Algorithmic Trading: A Dark Magic?

Boodles

Banned
Banned
A computer can never truly make a qualitative, pragmatic or ethical judgment, it has no basis upon which to make such decisions, for instance to consider the long term stability of bond prices that maintain nations. They works on rapid, incremental profit making and has no concept of what numbers represent on the ground, this man's wheat, that woman's steel, your pension fund, for instance.

BBC Radio 4 had a fantastic programme on this very subject some weeks ago, entitled Dark Magic, I thought it might be a good subject to raise here. Trillions of dollars are being traded at very high frequency on the big markets, on an hourly basis, using nothing but algorithms. The brokers and traders have left the buildings, to 'robots'. The question the BBC programme posed was, is this going to lead to an inevitable global catastrophe on the money markets?

I'm trying to think of a way to illustrate this. If one could imagine Zeno's paradox, but where both Achilles and the tortoise are on base amphetamine, I think that could be quite a good analogy. Two (actually, countless) algorithms in a face off of ever faster, yet ever diminishing gains, trading off one another's weaknesses thousands of times a second until bang! - The market crashes, if you can picture it?

There are many examples of this happening, already, on "smaller" billion dollar scales, it is a genuine problem. Are we really to entrust our global markets and therefore our economies to algorithmic formulae? Is this ethical? No! - And hardly anyone even realises it is happening. Is it profitable? Yes!

So, for the purposes of this site I would state that many report algorithmic high volume trading could and probably will eventually bring about a cataclysmic total meltdown to the global market place - unlike anything experienced before. Is this a genuine claim, something to be genuinely concerned about, or is it complete nonsense?
 
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Pete Tar

Senior Member.
Well on the face of it something to be concerned about. But I don't have the specialist knowledge to understand the dark magic. What does someone in the industry say? It would be interesting to hear what defence is made to justify the practice, if any.
 

Boodles

Banned
Banned
Well on the face of it something to be concerned about. But I don't have the specialist knowledge to understand the dark magic. What does someone in the industry say? It would be interesting to hear what defence is made to justify the practice, if any.
Firstly, my English is terrible, a correction:
"They works on rapid, incremental profit making and has have no concept of what numbers..."

The curious thing is it seems no one else has 'specialist' knowledge either! There are speculative theories emerging with little predictive certainty. It is an essentially unquantifiable area and therein lies the potential for bunk. One seemingly universally agreed advantage to the higher frequency of trade algorithmic 'robots' are bringing to the market place is one of increased liquidity or, literally, the rapid throwing of money into the usable pot adding confidence to exchange. However, Germany, with the EU to follow, are taking action with new regulations to mitigate perceived risks and to be seen to attempt to eliminate the unfair advantages it can give to certain traders.

What I mean by the latter is ordinarily were any of us to step to a market place we would expect transactions to take place that follow pretty simple but sound economic principles, the quality of a given product, for instance, it's utility or the degree to which we need or want it, it's relative scarcity, the negotiation of a price that reflects these factors but these new modes of trade have within them stacked advantages that are far more concerned with the speed of processing chips and, quite literally, the length of fibre optic cable between a trader and an exchange.

It seems regulatory measures have a sort of Luddite quality to them, a re-levelling of the field by slowing down connection speeds, or randomising the order in which queued transactions can be processed (removing technical advantage), which immediately strikes me as counter-intuitive, or counter-Moore's Law, if you will.
What's the bunk here? Is there a specific claim of evidence?
Yes, I've jumped the gun there, haven't I? - Sorry. I am hunting for bunk. As this area is relatively new, highly technical and in some aspects completely theoretically - indeed throwing open an entirely new paradigm - it is both difficult to create bunk and just as difficult to debunk it.

What seems to be apparent, at the very least, in terms of general claims, is that this technology, just like nanotechnology, is bringing with it an associated language of darkness, of portent of doom, of the rise of the autonomous robot and the enslavement of man to mechanism. Descriptions such as dark, rogue, malicious, clustering and mobbing populate the literature. The BBC piece was a case in point! I wonder if it, a total collapse, is a genuine concern or just more feeding into fear of the unknown for the sake of producing an engaging radio piece, or reading.

A little difficult to pull together bits and pieces from a phone but, referring back to Zeno's paradox, the central fear seems to revolve around some sort of emergent singularity. There are some interesting theories out there that concern, yes, a new dimension, of robotic autonomy, encompassing black swan theory but with a predicted increased likelihood of 'black swan events' (usually defined by rarity) within this unpredictable realm, this realm being interestingly described as Ultrafast Machine Ecology.

One writer has put forward a theory that the increasing number of black swan events, occurring over rapidly decreasing lengths of time, are the cause of the global economic downturn since 2006, which is a very big claim.

I suppose to anyone reading this -if I haven't been too clear- one could imagine a straight line along a horizontal axis, x to y, representing a value over time, a constant value of, say, "5", but when one moves within the ecology of the ultrafast machine one can perceive that this straight line is in fact not straight or constant, at all, but a rapid, almost vertical, flux between values of say, 0 and 10, across time spans so small they are utterly imperceptible to us.

[Edit: Have found a graphic that goes some way to illustrate this, and placed it below. This one concerns a related "flash crash" incident, at Wall Street]

feature_hftgraphic24__01__950b.jpg

Such fluctuations, or flashes, are increasingly frequent in markets, that they can be beyond our perception is the conduit to fear, whether fear has any basis in reason, I do not know.

It just struck me as interesting so I thought I'd put the topic up here for a little scrutiny, if anyone feels like it. As I have thus far found very little "bunk" please feel free to remove the topic. I do, however, suspect there'll be plenty of bunk out there regarding this, in future. I could probably start by debunking my own misinterpretations :)
 
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Mick West

Administrator
Staff member
Interesting related news today:
http://www.motherjones.com/kevin-drum/2013/09/somebody-stole-7-milliseconds-federal-reserve
I certainly don't think high speed quant trading is a good thing at all.
 

MikeC

Closed Account
I suspect timing errors rather than a conspiracy - cf faster-than-light neutrinos......
 

Boodles

Banned
Banned
Interesting related news today:
http://www.motherjones.com/kevin-drum/2013/09/somebody-stole-7-milliseconds-federal-reserve
I certainly don't think high speed quant trading is a good thing at all.

I have no idea what a neutrino communications network is and less still what a fluxing one would look like :)

However, that story would lead me to assume someone having inside knowledge, waiting, of course, to react at precisely 2pm, wanting to beat the market to purchase before a price rise but overlooking an astute person noticing the order got to Chicago before the news ever could have, and that someone being naughty i.e it points to someone in the Federal Reserve itself.
 
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Boodles

Banned
Banned
I certainly don't think high speed quant trading is a good thing at all.
No, I agree, it is not only technocratic but can create all sorts of fake conditions within a market, the importance of which mostly goes above my head, but I guess I just wonder if there are inherent weaknesses within the idea, or if it is merely computers doing the same things humans do (beating out profit from small margins at high turnover) but just a great deal faster. The early bird gets the worm and these formulae get up very, very early. It is interesting that something as practical as the speed of light is having a limiting effect. Over the radio they have just announced a mother-bluffa of a data centre opening in the "Silicon Roundabout" in London, today. That name is just spin for a dump in Hackney with I.T start-up companies but the data centre is there, specifically, because from there it will take fractionally less time, at the speed of light, for trades to reach the adjacent stock exchanges etc. in the financial square mile.

Anyhow, the BBC programme was here
http://www.bbc.co.uk/iplayer/episode/b036k1s3/A_Dark_Magic/ -not sure if anyone can legally access i-player outside the UK nowadays or even if that link still works in the UK but the programme may still be lurking around pirate sites or P2P.
 
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Mick West

Administrator
Staff member
However, that story would lead me to assume someone having inside knowledge, waiting, of course, to react at precisely 2pm, wanting to beat the market to purchase before a price rise but overlooking an astute person noticing the order got to Chicago before the news ever could have, and that someone being naughty i.e it points to someone in the Federal Reserve itself.

It was also possibly a hedge move. A large market order a few ms before the announcement would be unexpected, but the person placing the order would know it was there. Then when the announcement came they would be able to immediately react based on their previous order, so they actually have more information than other people, and could either leave it to profit, or place an order based on anticipated reaction incorporating their own order into the equations - basically anticipating market moves one step ahead for a few fractions of a second.

Either way, it's not good for the economy, or financial stability.
 

Oxymoron

Banned
Banned
It was also possibly a hedge move. A large market order a few ms before the announcement would be unexpected, but the person placing the order would know it was there. Then when the announcement came they would be able to immediately react based on their previous order, so they actually have more information than other people, and could either leave it to profit, or place an order based on anticipated reaction incorporating their own order into the equations - basically anticipating market moves one step ahead for a few fractions of a second.

Either way, it's not good for the economy, or financial stability.
It is no accident or timing error but another way of manipulating the markets. Legalised Insider Trading by 'Market makers', (Goldman Sachs/JP Morgan etc) get the 'flash trading tip off' a second before and the 'High Frequency Trades' are carried out in microseconds. Flash crashes are becoming evermore frequent. One aspect it is designed to take out the small investors aka 'Retail Investors', aka 'marks/mugs' by crashing through the stop loss setting at which point the 'pros' come in on auto and buy up at the cheap price before the price springs back.


 
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