November 9, 2013

"Since 2008, the financial industry has changed the way it does business. Can the S.E.C.’s Mary Jo White control it?"

A great article in The New Yorker by Nicholas Lemann. Excerpt:
Banks and hedge funds hire high-priced computer engineers to write algorithms that can predict minor, transitory movements in the markets—for example, by continuously comparing the prices of stocks and derivatives. Then they place orders on the electronic exchanges, hoping to make a small amount per share. They rarely hold a position for long. Because companies’ algorithms are written to behave similarly, the way to make money in high-frequency trading is to get the order to the exchange ahead of the competition’s, by microseconds, which are millionths of a second. An electronic signal is transmitted from Cage 06504 to Cage 06505 a few hundred microseconds faster than an electronic signal is sent from Manhattan. Recently, James Barksdale, the first C.E.O. of Netscape, started a company called Spread Networks, which built a fibre-optic cable from New York to Chicago, in order to offer its customers a three-millisecond advantage in the time it takes an order to travel from one city to the other.

21 comments:

eric said...

Because government control is the answer.

lemondog said...

It's called High Frequency Trading and it has been around for a while.

Oso Negro said...

When milliseconds count, the market is just seconds away for the average person.

rhhardin said...

It just means that you get fair prices everywhere. Arbitrage opportunities should disappear. You want them to. Then there's no point in shopping around.

The problem is instabilities driven by computer trading when something unanticipated comes up.

Systems find a way to go unstable every now and then.

rhhardin said...

If you read that the Dow dipped briefly to zero before recovering up ten points for the day, it's flawed computerized trading that made it happen.

EDH said...

In 2000, the S.E.C. permitted stocks to be traded in pennies or fractions of pennies, rather than the customary eighths or thirty-seconds of a dollar. That made it easier for traders to make money by placing very large orders for very small variances in the price of a stock.

To what extent are market problems the result of high frequency trades made over changes in price that are fractions of cent per share?

If significant, wouldn't a transaction fee/tax of one or a few cents per share be the least invasive form of curtailing those excesses?

rhhardin said...

One thing, for example, that automated arbitrage does is give the system of markets the same strength as the financially weakest exchange.

If a trader goes bankrupt, the exchange covers his obligations to other traders.

The system of completed trades is then only guaranteed by the weakest exchange.

Generally there's a backroom meeting to get it covered, but that's going to depend on how deep a hole the system got itself into.

Henry said...

I think there was one engineer that demonstrated a program that could read market orders and process its own order before the orders shifted the price.

Remember the Rock/Paper/Scissors robot?

That's what we're dealing with.

It has nothing to do with market efficiency or fair pricing. The markets need an interval timer. All orders processed once-a-second. Or better, once-a-day.

rhhardin said...

The traders are competing with each other, not with regular people.

They do regular people a service by keeping prices uniform.

Except when something goes wrong, but the traders want to avoid that as much as anybody.

rhhardin said...

Incidentally insider trading does regular people a service as well.

If a stock should fall, it will fall sooner than otherwise.

If a stock should rise, it will rise sooner than otherwise.

The price is fairer than otherwise for everybody.

The disparagement of it is one of those mysterious things that make no sense.

Like fining a company for cheating its stockholders. The stockholders pay twice. Idiocy.

The government makes things worse, mostly.

Michael K said...

This has all happened before. The next time will be farce.

Levi Starks said...

So my question is this..
Are they making money that wouldn't otherwise exist, which is to say out of thin air,
Or are they just figuring out how to get a larger piece of a fixed sized pie? which is to say taking it from someone else?

Levi Starks said...

It would seem that money is being made, but no product is being produced. I doesn't seem like a sustainable business plan to me.

Jay Vogt said...

Ah quants - the rock stars of finance. They do great until they don't. Nassim Taleb's famous fat tail lives here. In other words, really bad things happen more often than you'd expect. And, when they do, they're even worse than you've prepared for.

So it is with quant strats. Witness LCCM.

No doubt they'll make some money. I wish them well. Remember though guys, in then end everything gets arbed out. Everything.

bbkingfish said...

It was Ambrose Bierce in the 19th century who observed: "The gambling of business looks with severe disfavor on the business known as gambling."

Ernst Stavro Blofeld said...

To what extent are market problems the result of high frequency trades made over changes in price that are fractions of cent per share?

The smallest permissible price change is a penny per share. It used to be eighths of a dollar. The eighths rule allowed for a higher bid-ask spread, which generally benefitted brokers to the detriment of individual investors.

The HFT generally makes the market closer to the perfectly competitive ideal. Maybe individual investors get nicked for a penny or two per share when buying and selling but it's better than the alternative.

Ernst Stavro Blofeld said...

To what extent are market problems the result of high frequency trades made over changes in price that are fractions of cent per share?

The smallest permissible price change is a penny per share. It used to be eighths of a dollar. The eighths rule allowed for a higher bid-ask spread, which generally benefitted brokers to the detriment of individual investors.

The HFT generally makes the market closer to the perfectly competitive ideal. Maybe individual investors get nicked for a penny or two per share when buying and selling but it's better than the alternative.

Carl said...

A magnificent piece of misdirection. As if the big problems of the financial system these days stem from HFT and those nasty amoral arbitrageurs and bundlers of dodgy mortgages, and you need to place your faith in the plucky band of eagle-eyed government knights-errant in the DAs office and SEC.

The ignored elephant in the room is, of course, Federal Reserve policy, not to mention the games government plays with its FHA, Fannie and Freddie, and the new CFPB, which I'm sure Elizabeth Warren will imbue with similar Ms. Smith Goes To Washington feel-good narrative for the rubes.

The malignant influence of government and government-driven institutions following policies driven by political needs, such as the Fed, utterly dwarfs what the HFT coders can possibly imagine. Sure, if Goldman-Sachs could print up $85 billion a month on their color laser printers, they would, and who cares about the carnage that would wreak on everyone else? But...they don't have to! Their moles in the Obama Administration are doing it for them and letting them make $billions yearly at the expense of future taxpayers, mom 'n' pop bondholders, and savers everywhere -- while trotting out Jay Carney to haughtily insist the foxes are fiercely devoted to guarding the hen coop, you betcha.

As Cicero says, cui bono? There's a solid reason the Wall Street "villains" of this piece were candidate Obama's #1 fan, and why they are quite happy to have his mouthpieces paint them as "villians" requiring still more government manipulation of the financial system. They're weeping all the way to their numbered Swiss bank accounts.

Rusty said...

rhhardin said...
Incidentally insider trading does regular people a service as well.

If a stock should fall, it will fall sooner than otherwise.

If a stock should rise, it will rise sooner than otherwise.

The price is fairer than otherwise for everybody.

The disparagement of it is one of those mysterious things that make no sense.

Like fining a company for cheating its stockholders. The stockholders pay twice. Idiocy.

The government makes things worse, mostly.


One thing I noticed about this kind of trading.
It was/is wide open. No one has stepped in to regulate it except the players themselves. I think that was the attraction in the first place.

Government hs never made anything more efficient.

David Davenport said...

The malignant influence of government and government-driven institutions following policies driven by political needs, such as the Fed, utterly dwarfs what the HFT coders can possibly imagine. Sure, if Goldman-Sachs could print up $85 billion a month ...

USA gooberment bugging of Angela Merkel's cell phone is relevant here. If Germany ever decides to change its policy regarding quantitative easing for the EU, firms such as Golden Sacks would very much like to know ... before other peepul do.

NSA snoops on Angela Merkel's conversations --> maybe big Dem donors get some useful info.

Peter said...

It's said that if you don't know who the sucker at the poker table is, it's probably you.

So, who's the sucker at this poker table?

If there were no sucker, then one fast-trader's gain could only be another fast-trader's loss. But if this were, overall, just a zero-sum game then there would really be nothing overall to support all these aggressive, fast traders. . Yet overall they prosper.

So, who's the sucker? Well, guess what- it's you, the sucker who's paying those princely fees to all those aggressively managed funds (who do this fast trading).

Yet because this year's winner at aggressive, fast trading is likely to be next year's loser, practically everyone would be better off owning a basket of low-cost index funds.