Gillian Tett raises some interesting questions in her Financial Times article today: “What can be done to slow high-frequency trading?” (http://www.ft.com/cms/s/0/d72966fa-bc2d-11df-8c02-00144feab49a.html)
She closes her piece with the most important economic question that can be asked: “To my mind, the real question which needs to be discussed—but which regulators are still ducking—is why ultra-fast trading is needed at all?”
The answer: people believe that they can make money if they have a slight edge in the speed at which they can make trades.
I don’t think that this answer is changed by going into the debate relating to the neurological research which argues that “the brain has two contradictory instincts: part of it is hard-wired to chase instant gratification; however, another part of our brain also has the ability to be ‘patient’, and delay immediate gratification for future gains.”
This is just the argument raised by the behavioral finance and economics researchers. (See my review of the book “Snap Judgment” for a discussion of this issue: http://seekingalpha.com/article/145660-book-review-snap-judgment-by-david-e-adler.) The general assumption that accompanies this train of thought is that “instinctional” behavior is irrational and therefore not productive.
To quote from Tett’s article, “in practice innovation…has a darker, impatient side too: as markets have become deeper, and more liquid, that has enabled trading to become more frenetic; similarly, as information has become more frequently available this has encouraged skittish, herd behavior.”
But, life is full of situations in which “instinct” or the ability to make quick decisions is of crucial importance. For example, we need military leaders that can make decisions “on-the-spot” as well as those that can plan out strategies for long, drawn-out battles. The military trains people over-and-over again to develop the perception and experience to make decisions in the “real time” that is necessary for winning battles and winning wars.
We can find examples in many fields where “immediate” action is needed. The education and training in these areas is intense and efforts are made to find the people that are the very best in their ability to diagnose a situation and come up with the “right decision” as often as possible.
The real difference is the capability of the person or persons making the decisions. In the military, in medicine, and in many other professions, there is a hierarchy in terms of who makes the decision. Hopefully, the people that rise to the top are those individuals that can perform well and are able to make good “snap” decisions if they are needed.
Sometimes there is licensing or other forms of identification that require test taking and hurdles to overcome in order to get the certification or advancement that will put the “right people” in the “right spot” for a specific type of “real time” decision.
In economics, these tests or hurdles are called “barriers to entry”.
In the trading of stocks and other investment vehicles, there are low barriers to entry into the industry and this includes the costs one must pay to enter an industry. As a consequence, there are many traders and not all of these have the “jet pilot” capabilities to execute trades at the speeds that are now available.
The crucial thing is that in areas where quick decisions need to be made, a premium is paid to those with the education and training, the experience, and the mental capacity to make such decisions. As I stated in the post cited above, successful decision making, over any time period, depends upon “cold analytical methodology and steely discipline, characteristics that most people, who rely too much on their instincts, don’t possess.” That is, some people are better decision makers than others, even in the very short run.
People are going to engage in an activity where they believe that they can make money. So high-frequency trading is going to take place. Individuals that cannot perform within such an environment are going to lose, and could lose a lot.
The concern of the other market participants is “what damage can these not-so-good traders do to the overall market?” As Ms. Tett states, one result of the move to high-frequency trading seems to be “more market volatility.”
The fear in this: “rising levels of speed, impatience—and short-terminism—might have actually made the (financial) system less efficient, and rational, than before” this increase in speed.
My feeling with this is that speed is something we are going to have to live with. I have argued this point before in my post “Banking at the Speed of Light”. (http://seekingalpha.com/article/208513-banking-at-the-speed-of-light) The point is that this “speed up” is happening all over the world in different kinds of decision making. It is just that high-frequency trading is getting a lot of publicity now and thus attracting a lot of debate.
In the post just mentioned, I cite the example of events happening in South Africa relating to the use of mobile phones by commercial banks to develop their customer base. In this example the discussion was around the 15 million adult South Africans that had previously been excluded from the financial system. And, the players in this effort are not small.
But, this points to another issue, the growing strength of the “new rising powers” in the world as discussed in an opinion piece in the Financial Times titled “The new disintegration of finance.” (See http://www.ft.com/cms/s/0/938e7228-bc55-11df-a42b-00144feab49a.html.) The authors, Stéphane Rottier and Nicolas Véron, are concerned about how the effort to organize and co-ordinate global financial regulation and supervision is facing issues that might reverse the trend to great co-operation. One of their concerns is that “Financial institutions from emerging countries are beginning to overtake their western peers. New financial centers are gaining market share, while emerging countries are asserting themselves in global financial rulemaking, and increasingly resist standards proposed by the member of the old north Atlantic consensus.”
This is the world of the future. This is how competition is going to progress. See “The New World Order: Smaller and Faster”, my post of August 31, 2010 (http://seekingalpha.com/article/223127-the-new-world-order-smaller-and-faster). I think most of you know how I feel about the ability of regulations to control this world. I think most of you know that I believe that many, if not most, of the big players have already moved beyond what American…and world…regulators are trying to do with respect to financial institutions and markets. Laws, regulations, and regulators must deal with processes and not “outcomes.” I have written about this many times in my posts.
Hold on, it is going to be an interesting and exciting ride!
Showing posts with label high frequency trading. Show all posts
Showing posts with label high frequency trading. Show all posts
Friday, September 10, 2010
Friday, June 4, 2010
I Beat You By 200 Milliseconds, So Sue Me!
The future of finance is wrapped up in information technology. First because the technology deals with information and secondly because the technology is rapidly improving, even as I write this sentence.
In lectures I have given around the country on how information technology is going to impact the future I tell my audiences to keep their eyes on two groups of people and what they are doing with computers. First, check out what large governments, like the United States are doing about computers, because in order to keep their position in the world they must continue to be better than anyone else at killing people.
The first modern computer, the Eniac, was funded by the government in order to be able to better track the flight of artillery shells so that the army could be more accurate in hitting their targets. The Quantum Computer is going to be built because the government must be able to keep secrets and Quantum Computers are so fast that current coding systems are inadequate relative to the speed at which these new computers will be able to calculate. Also, these computers will be so fast that the ability to attack targets far away and the ability to simulate battles before they happen will be an overwhelming tool for the military. Obviously, America cannot afford to be second in the race to build the Quantum Computer.
Second, I suggested, watch what the kids are doing. If you want to know what is going to be “ubiquitous” in a few years, check out what that eight year old in your family is doing with electronic gadgets. And, by-the-way, in terms of stimulating battles and what kids are doing, read “Ender’s Game” by Orson Scott Card. In this book, a set of children are being trained to repeal an invasion of earth. The invasion is simulated by computer games with “faster than light” communications. After much practice, another game takes place. However, as we learn, it is an actual invasion and the only thing protecting the earth is these kids!
Great book…you should read it if you haven’t already read it. Actually, put “Ender’s Game” on your bookshelf right there along with “The Quants”! (See my review: http://seekingalpha.com/article/188342-model-misbehavior-the-quants-how-a-new-breed-of-math-whizzes-conquered-wall-street-and-nearly-destroyed-it-by-scott-patterson.) The important thing, however, is that this book is hugely popular, it is what young people are familiar with, and it presents a picture of what they believe the technology of the future will be like. And, the book was written in 1985!
What does this have to do with finance?
The Wall Street Journal this morning contains the article “Fast Traders’ New Edge.” (See http://online.wsj.com/article/SB10001424052748703340904575285002267286386.html#mod=todays_us_money_and_investing.) “Some fast-moving computer driven investment firms are getting an edge by trading on market data before it gets to other investors…The firms gain that advantage by buying data from stock exchanges and feeding it into supercomputers that calculate stock prices a fraction of a second before most other investors see the numbers.” Although these moves may only produce pennies, if one multiplies the pennies by thousands of trades, “big profits” can be made.
“The ability to estimate price moves ahead of the national best bid and offer price can give traders an advantage of about 100 to 200 milliseconds over investors who use standard market tools.”
This practice is called “latency arbitrage” and, of course, those investors that are not into it at the present time are searching for ways to protect themselves. Of course, the first thing you do is see whether or not you can compete electronically. Obviously, if you can’t compete electronically then you ask for regulation.
But, this is the world of the future. This is “Ender’s Game” only it is beyond the simulation exercises, it is the real thing. It is also a part of that netherworld that includes high frequency trading and dark pools.
My point is that advancements in computer technology are not going to slow down. If anything, these advancements will speed up. And, with the possibility that Quantum Computers will become a reality within the next decade or so the ‘speed up’ will tend to be exponential and not linear. Furthermore, the generations that will follow us expect this ‘speed up’ to happen and will look on these capabilities as just another part of their ‘normal’ lives.
If we do not comprehend this future, if our elected officials and regulators do not comprehend this future, then we will not be prepared for the economic and financial systems that are on the horizon. Hence, we will all make mistakes.
The “Quants” made mistakes this last time around. But, they are alive and well, and, I believe that it is a very safe bet to say that they have learned from their mistakes and have already modified their systems to take advantage of the most recent information available to them. Many “Quants” are trained in Information Theory, the study of the messages that are contained in strings of data, even though these strings may seem to be random in nature. Their systems are now more robust than they ever were in the past.
This is how humans become better decision makers. They adapt their models and systems so that they can make better predictions of the future in order to make better decisions or solve more difficult problems. This process is part of being a human and humans will not cease to put it into practice.
The discussion so far has been at the “top of the pyramid,” so to speak. But what about the “bottom of the pyramid”? How is technology playing out there?
This morning there appeared in the Financial Times a description of how banks in the South African Township of Tembisa are using mobile phones to develop their customer base. (See “Banks find potential in mobile phone growth,” http://www.ft.com/cms/s/0/0f6fad92-6f28-11df-9f43-00144feabdc0.html.) Banks have changed over the past decade because “as the spending power of low-income groups increases, more and more banks are competing for the business of the 15m adult South Africans who had previously been excluded from the financial system.” And they are using information technology to do it!
And, the players are not small. “In South Africa, Capitec and African Bank pioneered the drive…” and Vodafone, the British telecoms company, “launched one of the most celebrated mobile banking initiatives.” “Instead of opening an expensive branch network, many of these new operations work with agents such as shops or bars.” Mainstream banks are following suit.
This is not the only technological initiative taking place at the “local level” in the world. Electronic finance is here to stay and it is spreading further and further into previously under-served communities every day. Remember, finance is really nothing more than information and the exchange of information.
So the Obama administration, Congress, and the regulators in Washington (and politicians and regulators in the rest of the world) are attempting to prevent the last financial collapse from happening again.
Should I smile…or giggle…or break out in laughter?
In lectures I have given around the country on how information technology is going to impact the future I tell my audiences to keep their eyes on two groups of people and what they are doing with computers. First, check out what large governments, like the United States are doing about computers, because in order to keep their position in the world they must continue to be better than anyone else at killing people.
The first modern computer, the Eniac, was funded by the government in order to be able to better track the flight of artillery shells so that the army could be more accurate in hitting their targets. The Quantum Computer is going to be built because the government must be able to keep secrets and Quantum Computers are so fast that current coding systems are inadequate relative to the speed at which these new computers will be able to calculate. Also, these computers will be so fast that the ability to attack targets far away and the ability to simulate battles before they happen will be an overwhelming tool for the military. Obviously, America cannot afford to be second in the race to build the Quantum Computer.
Second, I suggested, watch what the kids are doing. If you want to know what is going to be “ubiquitous” in a few years, check out what that eight year old in your family is doing with electronic gadgets. And, by-the-way, in terms of stimulating battles and what kids are doing, read “Ender’s Game” by Orson Scott Card. In this book, a set of children are being trained to repeal an invasion of earth. The invasion is simulated by computer games with “faster than light” communications. After much practice, another game takes place. However, as we learn, it is an actual invasion and the only thing protecting the earth is these kids!
Great book…you should read it if you haven’t already read it. Actually, put “Ender’s Game” on your bookshelf right there along with “The Quants”! (See my review: http://seekingalpha.com/article/188342-model-misbehavior-the-quants-how-a-new-breed-of-math-whizzes-conquered-wall-street-and-nearly-destroyed-it-by-scott-patterson.) The important thing, however, is that this book is hugely popular, it is what young people are familiar with, and it presents a picture of what they believe the technology of the future will be like. And, the book was written in 1985!
What does this have to do with finance?
The Wall Street Journal this morning contains the article “Fast Traders’ New Edge.” (See http://online.wsj.com/article/SB10001424052748703340904575285002267286386.html#mod=todays_us_money_and_investing.) “Some fast-moving computer driven investment firms are getting an edge by trading on market data before it gets to other investors…The firms gain that advantage by buying data from stock exchanges and feeding it into supercomputers that calculate stock prices a fraction of a second before most other investors see the numbers.” Although these moves may only produce pennies, if one multiplies the pennies by thousands of trades, “big profits” can be made.
“The ability to estimate price moves ahead of the national best bid and offer price can give traders an advantage of about 100 to 200 milliseconds over investors who use standard market tools.”
This practice is called “latency arbitrage” and, of course, those investors that are not into it at the present time are searching for ways to protect themselves. Of course, the first thing you do is see whether or not you can compete electronically. Obviously, if you can’t compete electronically then you ask for regulation.
But, this is the world of the future. This is “Ender’s Game” only it is beyond the simulation exercises, it is the real thing. It is also a part of that netherworld that includes high frequency trading and dark pools.
My point is that advancements in computer technology are not going to slow down. If anything, these advancements will speed up. And, with the possibility that Quantum Computers will become a reality within the next decade or so the ‘speed up’ will tend to be exponential and not linear. Furthermore, the generations that will follow us expect this ‘speed up’ to happen and will look on these capabilities as just another part of their ‘normal’ lives.
If we do not comprehend this future, if our elected officials and regulators do not comprehend this future, then we will not be prepared for the economic and financial systems that are on the horizon. Hence, we will all make mistakes.
The “Quants” made mistakes this last time around. But, they are alive and well, and, I believe that it is a very safe bet to say that they have learned from their mistakes and have already modified their systems to take advantage of the most recent information available to them. Many “Quants” are trained in Information Theory, the study of the messages that are contained in strings of data, even though these strings may seem to be random in nature. Their systems are now more robust than they ever were in the past.
This is how humans become better decision makers. They adapt their models and systems so that they can make better predictions of the future in order to make better decisions or solve more difficult problems. This process is part of being a human and humans will not cease to put it into practice.
The discussion so far has been at the “top of the pyramid,” so to speak. But what about the “bottom of the pyramid”? How is technology playing out there?
This morning there appeared in the Financial Times a description of how banks in the South African Township of Tembisa are using mobile phones to develop their customer base. (See “Banks find potential in mobile phone growth,” http://www.ft.com/cms/s/0/0f6fad92-6f28-11df-9f43-00144feabdc0.html.) Banks have changed over the past decade because “as the spending power of low-income groups increases, more and more banks are competing for the business of the 15m adult South Africans who had previously been excluded from the financial system.” And they are using information technology to do it!
And, the players are not small. “In South Africa, Capitec and African Bank pioneered the drive…” and Vodafone, the British telecoms company, “launched one of the most celebrated mobile banking initiatives.” “Instead of opening an expensive branch network, many of these new operations work with agents such as shops or bars.” Mainstream banks are following suit.
This is not the only technological initiative taking place at the “local level” in the world. Electronic finance is here to stay and it is spreading further and further into previously under-served communities every day. Remember, finance is really nothing more than information and the exchange of information.
So the Obama administration, Congress, and the regulators in Washington (and politicians and regulators in the rest of the world) are attempting to prevent the last financial collapse from happening again.
Should I smile…or giggle…or break out in laughter?
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