and bonds, but I digress.

ap0258

justin88 Wrote:
——————————————————-
I never said that “without HFT we’d go back to the
$100 with spreads at 25c”. I was merely pointing
out that the bygone days you yearn for were far
worse than what we have now, particularly for
retail investors. A lot of the innovation we’ve
had has been beneficial for retail investors,
including IMO, HFT.
Yeah, I yearn for the days, perhaps 10 years ago, when everything was massively inefficient. There isn’t a single shred of “innovation” that has been good for retail investors in HFT.

HFT wouldn’t exist unless there was already a
market inefficiency. HFT in essence is providing
small amounts of liquidity for certain names, on
certain venues, at certain times. Retail
investors, while not getting perfect execution,
are getting better execution, partially due to
HFT, than ten years ago. (Very few even paid
attention to execution at all ten years ago.)
What “market inefficiency” are you speaking of? Taking advantage of minute price differences, or blatantly manipulating prices? I guess with such efficient markets we’d never have had the credit bubble or the .bombs. Thank god for HFT.

Perhaps your lolrage is better directed toward the
fragmentation of the markets than HFT? The reason
SS flash crashes happen is because liquidity is
fragmented across dozens of trading venues, many
of which are trading the exact same/fungible
things, but the price on one of those venues
temporarily plummets/rips because someone routed
an outsized amount of flow to that venue relative
to its liquidity.
Yeah, perhaps if we tripled the current volume on the major exchanges we’d have an uber-efficient market. Ohh wait, we already did that and it didn’t do dick to make them more efficient.

Finalnub

And what about stop-loss orders that are triggered. ZH has some good graphs of the volume pings that drop prices precipitously and the obvious market manipulation.
I’m with KidDynamite, just eliminate market orders. Problem solved.

dkishore1

spierce - I agree with you in principle.
Though, when talking about “frontrunning”, there should be a distinction between frontrunning, which is a broker specific problem, and simply trading. It does matter who’s doing it imo.

rkapoor

jmh530 Wrote:
——————————————————-
Front-running isn’t the same thing as HFT. You can
criticize front-running without criticizing HFT.
But you CAN criticize both. Sure, there can be front running without HFT, but HFT does enable faster front running.

If liquidity disappears and no one trades, then
the market won’t fall. It takes people wanting to
sell more than buy when liquidity dries up (no one
seems to are about liquidity drying up and the
market rising 100%, only falling 100%). I’m sorry,
but I don’t have much sympathy for the
panic-sellers. Anyway, if there are some prints
-20% down, that doesn’t mean that volume-weighted
prices for the day really changed much.

And what about stop-loss orders that are triggered. ZH has some good graphs of the volume pings that drop prices precipitously and the obvious market manipulation.
I think the decline in commission has more to do
with regulatory changes than the narrowing of
spreads.

  HFT has done nothing at all to
  help out retail investors and has merely cost
them
  millions if not tens of billions.

HFT would have to steal more money than the
narrowing of the spreads would have saved them.
I agree 100%, the answer is obvious.

CPATrader

spierce Wrote:
——————————————————-
you know what is abject nonsense? The idea that
some bank or fund can utterly front-run all
clients and every other market participant because
they have a super computer connected to an uber
internet pipe and they can quote stuff the sh!t
out of a stock to pop limits.
Front-running isn’t the same thing as HFT. You can criticize front-running without criticizing HFT.
or that this
“liqudity” can dissapear in a milisecond and cause
the entire market to crash within that period. Or
that they can flash-crash single stocks at the
push of a button.
If liquidity disappears and no one trades, then the market won’t fall. It takes people wanting to sell more than buy when liquidity dries up (no one seems to are about liquidity drying up and the market rising 100%, only falling 100%). I’m sorry, but I don’t have much sympathy for the panic-sellers. Anyway, if there are some prints -20% down, that doesn’t mean that volume-weighted prices for the day really changed much.
Then you attempt to say that without HFT we’d go
back to the $100 commission with spreads at 25c.
sorry, but that’s just a ridiculous argument.
I think the decline in commission has more to do with regulatory changes than the narrowing of spreads.
HFT has done nothing at all to
help out retail investors and has merely cost them
millions if not tens of billions.
HFT would have to steal more money than the narrowing of the spreads would have saved them.

anshultongia

I never said that “without HFT we’d go back to the $100 with spreads at 25c”. I was merely pointing out that the bygone days you yearn for were far worse than what we have now, particularly for retail investors. A lot of the innovation we’ve had has been beneficial for retail investors, including IMO, HFT.
HFT wouldn’t exist unless there was already a market inefficiency. HFT in essence is providing small amounts of liquidity for certain names, on certain venues, at certain times. Retail investors, while not getting perfect execution, are getting better execution, partially due to HFT, than ten years ago. (Very few even paid attention to execution at all ten years ago.)
Perhaps your lolrage is better directed toward the fragmentation of the markets than HFT? The reason SS flash crashes happen is because liquidity is fragmented across dozens of trading venues, many of which are trading the exact same/fungible things, but the price on one of those venues temporarily plummets/rips because someone routed an outsized amount of flow to that venue relative to its liquidity.